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HomeMy WebLinkAboutStaff Report 2507-4993CITY OF PALO ALTO Finance Committee Regular Meeting Tuesday, September 02, 2025   Agenda Item     2.Recommend City Council Direct Staff to use Proposition 26 as the Design Principle for the Gas Cost of Service Analysis and Work with the Utilities Advisory Commission on Review of a Recommended Gas Rate Schedule Effective by January 2026 Staff Presentation 7 7 8 6 Finance Committee Staff Report From: City Manager Report Type: ACTION ITEMS Lead Department: Utilities Meeting Date: September 2, 2025 Report #:2507-4993 TITLE Recommend City Council Direct Staff to use Proposition 26 as the Design Principle for the Gas Cost of Service Analysis and Work with the Utilities Advisory Commission on Review of a Recommended Gas Rate Schedule Effective by January 2026 RECOMMENDATION Staff, with support from the Utilities Advisory Commission (UAC) recommend that the Finance Committee recommend the Council direct staff to follow the reasonable-cost analysis required by Proposition 26, in lieu of adopting additional design principles, and that Council work with the UAC on a recommendation to the Council on revised gas rates effective January 2026. 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 reasonable costs 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. As outlined during the spring 2025 discussion, one step of a routine cost of service analysis includes a kick-off process affirming any guiding principles for the study, while always ensuring adherence to California Proposition 26 regulations. This action forwards the UAC’s advice recommending that Council direct staff to rely on Proposition 26 as the guiding principle for the 2026 Gas COSA with the intention to complete the necessary processes to implement new gas rates in accordance with the new 2026 gas COSA on or around January 1, 2026. 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 7 7 8 6 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 COSAs completed with the assistance of ratemaking consultants are designed to ensure that the City meets its burden to set rates accurately. Staff drafted a 2025 COSA and received guidance from the Finance Committee on May 7, 2025 through a unanimous vote (3-0) to return to the UAC to further review the 2025 Gas COSA assumptions and principles. Additionally, Council further directed staff through its vote on June 16, 2025 (5-1-1, Lythcott-Haims no, Stone absent) to return to the UAC to consider the issue of a one-time climate credit along with the revised Gas COSA. After discussing the proposed Design Principles and considering Council’s direction to the UAC to reconsider the 2025 Gas COSA, the UAC voted 6-1 in July to recommend: 1) relying on Proposition 26 as the design principle for the Gas COSA and 2) forming a UAC subcommittee to work with staff and the ratemaking consultant to develop a new 2026 Gas COSA and provide regular report-outs to the UAC, with recommendations to Council made by the full UAC. The UAC also expressed an interest in addressing only the gas rate-making design principles at this time. ANALYSIS Proposition 26 as the Gas COSA design principle On July 9, 2025, staff proposed to the UAC4 that the UAC recommend that Council accept design principles that would apply to both the City’s gas and electric rates5. Those principles were: 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 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). 4 Utilities Advisory Commission Staff Report 2505-4722, July 9, 2025 meeting, Item 3, https://cityofpaloalto.primegov.com/Portal/Meeting?meetingTemplateId=17717 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. 7 7 8 6 Design Principle 4: Review non-rate revenue sources that may be available for rate discounts or rebates Further details on these Design Principles are available in the UAC staff report 2505-4722.6 As an additional reference, the City Council approved prior gas COSA guidelines on November 14, 2016 (Staff Report 74167). During its July meeting, the UAC considered design principles which included some policy preferences to guide staff and the City’s ratemaking consultants on future gas and electric COSAs in alignment with California’s Constitutional requirements. The Commission considered whether revising them could provide clearer guidance for staff and the ratemaking consultant in developing the new 2026 Gas COSA. During the discussion, staff emphasized that the primary and overriding guiding principle is Proposition 26, which requires that rates be based on cost and does not address other policy considerations. Courts look to constitutional requirements when a public agency’s rates are challenged and have held that rates which incentivize policy choices must remain cost-based. Staff also noted that most cities rely on Proposition 26 alone, rather than creating their own set of design principles. The UAC voted 6-1 to recommend: 1) relying on Proposition 26 as the only design principle for the Gas COSA and 2) forming a UAC subcommittee to work with staff and the ratemaking consultant to develop the 2026 Gas COSA and provide regular report-outs to the full UAC to ultimately support a recommendation to the City Council. Staff with UAC support recommends the Finance Committee recommend that Council direct staff to apply Proposition 26 as the sole design principle for the 2026 Gas COSA. Alternatively, the Finance Committee could recommend that Council approve: •The Design Principles proposed by staff on July 9, 2025, for both the Gas and Electric Utilities, •The Design Principles proposed by staff on July 9, 2025, for the Gas Utility only, •The 2016 Gas COSA Design Principles adopted by Council, or •Modifications to any of the above. Tentative Timeline & UAC Review When Council directed the UAC to review the 2025 Gas COSA, some Councilmembers expressed an intent to complete the new COSA and implement new gas rates by early 2026. In order to minimize the impact on the project completion date and allow for thorough development and legal review of the proposed gas rates, staff’s