HomeMy WebLinkAboutStaff Report 2410-3669CITY OF PALO ALTO
Finance Committee
Regular Meeting
Tuesday, December 03, 2024
Agenda Item
3.Review and Discuss Preliminary Fiscal Year 2026 Utilities Financial Forecast and Rate
Projections Late Packet Report, Staff Presentation
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Finance Committee
Staff Report
From: City Manager
Report Type: ACTION ITEMS
Lead Department: Utilities
Meeting Date: December 3, 2024
Staff Report: 2410-3669
TITLE
Discuss the Fiscal Year 2026 Preliminary Utilities Financial Forecast and Rate Projections
RECOMMENDATION
This item is for discussion, and no action is requested. These preliminary calculations reflect an initial
estimate for review and feedback by the Finance Committee and Utilities Advisory Commission (UAC) on
key assumptions for the Electric, Gas, Water and Wastewater Collection Utilities to inform
recommended FY 2026 financial forecasts and proposed rate changes for each utility.
EXECUTIVE SUMMARY
The City of Palo Alto Utilities provides electricity, water, wastewater, natural gas, and fiber optics. The
City’s Public Works Department also provides refuse collection and processing for recycling, compost
and garbage, wastewater treatment and stormwater management services. Customers benefit from the
continued safe, reliable, environmentally sustainable, and cost-effective operations of each of these
utilities. FY 2026 preliminary calculations model necessary rate increases to support upkeep,
infrastructure replacements, and replenishment of reserves to allow the City to continue to provide high
quality utility services to the community.
Preliminary forecasts reflect a need for an overall 9% or $36.40 monthly rate increase in FY 2026 for the
median residential utility bill, encompassing six services (electric, gas, refuse, sewer, stormwater, water).
Table 1 shows the preliminary five-year rate projections necessary to restore reserves to within
guideline ranges within the five-year planning period, maintain operations given inflationary cost
increases, and enable ongoing capital work necessary to provide safe, reliable, and environmentally
sustainable utilities while balancing affordability. The City of Palo Alto Utilities is engaged in some
infrastructure projects including modernizing the electric grid, improving resiliency, replacing water
mains and reservoirs to continue to provide pristine drinking water to residents and businesses and pay
toward the rebuild of the wastewater treatment plant that provides a critical service to the community
24 hours a day, 365 days per year.
BACKGROUND
Annually, the Utilities Department prepares recommended rates forecasts and financial plans for the
Finance Committee review and ultimately City Council adoption in June. Rate adjustments are
recommended to maintain each utility’s financial health. Recognizing staffing transitions, initial
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estimates, and feedback from the rate review process, staff has prepared a preliminary forecast for
review and early feedback to better inform the official recommended forecasts expected in Spring 2025
for implementation in July 2025. The rate changes shown in this report are preliminary estimates; actual
rate changes will be based on updated financial data and the cost-of-service methodologies and studies
for each utility, and may differ by customer class and for individual customers depending on consumption
patterns. A cost-of-service study for the Gas Utility is expected to be completed in early 2025 and will be
factored into proposals for FY 2026. Cost of service studies for the Electric, Wastewater and Water Utilities
were completed in 2024, 2021 and 2019 respectively.
Over the past few years, utility reserve funds were drawn down due to a variety of factors. The Electric
and Gas Utilities were impacted by the energy price spikes in the winter of 2022 – 2023. The Water
Utility was impacted by reductions in water use during the drought in 2021 – 2023 and the subsequent
recovering period as well as cool and wet weather patterns which persisted locally in 2023. The
Wastewater Collection Utility experienced increased wastewater treatment costs due to a higher flow
share compared to the prior year forecast and other operating cost increases. For all Utilities throughout
the pandemic, the City of Palo Alto kept rate increases at minimal levels in order to alleviate the burden
of utility cost hikes on residents and businesses already grappling with the pandemic's economic effects.
A series of rate adjustments are necessary to restore reserves to within guidelines ranges with the 5-
year planning period.
