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HomeMy WebLinkAboutStaff Report 2505-47223.Design Principles for Gas and Electric Rates ACTION: 6:50 PM – 7:50 PM Presentation  Item No. 3. Page 1 of 3 Utilities Advisory Commission Staff Report From: Alan Kurotori, Director of Utilities Lead Department: Utilities Meeting Date: July 9, 2025 Report #: 2505-4722 TITLE Design Principles for Gas and Electric Rates RECOMMENDATION Staff recommends that the Utilities Advisory Commission (UAC) recommend that the Council accept the Design Principles for Gas and Electric Rates in Alignment with Proposition 26. EXECUTIVE SUMMARY Article XIII C of California Constitution (often referred to as Proposition 26) requires voter approval for municipal electric and gas rates that exceed the cost to the utility of providing service. The City Council can adopt cost-based utility rates without voter approval. Public agencies rely on ratemaking consultants to determine the costs of providing service and to design rates that accurately recover those costs; this is referred to as a “cost of service analysis”, or COSA. This report proposes design principles to guide staff and the City’s ratemaking consultants on future gas and electric COSAs in alignment with California’s Constitutional requirements. BACKGROUND COSAs took on greater significance for California publicly-owned utilities following the passage of Proposition 26 in 2010. Proposition 26 added provisions to the California Constitution defining every local government fee or charge as a tax requiring voter approval, unless one of seven exceptions applies.1 A rate set at a level “which does not exceed the reasonable costs to the local government of providing the service”2 is an exception to the voter approval requirement, and can be approved by Council. The City bears the burden to prove that a rate is not a tax, the amount is no more than necessary to cover the reasonable costs of providing service, and the manner in which those costs are allocated to ratepayers bears a fair or reasonable relationship to the ratepayer’s burdens on, or benefits received from, the governmental activity.3 1 CA. Const. Article XIII C(1)(e). 2 CA. Const. Article XIII C(1)(e)(2). 3 CA. Const. Article XIII C(1)(e). Item No. 3. Page 2 of 3 COSAs completed with the assistance of ratemaking consultants are designed to ensure that the City meets its burden to set rates accurately. While the City’s gas rates present the next opportunity for COSA review based on Council’s June 16, 2025 direction, 4 the proposed rate design principles apply to both the City’s gas and electric rates.5 ANALYSIS Proposition 26 requires public agencies to determine all of the costs incurred to provide electric and gas service to customers, in order to collect those costs via rates. Such costs can include direct and incidental expenses like the costs of capital projects, operations, commodity and distribution, administrative expenses, regulatory compliance and reasonable reserves. Each utility is operated as a separate enterprise; ratepayer funds are not comingled among enterprises. Within the electric and gas utilities, policy goals such as conservation can be implemented via rates, if doing so does not require one group of ratepayers to subsidize another. Staff propose that the UAC recommend Council accept the following design principles for gas and electric rates in alignment with Proposition 26, to guide the development of future gas and electric COSAs. Design Principle 1: Evaluate rates to ensure they are cost-based The goal of a COSA is to identify the costs associated with serving each customer class and the rates required to recover those costs. Specifically, a COSA determines the utility’s revenue requirement, matches costs to their causes or drivers, classifies and allocates those costs, and designs rates that accurately collect those costs from each customer class. Accurate and equitable allocation of costs is the COSA’s primary goal; all other rate design considerations are subsidiary. Design Principle 2: Evaluate rate schedules for continuation or redefinition Customer usage patterns and system impacts change over time. COSAs should evaluate existing rate schedules to determine whether they should be continued or redefined. For the upcoming Gas COSA, this review should evaluate whether Utility Rate Schedule G-2, serving small commercial and master-metered residential customers,6 should be subdivided or otherwise redefined to allocate costs within this customer class. This evaluation should study 4 On June 16, 2025, City Council voted (5-1-1 Lythcott-Haims no, Stone absent) to approve the FY 2026 Gas Utility Financial Forecast and Reserves Management Practices, wherein all gas distribution rates were increased by a uniform 8.7% effective July 1, 2025. The Council also directed staff to return to the UAC for review of the Gas Cost of Service Study and a potential climate credit. 5 A different constitutional provision, commonly referred to as Proposition 218, applies to the City’s water, wastewater and refuse rates, which are deemed “property-related fees”. While property-related fees must also be cost-based to avoid the voter approval requirement, the substantive and procedural rules for these fees differ from those applicable to electric and gas rates and are outside the scope of these rate design principles. 