HomeMy WebLinkAboutStaff Report 2507-4958CITY OF PALO ALTO
CITY COUNCIL
Monday, September 15, 2025
Council Chambers & Hybrid
5:30 PM
Agenda Item
3.Finance Committee Recommendation for City Council to Direct Staff to Follow the
Reasonable-Cost Analysis Required by Proposition 26 for the Gas Cost of Service Analysis
and Collaborate with the Utilities Advisory Commission to Develop Revised Gas Rate
Schedules Effective January 2026, Based on Five Design Principles; CEQA – Not a Project
City Council
Staff Report
From: City Manager
Report Type: CONSENT CALENDAR
Lead Department: Utilities
Meeting Date: September 15, 2025
Report #:2507-4958
TITLE
Finance Committee Recommendation for City Council to Direct Staff to Follow the Reasonable-
Cost Analysis Required by Proposition 26 for the Gas Cost of Service Analysis and Collaborate
with the Utilities Advisory Commission to Develop Revised Gas Rate Schedules Effective January
2026, Based on Five Design Principles; CEQA – Not a Project
RECOMMENDATION
The Finance Committee recommends that the Council direct staff to follow the reasonable-cost
analysis required by Proposition 26, and that staff collaborate with the UAC to develop revised
gas rates effective January 2026, based on the following design principles:
1. Rates must be based on the reasonable cost to serve customers. This is the overriding
principle for the cost of service analysis (COSA); all other rate design considerations are
subsidiary to this basic premise.
2. The COSA should involve a review of all existing rate schedules for applicability in the
COSA.
3. The impact of any proposed changes on low-income customers should be evaluated in
alignment with state law, including, without limitation, Public Utilities Code sections 890
and 898.
4. Determine the proper allocation of fixed and variable costs and how those can be
implemented in various rate designs.
5. Review non-rate revenue sources that may be available for rate discounts or rebates.
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’s Proposition 26. This action forwards the Finance Committee’s
recommendation that Council direct staff to follow the reasonable-cost analysis required by
Proposition 26, and that staff collaborate with the UAC to recommend revised gas rates effective
January 2026, based on the following design principles:
1. Rates must be based on the reasonable cost to serve customers. This is the overriding
principle for the cost of service analysis (COSA); all other rate design considerations are
subsidiary to this basic premise.
2. The COSA should involve a review of all existing rate schedules for applicability in the
COSA.
3. The impact of any proposed changes on low income customers should be evaluated in
alignment with state law, including, without limitation, Public Utilities Code sections 890
and 898.
4. Determine the proper allocation of fixed and variable costs and how those can be
implemented in various rate designs.
5. Review non-rate revenue sources that may be available for rate discounts or rebates.
BACKGROUND
COSAs took on greater significance for California publicly owned utilities following the passage of
Proposition 26 in 2010. Proposition 26 added provisions to the California Constitution defining
every local government fee or charge as a tax requiring voter approval, unless one of seven
exceptions applies.1 A rate set at a level “which does not exceed the reasonable costs to the local
government of providing the service”2 is an exception to the voter approval requirement and can
be approved by Council. The City bears the burden to prove that a rate is not a tax, the amount
is no more than necessary to cover the reasonable costs of providing service, and the manner in
which those costs are allocated to ratepayers bears a fair or reasonable relationship to the
ratepayer’s burdens on, or benefits received from, the governmental activity.3
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.
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).
ANALYSIS
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. 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. The UAC explored crafting an additional set of principles, but ultimately
as a body decided on reliance on Proposition 26.
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.
On September 2, 2025, the Finance Committee considered the UAC’s recommendation and
discussed the design guidelines from 2016 in greater detail as well as the design guidelines
proposed by staff in the July report to the UAC. After deliberating the pros and cons of each
possible guideline, and receiving guidance from staff and legal counsel, the Finance Committee
voted unanimously to recommend that Council direct staff to Support the UAC recommendation
to follow the reasonable-cost analysis required by Proposition 26, and that staff collaborate with
the UAC to recommend revised gas rates effective January 2026, but added the following design
principles:
1. Rates must be based on the reasonable cost to serve customers. This is the overriding
principle for the cost of service analysis (COSA); all other rate design considerations are
subsidiary to this basic premise.
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.
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-minutesreports/reports/city-manager-reports-
cmrs/year-archive/2016/final-staff-report-id-7416_gas-cost-of-service-and-rate-design-guidelines.pdf
2. The COSA should involve a review of all existing rate schedules for applicability in the
COSA.
3. The impact of any proposed changes on low income customers should be evaluated in
alignment with state law, including, without limitation, Public Utilities Code sections 890
and 898.
4. Determine the proper allocation of fixed and variable costs and how those can be
implemented in various rate designs.
5. Review non-rate revenue sources that may be available for rate discounts or rebates.
The Committee expressed appreciation for the UAC work, as well as the dedication of a
subcommittee to aid in a deeper dive of the COSA with staff as part of this process.
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
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.
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).)
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.
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 The Finance Committee reviewed this item on September 2, 2025 and
voted unanimously to recommend that Council direct staff to follow the reasonable-cost analysis
required by Proposition 26, and that staff collaborate with the UAC to recommend revised gas
rates effective January 2026, based on the design principles outlined above.
Two members of the public spoke at the Finance Committee meeting on September 2, 2025 and
two members of the public wrote a letter to the Finance Committee, each recommending that
the City keep the 2016 gas COSA design principles in place for the 2026 Gas COSA with certain
modifications. 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.
ENVIRONMENTAL REVIEW
A recommendation that Council direct staff to follow the reasonable-cost analysis required by
Proposition 26, and that staff collaborate with the UAC to recommend revised gas rates effective
January 2026 based on the five principles described above 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-minutesreports/agendas-minutes/utilities-advisory-
commission/archived-agenda-and-minutes/agendas-and-minutes-2025/07-july/public-letters-touac-7.09.25-v2.pdf