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HomeMy WebLinkAboutStaff Report 5063 City of Palo Alto (ID # 5063) Finance Committee Staff Report Report Type: Action Items Meeting Date: 9/16/2014 City of Palo Alto Page 1 Summary Title: Drought Rate Design Guidelines Title: Utilities Advisory Recommendation that the Finance Committee Recommend that the City Council Approve Design Guidelines for the 2014 Water Utility Drought Rate Cost of Service Study From: City Manager Lead Department: Utilities Recommendation Staff requests that the Finance Committee recommend that Council approve the proposed Design Guidelines for the 2014 Water Utility Drought Rate Cost of Service Study (Attachment A). The Utilities Advisory Commission (UAC) recommends rewording Attachment A Guideline number Five from “Rates for residential customers should provide an allowance for efficient landscaping through the use of three tiers, if feasible, and should otherwise be based on two tiers” to “Rates for residential customers should provide for efficient use of water for landscaping.” Executive Summary Staff seeks feedback from the Finance Committee and Council prior to commencing a cost of service analysis (COSA) for water rates to use during an extended drought. These rates will be designed to encourage conservation and preserve the utility’s financial stability should the drought continue for an extended period. The attached design guidelines set forth the parameters for the study. The guidelines include citywide demand targets for various levels of mandatory water use restrictions by the City’s water supplier, the San Francisco Public Utilities Commission (SFPUC), and projections of the use of water for indoor and outdoor consumption during a drought. Lastly, the guidelines include recommended drought rate designs for both residential and non-residential customer classes. Any drought rates that result from the COSA would be adopted as a separate rate schedule that could be activated by Council as part of a formal water shortage declaration. The development of drought rates, although not needed at this time, is prudent to ensure that the City has COSA - City of Palo Alto Page 2 based drought rates ready if they are needed to meet water usage targets and maintain the financial health of the water utility in a water shortage. Background California is currently experiencing drought conditions. On January 31, 2014, the City’s water supplier, the SFPUC, called for a 10% voluntary reduction in water use for its retail and wholesale customers. On June 23, 2014, the SFPUC renewed its 10% voluntary reduction request and is expected to continue the request through at least the end of 2014. If the drought continues through the upcoming winter, the SFPUC will likely make these re strictions mandatory, and possibly increase them. The current water rate schedules for the City of Palo Alto Utilities (CPAU) Water Utility are based on the 2012 COSA by Raftelis Financial Consultants. This COSA included rates based on normal year water sales. Higher rates will be necessary to fully fund water utility operations if mandatory water use reductions or voluntary drought-motivated conservation efforts result in decreased water sales. As part of the Finance Committee’s review of the Fiscal Year 2015-2024 General Fund Long Range Financial Forecast, the Finance Committee requested more information on the potential impact on the water utility rate schedule in case of an extended drought. Discussion CPAU customers have responded strongly to recent calls for conservation due to the drought. Water demand for February through June 2014 decreased nearly 17% compared to the same period in 2013. If additional conservation becomes necessary, drought rates will help by sending price signals to conserve. Drought rates are also essential to preserving the financial health of the water utility during an extended drought, since revenue from water sales decreases. Staff has engaged Raftelis Financial Consultants to update the 2012 COSA to include drought rates. Drought Rates and Revenue Recovery The drought has not yet significantly impacted the water utility’s financial position. The utility’s revenues for February through June 2014 were lower than projected in the fiscal year (FY) 2014 budget, but this was offset by higher than budgeted revenue in the preceding months, before customers began taking concerted conservation measures. The drought is anticipated to impact the water utility’s finances for FY 2015, however, and will impact future fiscal years if it continues beyond this winter. The Council-approved Water Utility Financial Plan for FY 2015-FY 20211 anticipates a 10% reduction in revenue due to the drought for FY 2015. It assumes that the drought ends in this upcoming winter and that the rev enue loss for FY 2015 can be offset by drawing down reserves. If the drought continues beyond the upcoming winter, however, the utility will experience additional revenue loss in FY 2015 and FY 2016 if the SFPUC’s call for water use reduction is increased from 10% or made mandatory. 1 The Financial Plans were approved by Council on June 9, 2014 (Staff Report 4799). City of Palo Alto Page 3 Figure 1 shows the revenue losses for FY 2015 through FY 2021 if CPAU experienced three more years of drought (calendar years 2015, 2016, and 2017), assuming CPAU did not implement drought rates.2 As shown in the figure, sales are assumed to remain lower after the drought ends because some customers are expected to maintain the conservation measures they adopt. Figure 1: Revenue Loss during a Three Year Drought2 Table 1 shows the impact of a three-year drought on reserves compared to the base case in the Water Utility Financial Plan. The net losses shown in this scenario would rapidly deplete the water utility’s reserves. The adoption of drought rates would prevent this by raising rates to raise additional revenue to offset those losses. 