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HomeMy WebLinkAboutStaff Report 2508-5088CITY OF PALO ALTO CITY COUNCIL Monday, November 17, 2025 Council Chambers & Hybrid 5:30 PM     Agenda Item     4.Climate Action and Sustainability Committee Recommendation to Approve Program Design Guidelines for the Advanced Packaged HVAC Pilot Program; CEQA Status – Categorically Exempt Under CEQA Guidelines Section 15302 (Replacement of Existing Facilities) City Council Staff Report From: City Manager Report Type: CONSENT CALENDAR Lead Department: Public Works Meeting Date: November 17, 2025 Report #:2508-5088 TITLE Climate Action and Sustainability Committee Recommendation to Approve Program Design Guidelines for the Advanced Packaged HVAC Pilot Program; CEQA Status – Categorically Exempt Under CEQA Guidelines Section 15302 (Replacement of Existing Facilities) RECOMMENDATION The Climate Action and Sustainability Committee and staff recommend the City Council approve the Program Design Guidelines for an Advanced Packaged HVAC Pilot Program to guide development of a large-scale program to help non-residential community members replace packaged HVAC units. EXECUTIVE SUMMARY As part of the City’s Sustainability and Climate Action Plan (S/CAP), staff launched a pilot program in summer 2024 to encourage commercial customers to replace gas-fired packaged HVAC units with electric heat pump HVAC systems.1 To date, 14 customers have enrolled in the pilot, six projects have secured permits, and three projects have been completed. Preliminary results confirm that heat pump replacements are technically feasible and ranged from an 18% savings in up-front cost to a 40% additional cost compared to like-for-like gas system replacements. When there is additional cost, voluntary adoption can be difficult without financing options. Early projects also highlighted permitting challenges that add to overall project costs and complexity. While these requirements are necessary for safety and compliance, they can discourage voluntary adoption. A study of non-residential building equipment performed by a City consultant indicated heat pump replacements may result in bill savings, but this is yet to be confirmed by the projects in progress. 1https://www.paloalto.gov/Departments/Utilities/Electrification/Business-Electrification/Commercial-Heat- PumpHVAC-Program Building on these lessons, staff proposes an Advanced Commercial Heat Pump HVAC (HPHVAC) Pilot Program. The goal of the program would be to replace direct incentives with scalable financing options while providing optional technical assistance. The program is designed to reduce barriers to adoption while maintaining compliance with all applicable permitting requirements. BACKGROUND •14 customers enrolled in the pilot •6 projects permitted •3 projects completed •Structural engineering studies on roof integrity for rooftop units. •Sound studies to demonstrate compliance with noise standards. •Visual screening/line-of-sight reviews. •Fire Department permits, including hazardous materials documentation and equipment labeling. Because participation in the pilot required securing all necessary permits, this added an average of $3,118 in permit costs plus a variable amount of cost in consulting and contractor fees to comply, sometimes in the tens of thousands of dollars. Since only three participants in the program have completed projects so far, staff has limited data points. One community member was quoted over $10,000 to complete a sound study, while another completed the study for a negligible increase to their overall project quote. One community member incurred a $5,000 cost for hazardous materials services. Another was looking at potential increases of over $10,000 related to roof structural calculations related to the HVAC roof attachment method. Staff is continuing to gather information on how these additional consulting and engineering services needs increase project costs, and ways to help community members comply at lower cost. These requirements are necessary to ensure safety, compliance, and community standards, but the additional project costs and time can sometimes create uncertainty and frustration for customers. Two customers withdrew from the program due to the cost and permitting requirements, despite the enhanced rebates. ANALYSIS Staff drew on its experience with the current HVAC enhanced rebate program,3 research done as part of the S/CAP Funding Study and corresponding Non-Residential Building Sector Study (which are not yet final), and some interviews (participants, contractors, a financing provider, and a consultant) as detailed in the Stakeholder Engagement section below, to develop the Program Design Guidelines for the Advanced Commercial Heat Pump Heating, Ventilation, and Cooling (HVAC) Pilot Program (Program Design Guidelines) in Attachment A. Staff has learned from its existing program how to navigate the permitting process and the associated costs. The studies gave staff indications that packaged space heating electrification should provide long- term utility bill savings. In the participant and business partner interviews, staff found potential interest in financing, particularly on-bill financing, and especially if it enabled the cost of improvements that benefit tenants to be passed through to them based on the bill savings they would realize. Customers consistently noted that they would not have been able to pursue these projects without the boosted incentive, underscoring the importance of strong financial support for large-scale upgrades. They noted the short payback period needed for a property investor to do these projects. They also appreciated the technical guidance provided by the third-party electrification engineering consultant, Prospect Silicon Valley, highlighting the value of ongoing 3 