ANALYSIS
Staff seeks input from the Finance Committee prior to finalizing the Utilities Financial Forecasts and
developing recommendations for rate changes that would be effective July 1, 2025. The proposed rate
adjustment recommendations, along with each utility’s Financial Forecasts, are currently scheduled to
be presented to the Finance Committee in Spring 2025. Staff’s preliminary system average rate
adjustment recommendations are:
Table 1: Preliminary Projected Residential Rate Changes
1. FY 2025 incorporates results of cost-of-service analysis
2. Gas rate in FY 2026 based on General Fund transfer of 18% of gross revenues in FY 2024; changes shown with
commodity rates held constant; actual gas commodity rates vary monthly
3. Stormwater fees increase by CPI index annually per approved 2017 ballot measure (2.6% in FY 2025)
4.Based on projected FY 2025 monthly residential bill of $402
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Electric
The preliminary electric forecast maintains the same annual 5% rate increase presented in last year’s FY
2025 financial plan. Net electric supply purchase costs are anticipated to be in line with the FY 2025
Financial Plan; revenues from surplus system Resource Adequacy and Renewable Energy Certificates
further reduce supply costs. On the expense side, transmission costs continue to rise, and capital
spending and distribution system maintenance spending is rising due to grid modernization, fiber-
related investments and an upgrade to the Hanover Substation which will benefit all electric rate payers.
Staff expects some of these costs to be offset with debt service through a bond issuance in FY 2026.
On balance, the net effect of these various one-time costs and revenues is expected to be positive,
enabling the utility to refill reserves to target levels; the Hydroelectric Rate Stabilization Reserve was
repaid in FY 2024 and had a balance of $17.4 million at the end of FY 2024. Replenishing this reserve
reduces the risk that, in the event of a significant degradation in hydro conditions, the City will need to
use the Hydro Rate Adjuster to recover higher supply costs. In FY 2025, the forecasts anticipate the
Electric Special Projects Reserve will also be repaid $7.5 million, bringing the balance from $22.6 million
to $30.1 million. This will fully repay the monies borrowed for the supply fund to cover higher costs
during the pandemic, the drought, and high winter energy prices during 2022-2023.
In the longer term (FY 2027 through FY 2030), projected increases in electric costs related to stricter
resource adequacy requirements, increasing transmission costs, and capital investment and operational
cost increases are expected to result in system average rate increases of 5% per year. Due to the
positive net ending position in FY 2024 and CIP reappropriation, the electric utility is able to defer debt
financing for grid modernization until FY 2026 and use existing balances for pay-go costs until financing
is needed.
The current year (FY 2025) financial plan for the Electric Utility (approved June 17, 2024) is available at:
https://www.cityofpaloalto.org/files/assets/public/v/2/agendas-minutes-reports/reports/city-manager-
reports-cmrs/attachments/2024-rates/electric-utility-financial-plan-fy25.pdf
Gas
Gas fund expenses are typically one-third supply-related and two-thirds distribution system-related.
Supply costs are market driven, change monthly according to market conditions, and are passed through
to customers. Distribution costs include distribution operations and maintenance, capital investment,
and the general fund transfer.
During the pandemic, the City kept overall gas utility rate increases at 2% to 3% annually and utilized
reserve funding to cover costs. In the winter of 2022-23, surging gas prices depleted the gas utility
reserves, which covered the gap between actual gas costs and the Council-approved maximum gas
commodity charge. Reserves need to be replenished over time to ensure funds are available for safety
and reliability needs, while managing ongoing cost inflation. In the FY 2025 financial plan, a gas rate
increase of 5% was forecasted for FY 2026. However, due to FY 2024 year-end financials which resulted
in lower sales revenues and higher operations and overhead costs, staff preliminary forecasts a 6%
overall rate increase for the Gas Utility effective July 1, 2025.
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On May 9, 2024, the Gas Utility received a recommendation letter from the U.S. Department of
Transportation Pipeline and Hazardous Materials Safety Administration (PHMSA) for the FY 2023 Natural
Gas Distribution Infrastructure Safety and Modernization (NGDISM) Grant. Staff expects this grant to
provide approximately $16.5 million for capital-related work that is additional to the utility’s already-
planned capital work over the next five-year period. The Gas Utility's transfer to the City’s General Fund
is a component of the City’s gas rates. This transfer was first authorized by voters in 1950 and reaffirmed
in November 2022 with the passage of Measure L which authorizes a transfer amount up to 18% of the
gross revenues of the gas utility. The preliminary forecast assumes a transfer based on 18% of estimated
gross revenues from FY 2024, to be $9.735 million in FY 2026. This transfer of 18% is in alignment with
the assumptions in the FY 2025 Adopted Budget process.