2 The Base Case scenario assumes the rate increases projected in the FY 2015-FY 2021 Water Utility Financial Plan, but no additional increases due to the drought or the imposition of drought surcharges. City of Palo Alto Page 4 Table 1: Impact of a Three Year Drought on Financial Reserves2 FY 2015 FY 2016 FY 2017 FY 2018 FY 2019 FY 2020 FY 2021 Water Demand (1000 CCF) Base Case 5,384 5,384 5,384 5,384 5,384 5,384 5,384 Drought Scenario 4,887 4,791 4,590 4,734 5,117 5,117 5,117 Difference (497) (593) (794) (650) (267) (267) (267) Net Income ($000) Base Case (835) (1,885) (783) (1,405) (1,933) (2,063) (518) Drought Scenario (1,933) (4,262) (4,268) (4,481) (3,371) (3,575) (2,181) Impact of Drought on Reserves (1,098) (2,377) (3,486) (3,076) (1,438) (1,513) (1,663) Projected Year-end Balance, Operations + Rate Stabilization Reserves Combined ($000) Base Case 13,432 12,547 12,764 13,360 13,426 11,364 10,846 Drought Scenario 12,334 9,072 5,804 3,323 1,951 (1,624) (3,805) Reserve Minimum 6,152 6,272 6,562 7,139 7,470 7,425 7,615 The City may also be able to offset the lower sales revenue with temporary cost reductions. Staff will design the proposed drought rate schedules to enable the adoption of rates up to the level required to cover any revenue shortfalls so that the Cit y would be able to adopt lower rates if temporary cost reductions are put in place. Rate Design: Consumption Targets and Revenue to be Recovered Staff will design rates to fully offset the revenue decreases described above. The rate design methodology will be very similar to that used in the 2012 COSA, but will take into account the changed consumption patterns during a drought and may involve additional tiers, as described below. The first step in the COSA is to identify the target levels of water d emand for various levels of drought severity to be used in the COSA. Table 2 shows the demand targets CPAU would be required to achieve under various SFPUC water shortage scenarios. These targets were calculated using the water shortage allocation methodology agreed to by the agencies served by the SFPUC (members of the Bay Area Water Supply and Conservation Agency, or BAWSCA) and written into the Water Supply Agreement. Table 2 also shows the revenue loss associated with each demand target, which is calculated based on the difference between normal year and drought year demand. City of Palo Alto Page 5 Table 2: Estimated Decrease in Sales Revenue under Mandatory Reduction Scenarios SFPUC System-wide Reduction in Available Supply CPAU Purchases (1000 CCF) CPAU Sales (1000 CCF) Estimated Net Income Decrease Assuming No Drought Rates None 5,384 4,946 - 10/15%3 4,976 4,571 $1.5 million 20% 4,586 4,213 $3.1 million 25%4 4,261 3,914 $4.4 million Note that staff may recommend Council activate the drought rates under 10% or 15% water use reduction requests. This is because drought rates are valuable for preserving the Water Utility’s financial position in addition to being a tool for reducing consumption. For example, without drought rates, Palo Alto water consumers have reduced water use by about 17% compared to 2013 since the SFPUC called for 10% voluntary water use reductions. However, if the water use restrictions persisted for an extended multi-year period, even under 10% or 15% reduction scenarios, normal water rates would have to be raised to account for reduced water sales. One advantage of having drought rates is having the ability to communicate that the rate inc reases are temporary (e.g. “drought rates are in effect, that’s why your bill went up”). Allocation of Reductions between Indoor and Outdoor Use The second step of the COSA will be to determine the demand levels of various customer groups during a drought for the purpose of allocating costs. This will be done by projecting the reductions in consumption expected under each scenario, and how much of the reduction will come from indoor vs. outdoor use to meet the water use reduction targets. Table 3 shows the projections for indoor and outdoor use reductions staff plans to use. Staff assumes that most of the reductions will occur in outdoor (landscaping) use, since indoor use for both businesses and residents is fairly inelastic. The allocations assume a 5-12% reduction in indoor water use compared to a normal year, with the remainder of the reductions coming from outdoor use. 3 Reduction targets for the 10% and 15% reduction targets are identical because of CPAU’s supply guarantee under the water supply contract with the SFPUC. The supply guarantee is high relative to CPAU normal year demand. 4 The 25% target is an estimate by CPAU staff, since the supply contract does not include an allocation methodology for system-wide reductions greater than 20%. The SFPUC operates the Hetch Hetchy system with the intention of making the water supply last through an 8.5- year “design drought” without requiring more than 20% mandatory water use reductions. If tighter restrictions were required, BAWSCA agencies would confer amongst each other and with the SFPUC to determine the allocation methodology. If the allocation methodology produces a substantially different result than what is shown in Table 2, the drought rates for the 25% reduction target would need to be modified. City of Palo Alto Page 6 Table 3: Indoor and Outdoor Allocations of Water SFPUC System- wide Reduction in Available Supply CPAU Sales (1000 CCF) Indoor Use Outdoor Use (1000 CCF) % reduction over normal year (1000 CCF) % reduction over normal year None 4,946 3,134 0% 1,812 0% 10/15%3 4,571 2,977 5% 1,589 12% 20% 4,213 2,852 9% 1,359 25% 25%4 3,914 2,758 12% 1,160 36% For example, as shown in Table 3, to meet a 20% system-wide water supply reduction target, Palo Alto’s indoor water use would need to be reduced by 9% and outdoor water use would need to be reduced by 25%. There are other formulae that could be used to achieve a 20% system-wide reduction, but staff chose the indoor/outdoor reductions repre sented in Table 3 because they are viewed as fair and achievable. Table 4 shows how the reduction targets would affect individual customer groups. All customer groups would face similar reductions compared to normal year consumption. In practice, most customers will compare their consumption during the drought to their calendar year (CY) 2013 consumption since CY 2013 was the last year before the SFPUC began requesting voluntary reductions in consumption. Details on current and historic consumption as well as projected water use reductions by customer group are provided in Attachment B. Table 4: Projected Reductions by Customer Group SFPUC System-wide Reduction in Available Supply W-1 (Single Family and Individually Metered Multi-Family) W-4 + W-7 (Non-Residential and Master-Metered Multi-Family) Volume (1000 CCF) reduction vs. normal year reduction vs. CY 2013 Volume (1000 CCF) reduction vs. normal year reduction vs. CY 2013 None (CY 2013*) 2,648 - - 2,601 - - None (Normal Year) 2,441 - - 2,505 - - 10/15%3 2,252 8% 15% 2,314 8% 11% 20% 2,075 15% 22% 2,135 15% 18% 25%4 1,929 21% 27% 1,988 21% 24% * 2013 was a dry year and, accordingly, more water was used than expected in a normal year. Rate Design The final step in the COSA will be to create individual rates. Staff proposes creating drought rates that differentiate between indoor and outdoor consumption for both residential and commercial consumption. This is accomplished using tiered rates such that the first tier would represent indoor use and the second tier would represent outdoor use. Sinc e larger reductions will be required for outdoor use than indoor use, the COSA will likely result in larger rate increases for outdoor use (higher tier use) than for indoor use (lower tier use). Staff’s intention City of Palo Alto Page 7 is to design the rates so that customers who achieve the indoor and outdoor reductions requested by CPAU would pay roughly the same as they would if there were no