https://www.paloalto.gov/Departments/Utilities/Electrification/Business-Electrification/Commercial-Heat- PumpHVAC-Program technical assistance for complex projects such as heat pump HVAC. In addition, customers valued the hands-on support and direct communication offered by Utilities and Planning and Development Services staff on permitting matters, which further facilitated successful project completion. The Program Design Guidelines generally address the following topics: Financing and Incentives One of the main challenges in the non-residential sector is the short payback period (2-4 years) required by most private investors before making a building or energy investment. Based on staff modeling using information from the S/CAP Funding Study and Non-Residential Building Sector Study (not yet final), the payback period for electrification of packaged HVAC units that cost 10% to 15% more than gas units would be 12 to 17 years. This means that even though these projects potentially provide a net benefit, they will not get done without some assistance. To date, staff has primarily used incentives. Incentives work if they are high enough, but high incentives are not a scalable solution for electrifying all of Palo Alto’s packaged HVAC units. In an Advanced HVAC Pilot Program staff would explore other approaches, primarily financing with on-bill repayment. Staff is in talks with a potential provider and has built the functionality in its billing system for on-bill repayment. Building owners prefer on-bill repayment, which they treat as an operating expense. They may be more willing to engage with this type of financing than traditional financing. Building owners also hesitate to make significant energy investments that save money for their tenants rather than themselves. Staff is exploring a potential tool called “electrification as a service” to address this. Modeled on “efficiency as a service” programs some energy efficiency companies run, an “electrification as a service” feature would involve the customer repaying some or all of the financing provided by the City or a 3rd party with a charge that does not exceed their utility bill savings. This may enable the placement of the charge on commercial tenant utility bills, with the right agreements in place, enabling the recovery of some of the costs for energy improvements from tenants, who experience utility bill reductions as a result. Funding sources and program structure are still being explored, though as noted in the Fiscal Impact section, some money is set aside for a program like this from Gas Cap and Trade revenues in the FY 2026 budget. These financing and “as a service” features, if feasible, may lead to more financially efficient, attractive commercial energy programs, that minimize the use of incentive funding. Technical Assistance The technical assistance envisioned for the Advanced Commercial HPHVAC Pilot Program is similar to that provided in the existing HP HVAC Pilot Program. These services included: •Evaluating electrification project designs, including conducting preliminary reviews of project designs for Heat Pump HVAC installations and performing limited design checks on equipment, engineering plans, and project specifications. •Providing electrification technical guidance, including offering non-biased, expert technical advice to CPAU commercial customers and validating equipment selections to ensure projects meet technical standards. •Providing electrification cost guidance, including performing savings calculations and general project cost evaluations, assessing financial feasibility, and providing cost insights for customer projects. The consultant, Prospect Silicon Valley, provided electrification technical advisory services to three commercial customers to support their Heat Pump HVAC projects. Without the consultant’s guidance, these projects would likely have been delayed for years, potentially causing the customers to miss rebate opportunities or drop out of the program entirely. To support the successful adoption of commercial Heat Pump HVAC projects, there is also a clear interest in some form of assistance finding qualified contractors. The guidelines envision some form of complementary contractor list, and possibly even providing services to contractors, such as the ability to use a City financing program or a contact for trying to understand common permitting pitfalls. Permit Assistance and Streamlining Early projects in the current enhanced rebate HVAC pilot have highlighted several permitting- related challenges that informed the design guidelines and will inform program design: •Many gas-for-gas replacements proceed without permits, avoiding compliance costs that are unavoidable for heat pump projects participating in a City program. •Noise reports are required for all projects (per PAMC 18.42.190(B)(iii)). Equipment must be no louder than 15 dB above local ambient noise levels at 25 feet. Hiring an acoustical engineer can cost thousands of dollars and adds time to the overall project timeline. •Structural engineering analysis is required for all rooftop packaged HVAC projects. These studies incur a cost and sometimes trigger additional work that needs to be completed for safety reasons. •Screening requirements add cost, and may result in additional roofing loads, which could then incur the cost of a roof structural analysis. If a roof upgrade is required, that can be prohibitively costly and can stop a project. •Fire Department requirements related to HVAC and hazardous materials permits, equipment labeling, and integration with fire alarm systems need more communication to applicants up front. Planning and Development Services and the Fire Department have been active in helping the Climate Action Team understand permitting requirements and discussing potential approaches to ease compliance costs and workload. FISCAL/RESOURCE