The current year (FY 2025) Financial Plan for the Gas utility (approved June 17, 2024) is available at:
https://www.cityofpaloalto.org/files/assets/public/v/2/agendas-minutes-reports/reports/city-manager-
reports-cmrs/attachments/2024-rates/gas-financial-plan-fy25.pdf
Water
The FY 2025 Financial Plan projected a distribution rate increase in FY 2026 of 17%, which is equivalent
to a 9% overall system average increase. However, given lower reserves and higher expected ongoing
costs going forward, preliminary forecasts reflect a 26% increase to the distribution rates, which is
equivalent to a 14% overall system average increase on customer’s water rates. This preliminary rate
increase is necessary to pay for inflationary cost increases and continued lower water sales, while
performing the necessary maintenance and replacement activities that contribute to the safe and
reliable provision of high-quality water to Palo Alto residents and businesses.
Water usage and revenues declined in FY 2022 and FY 2023 as customers successfully conserved water
in accordance with local, regional and state calls for water conservation. When the drought ended in FY
2024, water usage and sales revenue began to increase gradually. Some of the water conservation
achieved during the drought will be permanent, and staff expects water sales will continue to gradually
rebound before resuming a long-term decline. The lower revenue has been managed using $5 million
from the water rate stabilization reserve in FY 2023 and FY 2024 and approximately $7 million from the
water operations reserve from FY 2022 through FY 2024 to cover the utility’s costs. By taking this
approach of drawing down reserves, the City has only increased the distribution portion of the water
rate by an average of 4% annually from FY 2021 to FY 2025. The Finance Committee reaffirmed its
support for this approach on April 23, 2024 when it voted unanimously to limit the overall system
average water rate increase to 9.5% in FY 2025 while reducing reserve funds available in FY 2026 and
future years.1
At the end of FY 2024, the operations reserve was approximately $2 million below projected levels with
a balance of $7.1 million, which is below the minimum guideline level of $8.4 million. While revenues
were $2.3 million higher than forecasted (sales revenue, capacity and connection fees), operating and
capital expenses were $4.4 million higher than forecasted. Many of the cost increases are ongoing and
1 Finance Committee April 23, 2024, Action Minutes
https://cityofpaloalto.primegov.com/Public/CompiledDocument?meetingTemplateId=15050&compileOutputType=1
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the utility will need to continue to pay them annually. The rate stabilization reserve at the end of FY
2024 has $4 million remaining and the financial forecast plans to use all of that remaining funding to
cover costs in FY 2025 and 2026.
The Water Utility needs to plan for large capital projects in the five-year budget, including two reservoir
replacements or rehabilitations and a large main replacement every other year. This revised proposal
defers the reservoir work by two years from FY 2027 and FY 2028 to FY 2029 and FY 2030. The Water
Utility has used or planned for the use of all possible reserve funds to offset costs and set rates at a level
that is below the utility’s actual costs throughout the pandemic and drought. However, the reserves
have now reached a point where rate increases are needed to pay for distribution system costs.
In the April 12, 2024 rate notice from the City’s water supplier, the San Francisco Public Utilities
Commission (SFPUC), estimated no rate increase for wholesale water rates in FY 2026. Consistent with
this rate notice, the preliminary forecast assumes that in FY 2026 SFPUC does not increase the wholesale
water rate during FY 2026 from its current level of $5.67/CCF. Projections for FY 2027 – FY 2030 assume
annual increases of 3.4% in FY 2027, 7.5% in FY 2028, and 5.4% in FY 2029 on SFPUC’s wholesale rate in
accordance with SFPUC’s April 12, 2024 wholesale water rate notice. However, SFPUC’s wholesale rate
projection is subject to change and highly uncertain.