drought. However, customers who fail to conserve will pay more. 1. W-1 (Individually Metered Residential) Rate Design Existing rates for residential customers already attempt to distinguish between indoor and outdoor use for residential customers by using two tiers. Staff recommends a similar two - or three-tier drought rate design for the W-1 customer class. The first tier would represen t indoor consumption determined by the average winter usage for the class. The other tier(s) would represent outdoor use. A three-tier methodology would provide an allowance of water to allow customers to protect some of their investment in landscaping a nd trees and to recognize those customers who have already installed drought-tolerant landscaping. Under a three-tier methodology, the second tier would represent this efficient landscape use. Smaller reductions would be required in this tier. Heavy wat er users with usage in the third tier would be expected to make more substantial reductions in their third tier usage. The COSA will analyze the reasonableness of the proposed three tiered method. Alternative rate designs staff considered for the W-1 rate class, but is not recommending, are:  Individual allocations (budgets) based on pre-drought consumption. Staff does not recommend this alternative because it fails to recognize customers who reduced their water consumption and implemented water efficiency upgrades and behaviors before the drought was declared. This rate design is also more complex to implement.  Equal percentage rate increases to all tiers. This is the simplest method, but does not recognize the inelasticity of indoor use.  Individual allocations (budgets) based on factors like lot size or the number of people in the household. Staff does not recommend this alternative because it is very complex to implement, expensive to administer and not feasible given the short timeline for developing these drought rates. 2. Non-Residential Rate Design Existing rates for commercial customers do not have tiers due to the administrative complexity of implementing tiers for these customers. Non -residential customers are a less uniform group, and a uniform system of tiers like the one used for residential customers is not suitable during normal conditions. During a drought, however, it is more important to differentiate between indoor and outdoor consumption for these customers because some businesses hav e substantially less landscaping, and therefore significantly less ability to reduce. Without tiers, these businesses would pay more than businesses with landscaping. To avoid this scenario, staff recommends creating tiered rates with the first usage t ier set for each individual customer that represents indoor use. The first tier, or baseline, for each customer could be set to their pre-drought winter water consumption, a reasonable approximation of indoor use. Use up to the baseline level would be ch arged at a lower rate, City of Palo Alto Page 8 while any additional consumption would be charged at a higher rate. A methodology would have to be developed to set the baseline for new customers (who have no usage history). Staff considered, but does not recommend, these alternative methodologies:  Do not use baselines. With this methodology, the uniform rate for commercial customers would simply be increased to recover all required revenue. Staff does not recommend this alternative because it fails to recognize that some businesses have more landscaping than others, and are more easily able to conserve without affecting their core businesses.  Set the baseline usage for each customer based on their meter size. Staff does not recommend this approach because meter size does not correspond well to consumption for commercial customers.  Set baseline usage levels by business type. This approach is complex and difficult to administer. Individual businesses of the same type (such as a restaurants) can be different sizes, and more detailed methodologies for creating such baselines (such as by number of square feet, tables, or other metrics) rely on data that is not easily available to the utility. Separate Commodity Rate Component Staff also recommends making the cost of purchased wat er from the SFPUC a separate line on the rate schedule. This is recommended for all future water rates, not just drought rates. This will allow the utility to pass through increases in the water rate charged by the SFPUC and will make these types of increases more transparent to the customer. Lastly, it would allow changes to the rate on short notice, which may be important during a drought. Government Code Section 53756 allows for contractual water supply cost increases to be passed through to the customer without the formal mailing and protest process required under Proposition 218, though 30 days of notice is still required using a bill insert or similar method. Conservation Impacts of Drought Rates A recent economic study5 of the water agencies served by the SFPUC identified elasticities of demand for the customers in each agency’s territory. For the City of Palo Alto, the study found that a 10% increase in water rates would likely lead to a 1.5 -1.7% decrease in water consumption. Based on this study, staff estimates that the cost-of-service drought rates proposed by the COSA will likely cause a 1-3% reduction in water consumption. This means that CPAU cannot rely on drought rates alone to achieve its target water use reductions. CPAU has already had success by raising its water conservation rebates and launching an extensive marketing campaign. Water use restrictions on landscaping have also been adopted. Additional restrictions can be put into effect and new marketing campaigns launched if necessary to achieve greater reductions. Drought rates will complement these efforts. 5 Socioeconomic Impacts of Water Shortages within the Hetch Hetchy Regional Water System Service Area , David Sunding, Phd, The Brattle Group, March 13, 2014. City of Palo Alto Page 9 Proposed Design Guidelines for the 2014 Drought Rate COSA The proposed design guidelines for the drought rates (Attachment A) include the primary principle that any drought rate design resulting from the COSA must be based on the cost to serve customers. This principle overrides all other goals that may be desired, but that may not necessarily be cost based. The guidelines include the parameters discussed in this report regarding the target demand reductions that are needed to achieve potential water supply limitations from the SFPUC. The drought rate guidelines also include the recommendation to include the water supply cost component separately on the rate schedules t o enable a transparent pass-through of the actual cost of purchased water from the SFPUC. Commission Review and Recommendation On September 3, 2014, the UAC considered staff’s recommendation. Several Commissioners acknowledged staff’s effort to bring this item to