IMPACT 5 for the Advanced Commercial HPHVAC Pilot Program, funded by Gas Cap and Trade revenues (Gas Utility Funds), which will support incentives if needed, outreach, technical assistance, and 3rd party program operation. Launch and operation of the program is expected to require approximately 0.75 FTE, which will be performed by existing staff and will include program design and operation, outreach, customer care, and establishment and operation of a financing and on-bill repayment program if implemented. Staff will continue to explore opportunities to leverage State and Federal funds if available. STAKEHOLDER ENGAGEMENT 5 https://www.paloalto.gov/Departments/Administrative-Services/City-Budget ENVIRONMENTAL REVIEW 7 and Comprehensive Plan adopted in November 2017.8 ATTACHMENTS APPROVED BY: 7 https://www.paloalto.gov/City-Hall/Sustainability/SCAP 8 https://www.paloalto.gov/Departments/Planning-Development-Services/Housing-Policies- Projects/2030Comprehensive-Plan Program Design Guidelines for Advanced Heating, Ventilation, and Cooling (HVAC) Pilot Program These design guidelines are meant to guide development of a financially accessible Advanced Packaged HVAC Pilot Program for non-residential customers. Program goals and scope The program should: 1. Ease electrification of non-residential packaged HVAC units 2. Pilot financial designs that can be deployed community-wide with little or no additional funding from the City 3. Enable participation by a wide range of contractors, building types, and landlord-tenant arrangements for payment of energy bills 4. Address landlord/tenant split incentives while being economically attractive to both landlords and tenants Program financial design To ensure the program is cost-effective, legally viable, and scalable: 1. It should provide financing rather than up-front incentives, and ideally financing that will encumber a property owner’s balance sheet as little as is feasible, such as on-bill repayment out of utility bill savings 2. Financial incentives may be offered only if legally appropriate and available, and are intended to be offered on a temporary basis. 3. Repayment of any financing offered should come from those who benefit, which could include both tenants and landlords 4. Should not increase tenant utility bills 5. Should be accessible to a range of contractors 6. Should incorporate risk management measures to control risks to the City Program technical design To keep program costs lower and easier for participants, staff should explore: 1. Streamlining of permit processes 2. Technical and permitting assistance for participants 3. Contractor training on program rules and operation 4. A courtesy contractor list Commercial Heat Pump HVAC Program Update September 16, 2025 Current Enrollment As of September 16, 2025, a total of 14 customers applied for the Commercial Heat Pump HVAC Pilot program. Applicants have primarily learned about the pilot through the Business Electrification Technical Assistance Program, the Business Customer Rebate Program website, and the Commercial and Industrial Energy Efficiency Program. Customers become eligible for rebate approval only after submitting all required documentation and securing an approved permit. Of the 14 applicants, seven have initiated the permitting process with the City, and six have received their permits. One customer has received their permit but has not submitted project cost estimates, resulting in only five customers being officially approved at this stage. To date, three customers have completed installations and received program rebates. Detailed project information for these installations is provided in a subsequent section of this report. Two participants have unenrolled from the program. In one case, a customer required an emergency replacement and proceeded with equipment available through their contractor, which did not meet the program’s efficiency requirements. In the second case, permitting requirements significantly increased project costs, approximately doubling the original estimate, leading the customer to withdraw. Table 1 provides a summary of the status and progression of all pilot participants. Table 1. Current Program Participation for the Commercial Heat Pump HVAC Program Cost Analysis The tables below address the current cost comparisons between project estimates, project costs, and rebate amounts. Table 2 compares heat pump HVAC quotes and gas quotes received from 10 customers against project cost estimates developed by Peninsula Clean Energy (PCE) in its 2021 commercial electrification analysis. PCE’s estimates were based on average equipment and labor costs at the time, calculated per ton across three equipment size categories: less than 5 tons, 5–10 tons, and 15–20 tons. On average, heat pump HVAC project estimates were 21.8% higher than gas quotes. Table 2. Heat Pump HVAC Project Estimate Comparison Between Gas, Electric Heat Pump, and Peninsula Clean Energy Predicted Costs Project 2 High Quotes Explained: • $6,980 out of the total cost is related to a heat pump water heater, meaning part of the total project estimate was associated with another project this customer plans to do simultaneously. • The address has a split system (one condenser and four heating units spread through the building) serving the downstairs and it requires more ducting and equipment. o The upstairs units use existing ducting, which is lower cost, because they are replacing a gas rooftop unit (RTU) with a heat pump packaged unit Project 5 Quotes Explained: This customer’s total project cost is significantly higher than usual for a project like this. This is because this customer redid their ducting and piping, which also resulted in added carpentry and painting costs. They also had additional electrical work done. • This is the percentage split cost breakdown of the $541,000 project