The current year (FY 2025) financial plan for the Water Utility (approved June 17, 2024) is available at:
https://www.cityofpaloalto.org/files/assets/public/v/1/agendas-minutes-reports/reports/city-manager-
reports-cmrs/attachments/2024-rates/water-financial-plan-fy25.pdf
Wastewater Collection
Preliminary rate calculations reflect a needed 18% rate increase for FY 2026, which is equivalent to
approximately $10 per residential customer per month. With this increase, Palo Alto’s rate will be
approximately 6% below neighboring cities, assuming that neighbor rates remain at current levels
though rate increases are likely for those partners with the Regional Water Quality Control Plant. The
additional funding to be generated by this rate increase is required to pay for the ongoing wastewater
treatment charges, operations, and capital improvement; and deferral of some capital costs to manage
the magnitude of the rate increase needed.
In FY 2024 the Wastewater Operating Reserve level was about $1.2 million lower than expected due to
treatment costs being $1.4 million higher than forecasted, driven by higher Palo Alto flow share, and
higher operating expenses than initially forecasted. The Operations Reserve ended the year with
negative $1 million. The utility’s overall cash balance was positive $0.34 million at the end of FY 2024
due to the $3 million short-term loan that Council approved from the Fiber utility to the Wastewater
Collection Utility in FY 2024. The short-term loan is expected to be paid in FY 2026.
Looking ahead, from FY 2026 to FY 2030, staff updated the operating cost projection based on the most
recent recorded costs and rates of cost increase. Relative to last year’s financial forecast, this increased
the total operating costs by $6.2 million or 14% over the five-year forecast. Over the five-year forecast,
treatment costs are approximately $14.2 million higher due to additional minor CIP expenses and
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Section 115 Pension Trust expenses inadvertently excluded from the RWQCP’s forecast. To address
these challenges, the Wastewater Collection Utility preliminary forecast assumes deferral of the next
sewer main replacement budget to FY 2028 and reflects investments in minimally necessary projects to
allow the Wastewater Collection fund to recover and mitigate an even higher rate increase. This
assumption would defer the more aggressive replacement cycle adopted in the FY 2024 financial plan to
increase replacement from 1 miles to 2.5 miles of pipe annually starting in FY 2026.
The most recent (FY 2025) financial plan for the Wastewater Collection Utility (approved June 17, 2024)
is available at:
https://www.cityofpaloalto.org/files/assets/public/v/2/agendas-minutes-reports/reports/city-manager-
reports-cmrs/attachments/2024-rates/wastewater-financial-plan-fy25.pdf
FISCAL/RESOURCE IMPACT
Based on the preliminary rate increases as shown, the estimated revenue impacts in FY 2026 would be
an increase of $7.8 million in the Water Fund, $4.4 million in the Wastewater Collection Fund, $3.1
million in the Gas Fund and an increase of $8 million in the Electric Fund. Utility rate increases impact
the general fund because the City is a utilities customer. The impact to the general fund of these
preliminary rate increases is a$0.86 million expense increase.
STAKEHOLDER ENGAGEMENT
The Utilities Advisory Commission (UAC) will review the preliminary financial forecasts at its December
4, 2024 meeting. Staff will summarize feedback from the Finance Committee verbally during the UAC
meeting. An excerpt of the minutes from the UAC’s December 4, 2024 meeting will be located at the
Utilities Advisory Commission website.
The UAC is scheduled to review the long-term Financial Forecasts and proposed rate adjustments for the
Electric, Water, Wastewater and Gas Utilities in March. The Finance Committee is tentatively scheduled
to review the long-term Financial Forecasts and proposed rate adjustments in Spring 2025. In late April
or early May, notification of any recommended Water and Wastewater Collection rate adjustments will
be sent to customers, giving them the opportunity to protest the proposed changes as required by
Article XIIID of the State Constitution (added by Proposition 218). The Financial Forecasts and proposed
new rate schedules will be considered by the City Council with the FY 2026 budget, at which time the
public hearing required by Article XIIID of the State Constitution will be held.
ENVIRONMENTAL REVIEW
The Finance Committee’s review of the preliminary financial projections does not meet the definition
of a project, pursuant to Section 21065 of the California Environmental Quality Act, thus no
environmental review is required.