them for discussion before proceeding with the rate study. They emphasized that it was important to create a design that was simple to communicate. There was substantial discussion about the tension between fixed charges, which provide revenue stability, and volumetric charges, which communicate a price signal. There were comments regarding the need to preserve landscape investment, and some discussion of the desirability of individual allocations for non-residential customers. The UAC supported most of the staff-recommended guidelines, but there was an extensive discussion of guidelines five and six, which describe the residential and commercial rate designs. Some Commissioners advocated for creating a system of rates with individual allocations of landscape water for each residential customer based on their property characteristics rather than imposing a uniform system of tiers for all residential customers. After discussion the UAC voted to recommend approval of the staff recommended design guidelines, but to amend guideline five to read “Rates for residential customers should provide for efficient use of water for landscaping,” language which allowed for various rate options to be considered. The motion also included an amendment to guidel ine six to remove the word “excess.” The recommendation was approved by a vote of 3-1 (with Commissioner Waldfogel voting no and Commissioners Chang, Cook, and Hall absent). The Chair of the UAC also appointed a two-member sub-committee, comprising Vice Chair Waldfogel and Commissioner Melton, to review the drought rate analysis as it progressed. The draft minutes from the UAC’s September 3, 2014 meeting are provided as Attachment C. Next Steps Staff intends to have drought rates ready for potenti al adoption by Council by February 2015. This will allow for their adoption if water shortage conditions continue through this winter or worsen. Resource Impact This update to the COSA will be completed with existing budgeted resources. The drough t rate schedules, once adopted, will not take effect unless the Council puts them in to effect as part of a water shortage. If they do, they are expected to recover the cost of operating the utility City of Palo Alto Page 10 when sales are lower during a drought. The proposed rates will trigger the notice and protest hearing procedures required by Proposition 218. Policy Implications The creation of drought rate schedules enables Council to implement them when it deems appropriate, which would typically occur as part of a Stage II or higher water shortage, as set forth in the 2010 Urban Water Management Plan. Environmental Review Adoption of drought rate design guidelines does not meet the definition of a project, pursuant to Section 21065 of the California Environmental Quality Act, thus no environmental review is required. Attachments:  Attachment A: Design Guidelines for Drought Rate COSA (DOCX)  Attachment B: Water Consumption Information by Customer Group (PDF)  Attachment C: Excerpted Draft UAC Minutes of 9-3-14 (PDF) Attachment A Design Guidelines for the 2014 Water Utility Drought Rate Cost of Service Study 1. Drought rates must be based on the cost to serve customers. This is the overriding principle for this study; all other rate design considerations must fall within this basic premise. 2. The drought rate design should be consistent with the water shortage response plan evaluation criteria in Appendix G of the City’s 2010 Urban Water Management Plan, summarized as follows: a. Reduce overall City consumption to reduction target required b. Provide sufficient water available for personal use c. Design should be acceptable to the community d. Unemployment and business loss should be minimized e. Landscaping investment losses should be minimized f. Plan should be cost-effective, enforceable, and achievable in the given timeline g. Plan should allow for flexibility h. Plan should take into account for new water services i. Plan should recover penalties applied by suppliers These criteria are discussed in more detail in the 2010 Urban Water Management Plan. 3. Rates will be designed for the following demand targets: San Francisco Public Utilities Commission System-wide Demand Reduction Target Palo Alto Demand (CCF) Projected Sales (CCF) 10/15% 4.976 million 4.571 million 20% 4.586 million 4.213 million 25% 4.261 million 3.914 million 4. Rates will be designed assuming the following allocation of water between indoor and outdoor (irrigation) use. SFPUC System- wide Reduction in Available Supply CPAU Sales (CCF) Indoor Use Outdoor Use (CCF) % reduction over normal year (CCF) % reduction over normal year None 4.946 million 3.134 million - 1.812 million - 10/15% 4.571 million 2.977 million 5% 1.589 million 12% 20% 4.213 million 2.852 million 9% 1.359 million 25% 25% 3.914 million 2.758 million 12% 1.160 million 36% 5. Rates for residential customers should provide an allowance for efficient landscaping through the use of three tiers, if feasible, and should otherwise be based on two tiers. Attachment A 6. Rates for commercial customers should provide an individual baseline allocation representing indoor use (based on winter use in a pre-drought year) and a second tier for outdoor use. 7. Water purchase costs should be passed through directly on the bill as a separate rate component. 8. Evaluate variance processes for customers needing additional water for medical necessity, health and safety, and other critical needs. Attachment B Detailed Consumption Data by City of Palo Alto Utilities Customer Group Note: Indoor usage estimated based on Jan-Mar billed consumption Attachment B Detailed Consumption Data by City of Palo Alto Utilities Customer Group Note: Indoor usage estimated based on Jan-Mar billed consumption Attachment B Detailed Consumption Data by City of Palo Alto Utilities Customer Group Note: Indoor usage estimated based on Jan-Mar billed consumption Attachment B Detailed Consumption Data by City of Palo Alto Utilities Customer Group Note: Indoor usage estimated based on Jan-Mar billed consumption Attachment B Detailed Consumption Data by City of Palo Alto Utilities Customer Group Attachment B Detailed Consumption Data by City of Palo Alto Utilities Customer Group W-1 Consumption Under Mandatory SFPUC System-Wide Reductions W-4 + W-7 Consumption Under Mandatory SFPUC System-Wide Reductions None None (CY 2013)(Normal Year)  Volume (CCF)1.611 million 1.530 million 1.453 million 1.392 million 1.346 million % reduction vs normal year  ---5%-9%-12% % reduction vs CY 2013  ---10%-14%-16% Volume (CCF)1.037 million 0.911 million 0.799 million 0.683 million 0.583 million % reduction vs normal year  - --12%-25%-36% % reduction vs CY 2013  - --23%-34%-44%  Volume (CCF)2.648 million 2.441 million 2.252 million 2.075 million 1.929 million % reduction vs normal year ---8%-15%-21% % reduction vs CY 2013 ---15%-22%-27% Total Use Outdoor Use SFPUC System-wide Reduction