6 Commercial customers who use less than 250,000 therms per year at one site and master-metered residential customers in multi-family residential facilities. Item No. 3. Page 3 of 3 impacts on customers who use different amounts of energy or have different meter configurations or meter capacities. Design Principle 3: Determine the proper allocation of fixed and variable costs and how those can be implemented in various rate designs The gas and electric utilities incur costs for billing, metering, and system maintenance for each customer connected to its distribution system, regardless of that customer’s consumption level. COSAs should consider how best to allocate and collect those costs among customer classes, using the City’s specific revenue requirements and industrywide best-practices. COSAs should also examine all appropriate rate designs, including volumetric, tiered, flat, and demand-based charges, to determine which rate design best recovers costs for each customer class. Design Principle 4: Review non-rate revenue sources that may be available for rate discounts or rebates Proposition 26 does not permit a local agency to fund certain rate discounts or rebates, including low-income discounts, with revenue from fees charged to other customers. The City is nonetheless invested in assessing rate impacts on all customers. Staff should work with the City’s ratemaking consultant to identify other available revenue sources. These may include revenues available for low income programs as directed by statute, or revenues derived from the City’s participation in state-mandated Cap and Trade and Low Carbon Fuel Standard programs. FISCAL/RESOURCE IMPACT The work associated with this project will be absorbed using existing staff and contract budgets. STAKEHOLDER ENGAGEMENT After receiving the UAC’s recommendation, staff will present the Design Principles for Gas and Electric Rates to the Finance Committee, followed by review and consideration by the City Council. If accepted by Council, staff will apply these Design Principles to the COSA which will be used to develop gas rates, effective January 1, 2026. Additionally, if accepted by Council, staff will apply these Design Principles to the next electric COSA. The most recent electric COSA was completed in 2024 and staff plans to update the electric COSA every three to five years. In the next one to two years staff plans to supplement the electric COSA with a review of the commercial time of use rates. ENVIRONMENTAL REVIEW Acceptance of the Design Principles for Gas and Electric Rates does not meet the definition of a project, under Public Resources Code Section 21065 and CEQA Guidelines Section 15378(b)(5), because it is an administrative governmental activity which will not cause a direct or indirect physical change in the environment, thus no environmental review is required. AUTHOR/TITLE: Alan Kurotori, Director of Utilities Staff: Lisa Bilir, Senior Resource Planner July 9, 2025 www.cityofpaloalto.org Design Principles for Gas and Electric Rates Utility Advisory Commission 2 Proposed Design Principles for Gas and Electric Rates (1/2) Design Principle 1: Evaluate rates to ensure they are cost-based §Goal of any COSA: Accurate and equitable allocation of costs §All other rate design considerations are subsidiary Design Principle 2: Evaluate rate schedules for continuation or redefinition For 2026 Gas COSA: §Evaluate whether Utility Rate Schedule G-2 (small commercial and master-metered residential  customers) should be subdivided or otherwise redefined to allocate costs within customer class §Study impacts on customers who use different amounts of energy or have different meter configurations  or meter capacities (cont.) 3 Proposed Design Principles for Gas and Electric Rates (2/2) Design Principle 3: Determine the proper allocation of fixed and variable costs and how those can be implemented in various rate designs §Gas and electric utilities incur costs for billing, metering, and system maintenance for each customer  connected to its distribution system, regardless of that customer’s consumption level. §Consider cost allocation and collection among customer classes, using City’s specific revenue  requirements and industrywide best-practices   §Examine appropriate rate designs, including volumetric, tiered, flat, and demand-based charges, to  determine which rate design best recovers costs for each customer class     Design Principle 4: Review non-rate revenue sources that may be available for rate discounts or rebates §Proposition 26 prohibits local agencies from funding certain rate discounts or rebates, including low- income discounts, with revenue from fees charged to other customers.  §City is invested in assessing rate impacts on all customers. §Staff to work with City’s ratemaking consultant to identify other available revenue sources.   4 Timeline Proposed Design Principles for Gas and Electric Rates Public Meeting Schedule Finance Committee – August 5, 2025 Council – August 18, 2025 Proposed Gas COSA Study and Rate Changes Public Meeting Schedule Utilities Advisory Commission – September 2025 Finance Committee – October 2025 Council – November 2025 Rates Effective – January 1, 2026 5 Recommendation Staff recommends the UAC recommend that the Council accept the Design Principles for Gas and Electric Rates in alignment with Proposition 26 Design Principle 1: Evaluate rates to ensure they are cost-based Design Principle 2: Evaluate rate schedules for continuation or redefinition Design Principle 3: Determine the proper allocation of fixed and variable costs and how those can be  implemented in various rate designs Design Principle 4: Review non-rate revenue sources that may be available for rate discounts or rebates