APPROVED BY:
Dean Batchelor, Director of Utilities
Staff: Lisa Bilir, Senior Resource Planner
December 3, 2024 www.cityofpaloalto.org
PRELIMINARY FY 2026 RATE CHANGES
Finance Committee
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Preliminary Residential System Average Rate Projections
1)FY 2025 incorporates results of cost-of-service analysis
2)Gas rate in FY 2026 based on General Fund transfer of 18% of gross revenue in FY 2024; changes shown with
commodity rates held constant; actual gas commodity rates vary monthly
3)Stormwater fees increase by CPI index annually per approved 2017 ballot measure (2.6% in FY 2025)
4)Based on projected FY 2025 monthly residential bill of $402
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ONGOING COST CONTAINMENT for All Utilities
•Consistent with the Utilities Strategic Plan, cost containment
is being instituted as an ongoing priority and annual cycle
•Ongoing management review of personnel actions
•Regular review of performance metrics and expenditures
RECENTLY IMPLEMENTED COST CONTAINMENT
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•Expanded use of bank draft to reduce credit card fees
•Scheduled larger CIP projects every other year achieving efficient project management and lower construction costs
(estimated $50K per CIP project)
•Implemented mobile workforce applications, reducing administrative data entry time, freeing up staff for other work
Water, Gas, and Wastewater
•Established cross-functional field
crew to install water, gas, and
sewer services simultaneously at
new construction sites, reducing
hours spent in the field by
minimum 20%
Electric Utility
•Selling surplus Resource
Adequacy and Renewable Energy
Credits ($20+ million/year)
•Negotiated improvements to
Western hydroelectric contract
($2 million/year)
•Negotiated layoff of transmission
asset generating $550k/year
Water Utility
•Agreement with Valley Water
yielded $16 million in funding for
reverse osmosis facility to
improve recycled water quality
and $250K to $1M/year
•BAWSCA water bond refunding in
2023 achieved lower debt service
payments ($185K/year 2023-
2034)
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FUTURE POTENTIAL COST CONTAINMENT
•Implement new customer information system with reduced support costs
•Increase water and energy end use technical training for Customer Service
Representatives, reducing transferred phone calls and staff time
Water, Gas, and Wastewater
•Cluster gas main replacements
to reduce mobilization costs for
construction contractors ($5K-
$10K for each project group)
Electric Utility
•Prepay of renewable power purchase
agreements to monetize municipal tax-
exempt debt
•Optimize debt issuance timing and
amount for Grid Modernization to
minimize debt service costs to electric
customers
•Additional value from Western federally-
owned transmission ($500K/year)
•Challenge transmission rates via Northern
California Power Agency ($500K/year)
ELECTRIC UTILITY (Preliminary)
www.cityofpaloalto.org
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FY 2026 PRELIMINARY PROJECTION
•5% rate increase across all customer classes in FY 2026
•Significant investment in grid modernization, but able to delay bond issuance to FY 2026
•Reserves recovering from 2020-2022 drawdown
•Repaid Hydroelectric Rate Stabilization in FY 2024
•Repaying Electric Special Projects Reserves in FY 2025
•Net supply costs forecast in line with FY 2025 Financial Plan
•Revenues from surplus system Resource Adequacy and Renewable Energy Certificates further
reducing supply costs
FUTURE YEARS
•5% rate increase per year projected for FY 2027-FY 2030
•Issue debt for Grid Modernization in first half of FY 2026
Preliminary Electric Rate Projection
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Preliminary Electric Cost and Revenue Projections
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Grid Mod CIP (pay as you go)
Debt Financing in 2026
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Preliminary Electric Supply Operating Reserve Projections
Received $24M Overcharges Refund
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Preliminary Electric Distribution Operating Reserve Projections
Maintained rates with no
increases in FY2021 and FY2022,
and utilized the operating
reserve to cover expenses
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Electric Residential Bill Comparisons
*PG&E and Santa Clara Rates Effective November 2024; Palo Alto proposed rates July 2025
GAS UTILITY (Preliminary)
www.cityofpaloalto.org
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FY 2026 PRELIMINARY PROJECTION
•6% overall rate increase in FY 2026, due to 10% distribution rate increase
•6% overall rate increases annually in FY 2027-30
•Gas General Fund Transfer in FY26 is estimated at $9.735M, calculated
from 18% of FY24 gross revenue
Drivers
•Reserves $1.5 million lower than forecast due to lower retail sales and
connection fee revenues
•Projection reflects lower sales projection, higher other operating costs
Preliminary Gas Rate Projections
*excludes supply-related rate changes
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Preliminary Gas Cost and Revenue Projections
*Revenue excludes Cap-and-Trade auction sales
revenue, which goes directly to the Cap-and-Trade
reserve
**FY25 Commitments and Reappropriations reserves
balances for Operations and Capital Investment are
anticipated to be utilized in FY26 and FY27
***The grant-funded $16.5M CIP project is anticipated
to be under construction in FY26 and FY27
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Spike in gas prices
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Preliminary Gas Operations Reserve Projections
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Preliminary Gas CIP Reserve Projections
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Projections for reserve level needs
reflect the significant increase in
capital investment costs and prior
planned projects in FY 2025
deferred to future years
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Gas Bill Comparisons ($/Mo.)