in Available Supply 10/15%20%25% Indoor Use None None (CY 2013)(Normal Year)  Volume (CCF)1.570 million 1.604 million 1.524 million 1.460 million 1.412 million % reduction vs normal year  ---5%-9%-12% % reduction vs CY 2013  ---3%-7%-10% Volume (CCF)1.030 million 0.901 million 0.790 million 0.676 million 0.577 million % reduction vs normal year  - --12%-25%-36% % reduction vs CY 2013  - --23%-34%-44%  Volume (CCF)2.601 million 2.505 million 2.314 million 2.135 million 1.988 million % reduction vs normal year ---8%-15%-21% % reduction vs CY 2013 ---11%-18%-24% Total Use Outdoor Use SFPUC System-wide Reduction in Available Supply 10/15%20%25% Indoor Use EXCERPTED DRAFT MINUTES OF THE SEPTEMBER 3, 2014 UTILITIES ADVISORY COMMISSION MEETING ITEM 5 (PREVIOUSLY ITEM 3): ACTION: Staff Recommendation that the Utilities Advisory Commission Recommend that the City Council Approve Design Guidelines for the 2014 Water Utility Drought Rate Cost of Service Study Senior Resource Planner Abendschein said staff was seeking feedback on a set of guidelines for a cost of service study for drought rates, with the goal of aligning the rate designs with policy guidance to the extent possible while respecting cost of service limitations. Drought rates are used to replace lost revenue associated with reduced water consumption and to send a price signal for customers to reduce consumption. Drought rates are one tool to manage the utility’s financial position during a drought. Other tools include temporary cost reductions and use of reserves. Abendschein summarized the design considerations included in the guidelines, including ensuring that the rates are cost based, reflect the required consumption reductions, minimize business and landscaping investment losses, provide adequate water for personal use, and are flexible and easy to implement. He then gave an overview of the key rate design components of the proposed guidelines, including the separation of the commodity portion of the rate from the non-commodity portions, tiered non-commodity rates for commercial customers, and a third tier for residential customers. PUBLIC COMMENT: Susan Rosenburg, a Board Member of Canopy, spoke regarding the staff proposal. She said Canopy was concerned that the proposal’s sole focus on conservation and financ ial stability did not take into consideration the impact of the proposal on trees. Canopy considered trees to be the most valuable part of the urban landscape that were not heavy water users and provided most of the benefits of the urban landscape. Ms. Rosenburg questioned the distinction between indoor and outdoor uses of water to determine what was “wasteful” and argued trees were not wasteful uses of water. She asked that staff explain the mechanism by which a third tier would enable customers to maintain their investment in efficient landscape investment. She said that in the past Canopy had advocated for an allocation-based methodology of determining water rates similar to the methodology used by the Irvine Ranch Water District. She wanted to know how long it would take to implement such a program and how much it would cost. She asked that the City undertake a citywide marketing campaign focused on preserving trees, and that the City’s Arborist be included in discussions regarding the drought. ATTACHMENT C Resident Herb Borock commented on the staff proposal. He said with drought rates the utility had to balance conservation and cost of service. He agreed that a three tier pricing methodology was an appropriate strategy to look at and he recommended using the three tier proposal previously discussed by Council which had been rejected when a resident with a large lot complained about it. Mr. Borock talked about the portion of the proposal involving passing through the supply cost, saying the lower tiers would be more heavily affected by such a strategy and that one way to manage that would be to use a fixed charge to recover distribution costs. He suggested that the discussion regarding the urban forest should take place in the context of a discussion of basement dewatering. He said the rate schedule should not vary based on the number of people or size of the landscape as these were personal choices and not reason for higher water allocations. The Commissioners generally appreciated the opportunity for UA C input prior to a cost-of- service study (COSA). Commissioner Eglash appreciated that one of the design considerations listed in the guidelines was to minimize landscape investment losses and he recognized the value of trees in Palo Alto. He supported a structure that was easy to communicate as rate increases are difficult enough to communicate during a drought . Commissioner Eglash also stressed that drought rates should not produce a revenue windfall and ratepayers should not pay more in absolute dollars than they would have if there had not been a drought. He noted the SFPUC may also need to raise its rates due to the decreased consumption and the new rate design should take into account any need to pass through those increases as the drought proceeds. Commissioner Melton said one of the big challenges in designing these rates will be that revenue stability is achieved through fixed charges but price signals are achieved through variable charges. Balancing those two effects was a challenge the UAC always faced with water rates. He was encouraged that the high level objective was keeping the fund solvent in the face of drought use reductions. Rates, reserves and other tools would have to be used to make sure the fund was kept on a sound basis. He said any conclusions from this COSA would likely carry over to future normal year rates. The City should think far enough ahead to understand the impacts of any pricing scheme on non-drought years. Commissioner Cook agreed that messaging was important because it was difficult for people to understand why their bills do not decrease when they conserve. He asked how rates were designed to differentiate between indoor and outdoor usage given that there was only one meter and Director Fong explained it came down to a comparison of winter vs summer usage. Commissioner Cook said it was important to incorporate comments from Canopy and other stakeholders. He agreed it was a good idea to use a separate commodity rate component because it would make it clear how much of the rate increase came from the SFPUC. Vice Chair Waldfogel said he was forced to disagree with some comments from colleagues. He mentioned that the president of one of Palo Alto’s garden clubs had intended to be here, but was unable. He was concerned that two years ago staff completed a COSA and that costs had not changed in that time, but instead revenues had fallen. He said that if a 10 or 15% change in demand undermines a COSA it brings into question the quality of the rate study. He said under pricing structure previously adopted there had been unwillingness