total. o Carpentry, painting and electrical 21% o Equipment (condensers outdoor units and fan coils with new stats) 13% o Piping (drain pans, condensate piping and hard copper piping for long runs) Labor and material 28% o HVAC & Refrigerant (line sets, refrigerant and duct connections, including new plenums) Labor and material 37% Project 8 Low Gas Quote Explained: This participant did not address the cost differential in his documentation. The contractor who provided him with these quotes has been unresponsive, so he is now going to reach out to a new potential contractor to receive new quotes. Project 10 Quotes Explained: This participant’s higher heat pump HVAC quote reflects several factors: higher equipment and material costs compared to the gas alternative, additional work such as line setting, conduit, and breaker installation, and higher anticipated permitting expenses. In contrast, the gas quote did not account for replacement of the AC units. If those costs had been included, the “like-for-like” comparison would have been closer. Completed Project Details As of September 16, 2025, three customers have fully completed their projects. Table 3-5 highlights the cost comparison between these customer’s initial quote, final project cost, and rebate paid. Table 3. Dollar Comparison Between Project #1’s Quote, Project Cost, and Rebate Please note that this customer’s total project cost is less than the original price estimate received in the quote because the customer negotiated a lower cost when hiring the contractor to work on multiple projects at once. The City’s rebate covered 96% of this customer’s project cost. Table 4. Dollar Comparison Between Project #5’s Quote, Project Cost, and Rebate This customer’s costs increased from the original quote due to added work by the contractor and permitting costs, which were $1,268.90. The City’s rebate covered 17% of this customer’s project cost. Table 5. Dollar Comparison Between Project #7’s Quote, Project Cost, and Rebate This customer’s total project cost was higher due to the addition of a phase 2 to their project and the $1,437.84 permit fee. This addition came after the quotes were processed and phase 1 was completed. The reason for their decision to replace another unit was due to the increased rebates offered by CPAU and the ease of completing phase 1. Due to the added unit on this project, their rebate came out to be $43,750, which covered 67% of their total project cost. Installation Location for HP HVAC Equipment At this time, we do not have complete data on the installation locations of the heat pump HVAC equipment for all applicants. Among those who have submitted site plans or permit information, four projects consist of rooftop HVAC units. Due to the structure of the rooftop, three projects are ground- level installations. The installation location for the remaining 6 active participants is currently unknown. It is also possible that some customers may install equipment in both rooftop and ground locations, but this has not been confirmed. Table 6 below summarizes the number of customers in each category. Table 6. Locations of Installed Heat Pump HVAC Equipment Summary of Permitting Comments As of September 15, 2025, 7 customers have applied for the commercial heat pump HVAC permit through the City’s Planning and Development Services (PDS) Department. Here is a consolidated list of corrective comments provided to the customers and their contractors from the City’s PDS Department. Many customers who participated in the pilot program received similar feedback on their permit submissions. Learning about these recurring comments help us understand where there are gaps in permitting instructions and opportunities on where we can smooth out the process for customers. When submitting plans, PDS wants all details to be accurate and documentation to be complete, including manufacturer’s specs that match the project plan details, showing where equipment and electrical panels will be located, and clearly labeling the mechanical and electrical scope. Plans must show property lines and setbacks. For rooftop equipment, engineers need to confirm the roof can handle the added weight, show how it will be anchored, and provide details on ductwork, drains, and demolition. Wood blocks (sleepers) aren’t allowed unless fully roofed over. The City also checks for noise and safety. Equipment must meet local noise limits, and an acoustical engineer’s report or post-installation testing is required. Fire safety permits are needed for both refrigerant removal and installation, and the Fire Department requires notes on the plans and how the HVAC system connects with the fire system in the building. A special inspection form must also be submitted, listing contractors, agencies, and required safety checks. Overall, the City’s goal is to make sure projects are well-documented, safe, and considerate of the community. Based on the permitting requirements outlined above, some customers were able to provide details on the additional costs some of these requirements added to their projects. For the structural analysis, one customer’s initial cost for this study was around $25,000. There is a possibility there will be an added cost of $12,000-$15,000 if the City’s PDS requires additional analysis for the curbs. For the HazMat permitting, one customer was quoted $5,000. This is not confirmed though, since the customer hasn’t completed this portion of the permit yet. There has been mixed feedback on the added cost for the sound engineering analysis. One customer was told the cost would be “insignificant.” On the other hand, another customer was quoted $10,000-$12,000. It has been challenging to pinpoint the exact cost of each study because most engineers group the costs in the final invoice. We are waiting for more feedback on these items as projects move forward.