Staff is currently conducting a Cost-of-Service Study and
will provide an update in 2025
Residential Commercial
10 33.46 11.58 189%
(Median) 17 45.03 29.20 54%
30 78.84 66.35 19%
45 122.85 109.22 12%
30 64.75 81.27 (20%)
(Median) 51 98.23 143.27 (31%)
80 169.57 228.88 (26%)
150 370.86 435.55 (15%)
Annual (Median) 31 67.20 76.73 (12%)
PG&EPalo AltoUsage
(Therms)Season
Summer
PA/PG&E
(%)Rate
Winter
G-1
WATER UTILITY (Preliminary)
www.cityofpaloalto.org
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Preliminary Water Rate Projections
FY 2026 PRELIMINARY PROJECTION
•14% overall rate increase in FY 26 (26% distribution rate increase)
•Operations Reserve and CIP Reserve projected to be below minimum guideline range in FY 2026
and return within guideline range in FY 2027
•Commodity rate increase projection: 0% in FY 2026, 3.4% in FY 2027, 7.5% in FY 2028 and 5.4% in
FY 2029 (SFPUC rate notice April 2024); highly uncertain and subject to change
Projected Water Distribution Rate Trajectory
Projected Total Water Rate Trajectory
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Preliminary Water Cost and Revenue Projections
* Includes changes due to
commitments/reappropriations
and funds transferred to the CIP
Reserve
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Preliminary Water Operations Reserve Projections
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Preliminary Water CIP Reserve Projections
Note: Prior to FY21, CIP reserve guidelines were set at
12-24 months of budgeted CIP expenses, with FY20
spiking due to high CIP budgets. In FY21, the reserve
guidelines policy updated to a 48-month of average
budgeted CIP expenses
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Water Bill Comparisons ($/Month)
Single-Family Residential
Palo Alto is 18% above comparison city average
Palo Alto is 6% above comparison city average
Commercial
WASTEWATER COLLECTION (Preliminary)
www.cityofpaloalto.org
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Preliminary Wastewater Rate Projections
FY 2026 PRELIMINARY PROJECTION
•18% rate increase in FY 2026, approximately $10/month increase for residential customers
•15% rate increase in FY 2027 and FY 2028, 7% in FY 2029 and FY 2030
Drivers
•Treatment operational cost increases (budgets uncertain and subject to change)
•Reserves very low, operations reserve balance negative $1 million at year end, need to
restore reserves to within guideline range
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Preliminary Wastewater Cost and Revenue Projections
*FY25 Commitments and Reappropriations
reserves balances for Operations and Capital
Investment are anticipated to be utilized in
FY26 and FY27
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Preliminary Wastewater Operations Reserve Projections
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Preliminary Wastewater CIP Reserve Projections
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Wastewater Bill Comparisons ($/Month) October 2024
Residential
General Commercial
Palo Alto is 13% higher than
comparison city average
Restaurant – Palo Alto is 7% below
comparison city average
Palo Alto is 21% below comparison
city average