to set fixed charges equal to fixed costs. He was not recommending doing that, but the consequence was that a reduction in demand sends revenues below cost. Vice Chair Waldfogel’s opinion is that the original COSA was still valid and that we should be having a pricing discussion within the existing COSA, not a new COSA. He also felt that the community would be concerned that we were willing to do individual allocations for business customers but not for residential customers to accommodate landscaping issues. He said given the huge variations in lot sizes setting arbitrary limits and saying anything above that level was wasteful was not an accurate way to portray water use. The consequence was that trees and other landscaping would die. Abendschein said the basic structure of our costs had not changed. The COSA from two years ago had not incorporated a drought scenario. This was not a new COSA but an update to the previous COSA to include drought level consumption and rates necessary to cover costs. Vice Chair Waldfogel said that meant that the pricing used in that COSA was too sensitive to demand. He agreed that the financial viability of the fund was important, but it did not mean there was a cost analysis problem, it was a price analysis problem. Commissioner Melton said that once the COSA was established, deviating from it was not a good idea. If the COSA did not include rates that worked during the drought, then it was insufficient and a new COSA was necessary. Vice Chair Waldfogel said the COSA set the amount of revenue to be collected from fixed versus variable charges. He said if the COSA could not survive relatively small changes in demand it called into question of whether the City was on the right track with this study. Abendschein said staff was comfortable with the COSA under normal conditions. It needed something added to address an extended water shortage. Every agency struggled with the issue of collecting fixed costs through variable charges. There was a constitutional mandate to not waste water. The California Urban Water Conservation Council which includes advocacy groups and water utilities established best management practices for water agencies. One of these practices was that no more than 30% of fixed costs should be recovered through fixed charges. The way other agencies dealt with lost revenue in a drought was to have different rates for different drought scenarios. Roseville was one example of an agency with that practice. What was being proposed tonight did not call into question the validity of the previous study. Abendschein said the goal tonight was to get feedback from the Commission, and if the balance between fixed and variable costs was not what they hoped to see, this was the time to get that feedback. Chair Foster asked whether it made sense to achieve resolution now. He asked if anyone wanted to recommend anything other than the staff recommendation. Commissioner Cook asked how the rates would revert to normal rates if it rained. Abendschein said staff intended to get the rates designed and ready for adopt ion, and if it rained in December the rates would not be adopted and would instead be adopted in June. Commissioner Cook asked about the mechanism for reverting to normal rates. Abendschein said that the rates would go through the Prop 218 process and be ready in case of a drought. The trigger for activating them would be the declaration of drought conditions by the SFPUC, and the trigger for deactivating them would be the end of that declaration. Commissioner Eglash questioned staff on the purpose of this action item to approve guidelines and considered it unprecedented to have the UAC or Council approve design guidelines. Abendschein pointed to other examples of UAC review and approval of design guidelines, such as the Palo Alto CLEAN program. Abendschein also explained how the guidelines would form the basis for the COSA and it would be challenging to deviate from the COSA after the fact . Director Fong reminded the Commission that staff had been criticized in the past for not providing the UAC an opportunity to provide more definitive action prior to completing a rate analysis. Commissioner Melton agreed and said he was a supporter of UAC input early in the process. Commissioner Eglash explained his concerns with the guidelines as presented and his main issue with Attachment A were items 2a through 2i and what implications they had for rate design. Abendschein explained these items were a restatement of policies already included in the Urban Water Management Plan and that none of these items implied a specific rate design. They were broad goals that staff was to keep in mind when designing rates. When staff returned with a rate design, they should be able to explain how that rate design is consistent with these goals. Commissioner Eglash also had a concern that there was a disconnect between the presentation and the guidelines. For example, the presentation said one goal was to achieve the water use reductions mandated by the SFPUC, but the guidelines did not talk about that at all. Director Fong said she thought the presentation and guidelines were fairly similar , noted several bullets that were identical, and pointed out that guideline three discussed the need to achieve water use reductions, but she invited recommendations for changes. Commissioner Eglash said he interpreted guideline three to mean that the rates should be designed to cover costs in the event usage dropped to those levels , but that using rates to achieve those mandated water use reduction levels was something different . Abendschein agreed that the presentation could be worded better, and that the intent was to communicate in the presentation that guideline three was intended to mean that rates should be designed to cover costs in the event usage dropped to those levels , not that the rates would be designed to achieve those levels. Vice Chair Waldfogel said that the staff report had documented that price signals were not the primary mechanism for achieving the reductions. He said the report noted a price elasticity of - 0.15 to -0.17, which was a bit higher than he had seen in other studies for water rates, but not high enough to achieve the required reductions on their own. Director Fong noted that the water use reduction levels noted in guideline three were from th e water contract with the SFPUC. They represented the water consumption allocated under the drought formula and Chair Foster said guideline three could be reworded to reflect that. Vice Chair Waldfogel and Commissioner Eglash debated how conservation signals and design of rates to reflect the level of water use reductions should be handled. Further clarification that the rate design was intended to collect the revenue requirement and was not intended to be the primary mechanism for achieving water use reductions, thereby potentially over -collecting