estimate the fastest process possible under ideal conditions would reflect the following; actual timing may shift depending on requested analysis: •September/October: UAC subcommittee to review (see below for details) and provide report outs to the full UAC verbally 6 Utilities Advisory Commission Staff Report 2505-4722, July 9, 2025 meeting, Item 3, https://cityofpaloalto.primegov.com/Portal/Meeting?meetingTemplateId=17717 7 City Council Staff Report 7416, November 14, 2016: https://www.cityofpaloalto.org/files/assets/public/v/1/agendas-minutes- reports/reports/city-manager-reports-cmrs/year-archive/2016/final-staff-report-id-7416_gas-cost-of-service-and-rate-design-guidelines.pdf 7 7 8 6 •November (week 1): UAC review and discuss proposed 2026 Gas COSA study results for recommendation to Finance Committee and City Council •November (week 3): Finance Committee review and discuss proposed 2026 Gas COSA study results and rate changes for recommendation to City Council •December: City Council review and adoption of final 2026 Gas COSA study results and rate changes including Public Hearing •Gas rates effective on or around January 1, 2026 depending on the complexity and timeline necessary to implement rate changes. The use of a UAC subcommittee8 permits a subset comprised of less than a quorum of the UAC to engage in detailed and candid discussion with staff and the City’s ratemaking experts, followed by verbal reports to the full UAC to facilitate discussion and recommendation to Council on the proposed 2026 Gas COSA. During UAC Subcommittee Meetings, the subcommittee reviews draft materials and provides input and feedback to staff and the ratemaking consultant on several key topics. These include the design of fixed and variable customer charges, as well as an analysis of whether to subdivide the current G-2 customer class. This analysis will explore the potential creation of a distinct customer class comprised of multi-family master-metered customers, or other appropriate cost-based reclassifications. FISCAL/RESOURCE IMPACT The work associated with this project will be absorbed using existing staff and contract budgets. Staff may need to push back other rate-related work to later in the fiscal year. If additional subcommittee meetings or other meetings are required, or substantive additional models and analysis is requested during the final stages of drafting the Gas COSA report, the schedule and cost will be impacted. This will mean the effective date of new rates will be later in 2026 and there will be additional costs to the City of working with the expert consultants. 8 A temporary advisory committee composed solely of less than a quorum of the legislative body that serves a limited or single purpose, that is not perpetual, and that will be dissolved once its specific task is completed is not subject to the Brown Act. (Cal. Gov. Code sec. 54952(b).) 7 7 8 6 STAKEHOLDER ENGAGEMENT The UAC and staff received numerous communications expressing a variety of concerns about the gas utility. Those letters and all of the public letters to the UAC for the July 9, 2025 meeting are available for viewing.9 Public review and feedback as part of this next process will be available and advertised through the public review at the UAC, Finance Committee, and City Council. 10111213ENVIRONMENTAL REVIEW A recommendation that Council direct staff to follow the reasonable-cost analysis required by Proposition 26, in lieu of adopting additional design principles, and acceptance of the tentative gas rate adoption schedule shown in Table 1 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. APPROVED BY: Alan Kurotori, Director of Utilities 9 Link to public letters to the UAC from the July 9, 2025 agenda: http://www.paloalto.gov/files/assets/public/v/2/agendas-minutes- reports/agendas-minutes/utilities-advisory-commission/archived-agenda-and-minutes/agendas-and-minutes-2025/07-july/public-letters-to- uac-7.09.25-v2.pdf September 2, 2025 www.cityofpaloalto.org Gas Cost of Service Analysis Design Process Finance Committee 2 Background The primary and overriding guiding principle is Proposition 26, which requires that rates be based on cost and does not address other policy considerations. During its July meeting, the UAC discussed staff-proposed Design Principles for the gas and electric COSAs and voted 6-1 to recommend: 1)Relying on Proposition 26 as the design principle for the Gas COSA and 2)Forming a UAC subcommittee to work with staff and the ratemaking consultant to develop the 2026 Gas COSA and provide regular report-outs to the full UAC. September/ October: UAC subcommittee review (provide verbal report out to the full UAC) November (week 1): UAC review 2026 Gas COSA study results and rate changes (recommendation to Finance Committee) November (week 3): Finance Committee review 2026 Gas COSA study results and rate changes (recommendation to City Council) December: City Council adoption of final 2026 Gas COSA study results, rate changes, and Public Hearing Gas rates effective January 1, 2026 (on or around) 3 Timeline for 2026 Gas COSA 4 Recommendation Based on a Utilities Advisory Commission (UAC) July 9, 2025 action, staff recommends that the Finance Committee recommend that Council direct staff to follow the reasonable cost-analysis required by Proposition 26, in-lieu of adopting additional design principles, and accept the tentative gas rate design schedule. Alternatives for the Finance Committee to Consider recommending to Council: Alternative Design Principles: 1. The Design Principles proposed by staff on July 9, 2025, for both the Gas and Electric Utilities, 2. The Design Principles proposed by staff on July 9, 2025, for the Gas Utility only, 3. The 2016 Gas COSA Design Principles adopted by Council, or 4. Modifications to any of the above. Alternative Timeline: Finance Committee could recommend a modified timeline to Council; if additional subcommittee meetings or other meetings are required, or substantive feedback is provided during the final stages of drafting the 2026 Gas COSA report, the schedule and cost will be impacted.