revenues, resulted in Commissioner Eglash’s withdrawing his objections to the guidelines. Chair Foster said there were three options: first, recommend the s taff language, second, provide some general guidance to staff on changes, but not specific language, or th ird, provide staff with specific language. Commissioner Eglash said he was now willing to recommend Attachment A (the design guidelines) as written. Vice Chair Waldfogel said he would not support the design guidelines as written. He would support it with two changes. Guideline five should say “Rates for residential customers should provide an allowance for efficient landscaping,” without saying anything about the number of tiers to be implemented. The number of tiers should fall out of costs and be cost driven. He also wanted to change “commercial customers” to “all customers” under guideline six and remove the word “excess.” Commissioner Eglash said he would not support the changes. He said rate design could be an important part of encouraging conservation. It was important to speak to tiers in guideline five because all landscaping was not equally important. He said that trees were a longe r term investment requiring only a modest investment of water. Shrubs and lawns were a lower priority. He thought that weakening guideline five would make it too easy for people to keep all of their landscaping, and this was not the right approach during a drought. He supported guideline five as written. He thought they recognized the need to preserve trees during a drought. Director Fong said staff agreed with deleting the word “excess” in guideline six. MOTION: Foster moved, seconded by Eglash, to approve the staff recommendation with the removal of the word “excess” from guideline six. SUBSTITUTE MOTION: Waldfogel moved, seconded by Melton, to approve the staff recommendation with the following amendments: 1) modify guideline five so it reads “R ates for residential customers should provide an allowance for efficient landscaping,” without the subsequent language regarding tiers, 2) change “commercial customers” to “all customers” under guideline six, and 3) remove the word “excess” from guideline six. Commissioner Melton said he had seconded the motion, but suggested to Vice Chair Waldfogel that guideline six not be modified. They were not in a position to do individual allocations for each residential customer. Vice Chair Waldfogel said it was important to acknowledge different levels of reasonable landscape water use for smaller and larger lots. Setting the same tiers for all customers would result in the acceleration of dying landscape. He was already seeing both brown lawns and stressed trees around his neighborhood. He thought they were on track to accelerate this trend, and that there would be backlash from the community if there were individual allocations for commercial but not for residential customers. Commissioner Eglash said that the individual allocations for commercial customers mainly had to do with economics, not landscaping. Vice Chair Waldfogel agreed. He said this was about protecting the capital base of the city and the landscape investment. He asked if other Commissioners had a suggestion on how to capture his comments regarding capturing number of people and lot size in residential rate design. Commissioner Eglash said that the word "excessive" in guideline six was unfortunate, and really the discussion was just about a second tier for landscaping. He asked whether staff had considered ways to deal with unusual landscape situations. Abendschein said that guideline eight regarding variances addressed some of those concerns. He noted that non-residential customers were far less homogeneous than residential customers, and that the only way to make a distinction between indoor and outdoor use for non-residential customers was via individual allocations for indoor outdoor use. The indoor use represented the business use of water. Vice Chair Waldfogel said he understood that argument, but still thought it would rub people the wrong way. Given the recent concerns about development in Palo Alto and the impact on neighborhoods, he thought that individual allocations that potentially might reflect businesses loading 8-10 people per thousand square feet versus 6 people per thousand square feet into a commercial space might rub people the wrong way. He did not want to support that in the context of all the other land use discussions going on in the community. Commissioner Melton said that to him, Vice Chair Waldfogel's proposed edits to guideline five meant that, for residential customers, an allowance for efficient landscaping would be required, which would take into consideration lot size. That data was in the City’s database. Lot size was a relatively good measure of landscaping. Commissioner Eglash said that such a revision to guideline five turns the intent of the guideline on its head. He said that although the guideline used the word “allowance,” the intent of the third tier was to be a higher rate that would provide a disincentive for using water for landscaping. Vice Chair Waldfogel said the rates still had to be cost based. He said the cos t basis for that tier would fall out of the COSA if there were one. All of the elasticity studies he had seen said that the largest users were the least price elastic consumers, so to create an incentive for them to reduce would require a high rate. This would lower the rate for low users, the ones with the highest price elasticity, sending them a price signal to use more. Commissioner Eglash was sympathetic to Vice Chair Waldfogel’s concerns, and the concern that there might be some unusual situations that required special consideration, but he was concerned that the modifications being proposed to the design guidelines would be a disaster for water conservation. He thought it would lead to too much bad behavior by too many people. He said Vice Chair Waldfogel was trying to engineer the rate structure to provide a small benefit to a small number of people and it would cause an overwhelming number of people to do the wrong thing. He thought they really did need a third tier that was moderately, not extremely, more expensive than the other two tiers. Commissioner Foster said he did not support removing the language regarding three tiers, but asked whether removing it would really affect the outcome of the rate study. Commissioner Melton asked whether tiers were even the only way to do it. Commissioner Foster said he was asking a slightly different question. The revised language said “Rates for residential customers should provide an allowance for efficient landscaping.” Commissioner Eglash said that was an ambiguous sentence because of the word allowance. If that sentence were rewritten to say that the rates should provide an incentive to water landscapes efficiently, to use less water, that would be one thing, but as worded, without a reference to tiers, it could be interpreted to mean that customers should be allowed to water their landscaping like crazy, and that was not what was intended. Commissioner Foster said that was an intriguing point. He was trying to figure out whether staff needed the reference to three tiers in the guidelines in order to implement a three tier rate structure. Abendschein thought the wording left open a range of other possibilities. It did postpone the discussion the UAC was currently having until the rate study was completed. Commissioner Eglash asked staff to elaborate on the word “allowance.” Abendschein asked whether there had been some previous discussion of wording saying “Rates for residential customers should provide for efficient use of water for landscaping.” Vice Chair Waldfogel said this wording put the city on a slippery slope. “Efficient” and “excess” were two sides of the same coin. The fact was, the City was already seeing a great response to its calls for action without changing any prices. He said the price signal was superfluous. The community was being responsive, perhaps excessively responsive with respect to trees and landscape. Now the discussion was about recovering from that response. Commissioner Eglash said it was a feature of rate structures statewide that fixed costs were not fully recovered through fixed charges. To do so would send the wrong price signals. That bridge had been crossed many years before. Vice Chair Waldfogel said he was not arguing to change that. The last COSA had settled on charges that had gone too far for some people and not far enough for others. Now the point was to develop prices that would withstand a decrease in demand, and to decide what other efficiency programs were needed to achieve the required reductions without destroying the entire urban forest and urban landscape. Commissioner Eglash said there was no scenario where the rates would become significantly more aggressive than they are. He did not want to do anything to convey a desire to roll back the fact that current rates send a price signal and that the City might want to send a slightly stronger price signal. He did not want to paper over a disagreement, and thought it might be getting toward time to indicate to the Council that there is disagreement among UAC members. Chair Foster asked if it would be possible to indicate to Council agreement on the staff recommendation but a split vote on the wording of guidelines five and six. Director Fong said there was no decision if there was a 2-2 vote. The UAC could break the other language out from the main motion. Mullan said there were two motions pending to be dealt with. Vice Chair Waldfogel asked Commissioner Melton to reiterate his previous suggestion regarding guideline six. Commissioner Melton said he suggested leaving guideline six as it was and removing the word “excess.” Vice Chair Waldfogel asked whether he would be willing to remove guideline six altogether. Commissioner Melton said that would leave no guidance with respect to commercial customers. Vice Chair Waldfogel said it would indicate a desire to leave commercial rates structured as they currently are, with a single tier. Commissioner Melton said the City had to change that due to drought conditions. Vice Chair Waldfogel said with all the other discussions about development going on he did not want to support a proposal that would lead to lower rates for businesses with 80 people sitting in a small amount of space. He thought that was untimely. There was a discussion going on about retail spaces Downtown becoming offices and office spaces becoming more heavily used than had been anticipated when they were permitted. By setting up these individual allocations the UAC was stepping into that land use debate and he did not want to do that. Chair Foster asked whether there was additional text Vice Chair Waldfogel could suggest adding to guideline six to address those concerns given the diversity of consumption patterns mentioned previously by staff. Vice Chair Waldfogel said it was a defined customer class and it was not the UAC’s problem if it had a lot of diversity. Chair Foster asked whether it would make sense to remove the language regarding individual allocations from guideline six but keep the reference to tiers. Commissioner Eglash did not think guideline six was relevant to the issue of densely populated buildings. The intention of staff was to make it a bit more difficult for commercial facilities with large lawns to continue to water them seven days a week, while not affecting their winter water consumption. Vice Chair Waldfogel recommended an allocation based on the square footage and density of the planned occupancy. Commissioner Eglash said the virtue of the staff proposal was that it worked for other type s of occupancy as well. There were industrial operations and retail space. Staff did not want to come up with 1800 different types of allocations, instead basing it on winter water consumption for all customers. Chair Foster asked what Commissioner Melton’s concern was regarding the language of guideline five. Commissioner Melton said he was comfortable with the language mentioned by staff earlier in the meeting. He was trying to provide more flexibility so that staff could consider allocation-based rates in addition to tiers. Commissioner Eglash said the problem with that approach is that it would postpone the discussion until after the COSA was done. SUBSTITUTE MOTION: Chair Foster moved, seconded by Eglash, to approve the staff recommendation with the following amendments: 1) modify guideline five so it reads “Rates for residential customers should provide for efficient use of water for landscaping,” and 2) remove the word “excess” from guideline six. Chair Foster said he would nominate an ad hoc subcommittee with Commissioners Melton, Waldfogel, and Eglash to work with staff on the rate design, which would provide Commissioners Waldfogel and Melton the opportunity to comment on staff’s proposed designs. He asked whether the absence of the words “three tiers” would prevent staff from pursuing a three tier structure. Abendschein said the language provided enough leeway to staff to pursue different rate structures. Commissioner Eglash said he was not available to be on the subcommittee. Chair Foster said the ad hoc subcommittee would only include Commissioners Melton and Waldfogel. ACTION: Motion approved (3-1, Vice Chair Waldfogel “no” with Commissioners Chang, Cook and Hall absent) Commissioner Melton asked what the next steps were and whether the guidelines would go to Council. Abendschein said the proposal would go to Finance Committee on the 16 th. They would have to discuss with the Finance Committee whether it made sense to send the guidelines to Council. Chair Foster appointed an Ad Hoc Committee of the UAC consisting of Commissioners Waldfogel and Melton to work with staff on rate design issues.