City Council
Staff Report
From: City Manager
Report Type: STUDY SESSION
Lead Department: Public Works
Meeting Date: May 12, 2025
Report #:2503-4421
TITLE
Discussion of Strategies for the Use of Low Carbon Fuel Standard, Electric and Gas Cap and Trade, and Electric and Gas Public Benefits Revenues; CEQA Status - Not a Project
RECOMMENDATION
This is a study session item and no Council action is requested. Staff is requesting feedback on its strategy for the use of Low Carbon Fuel Standard, Electric and Gas Cap and Trade, and Electric and Gas Public Benefits revenues in the FY 2026 Budget. In addition, staff requests feedback on proposed general guidelines for future adoption regarding the use of Public Benefits revenues.
EXECUTIVE SUMMARY
The City, through operating a utility, receives and collects revenues designed to promote efficiency, conservation, and emissions reduction, and which can also be used in ways that reduce electric and gas rates or bills. These include revenues related to State-mandated participation by both the electric and gas utilities in the Western Climate Initiative Cap and Trade Program (Cap and Trade), the electric utility’s participation in the State’s Low Carbon Fuel Standard Program, and mandated electric and gas utility spending on public benefits programs.
Each revenue source has its own regulatory constraints, but within those constraints Council direction has generally been to prioritize efficiency, conservation, and emissions reduction.
To date, these revenue sources have been used to buy renewable energy, fund low-income programs, deliver energy efficiency programs, and for building and vehicle electrification. While Cap and Trade revenues have been routinely utilized by PG&E and many publicly owned utilities to customers in the form of “climate credits”, Palo Alto has not historically used the funds in that manner. However, staff and the Utilities Advisory Commission currently recommend use of $1.6 million for a one-time climate credit in FY 2026 to mitigate the impact of proposed gas rate increases on residential gas customers.
The City is completing a Sustainability and Climate Action Plan (S/CAP) Funding Study to develop potential strategies for scaling up building and vehicle electrification in line with the S/CAP goal of reducing emissions 80% from 1990 levels by 2030 (80x30 goal). Discussions on these strategies will take place with the Climate Action and Sustainability Committee, other Committees or Commissions, and the full Council throughout 2025. This study session item will support discussions of longer-term commitments of these revenue sources for renewable energy procurement to meet State RPS mandates, climate programs, rate and bill reduction, and other utility purposes.
For the FY 2026 budget, staff is proposing to continue spending on renewable energy and energy efficiency, and to expand building and vehicle electrification program spending for one year in support of Council Climate priorities and the S/CAP 2023-2025 Work Plan Climate work items. Staff is also recommending the addition of a one-year gas climate credit for rate relief.
Given the complexity of the current economic, budgetary, and policy environment and the need to balance community climate goals, utility rate affordability, and other community goals, staff is seeking to brief Council on this strategy as part of the FY 2026 budget process.
In developing these strategies staff noted the difference between the Cap and Trade and Low Carbon Fuel Standard revenue sources, which have formal Council policies adopted by resolution outlining uses of funds, and the Public Benefits funds, which do not. Spending for Public Benefits is determined by regular budget adoption and goal setting, but it would be helpful to establish policies to guide development of budget proposals going forward. Staff is seeking feedback regarding a proposal for formalizing the acceptable uses of Public Benefits revenue sources.
BACKGROUND
The City receives or collects special non-rate revenues related to several programs as part of its operations as a public utility:
•Cap and Trade: The City is allocated allowances as part of the State-mandated participation by its electric and gas utilities in the Western Climate Initiative Cap and Trade Program (Cap and Trade). The mandated sale of these allowances generates revenues (Electric and Gas Cap and Trade revenues).
•Low Carbon Fuel Standard: The City receives credits under the State’s Low Carbon Fuel Standard (LCFS) program for delivering electricity to electric vehicles (EVs) in Palo Alto. It auctions these credits to fossil fuel suppliers, who are required to buy them to fulfill program mandates.
•Public Benefits: The State mandates that electric utilities collect a surcharge equal to a fixed percentage of revenues (the Public Benefits surcharge) and use those revenues for specific public purposes. The State also requires gas utilities to provide certain types of public purpose programs if they want to avoid paying into a collective fund run by the California Energy Commission to provide those programs.
These revenue sources are subject to various state laws and regulatory requirements and Council policies (summarized below and in more detail in Attachment A):
•Cap and Trade revenues must be used for GHG emissions reduction programs (including renewable energy, efficiency, fuel switching, SF6 reduction, and more, with different opportunities for the gas vs. electric utility) or returned to ratepayers on a non-volumetric basis as a climate credit. Council has adopted a policy1 for the use of Cap and Trade revenues and has expressed a preference for emissions reductions over climate credits.
•LCFS revenues must be used for the benefit of current or future EV owners, with a particular focus on income-qualified EV owners. Council has adopted a program2 for the use of LCFS revenues focused heavily on education and outreach and on multi-family EV charging.
•Public Benefits revenues must be used for electric or gas efficiency, research and development, low-income programs, and may be used to buy renewable energy for the electric utility. Council has approved spending plans for Public Benefits revenues and has expressed policy goals through the adoption of energy efficiency goals and local solar plans. However, no general statement of policy preference exists for Public Benefits revenues as exists for Cap and Trade and LCFS revenues.
Attachment A summarizes the regulatory requirements, Council policies, the history of policy adoption and approved uses of revenues, and examples of allowable uses of revenues.
Historically, Council has approved the use of Cap and Trade, LCFS, and Public Benefits revenues to buy renewable energy, deliver energy efficiency and local solar programs, and for building and vehicle electrification, as shown in Attachment B. Challenges through the pandemic have resulted in a slower spend of some (but not all) of these funds than planned resulting in some increased reserve levels. However, the programs and activities anticipated for sustainability and climate actions far exceed these funds in total, which is what the long term funding strategy seeks to look into for sustainable funding sources. Some of these funds must also be spent within 10 years of collection, which is a consideration for Gas Cap and Trade funds in particular.
1 Resolution 10077, October 3, 2022, Resolution of the Council of the City of Palo Alto Amending the City’s Policy on the Use of Freely Allocated Allowance Under the State's Cap-and-Trade Program and Authorizing the City Manager to use $1.25 million from the Gas Utility Cap and Trade Reserve for the Advanced Heat Pump Water Heater program - also see Attachment A for more detail. 2 Resolution 9871, December 2, 2019, Resolution Amending Utility Rate Schedule E-15 (Electric Service Connection Charges), and Approving Updates to the City’s Program for use of Revenues from the Sale of Low Carbon Fuel Standard Credits – also see Attachment A for more detail
ANALYSIS
Strategy for FY 2026 Budget Process
There are several community priorities these revenues could be helpful in advancing:
•Achieving 80x30 and other S/CAP climate goals.
•Meeting or exceeding State Mandates on Renewable Portfolio Standard of 60% by 2030. •Implementing programs supportive of State and regional vehicle and building electrification regulations.
•Maintaining electric competitive utility rates for affordability and promoting fuel switching. •Advancing community goals, some of which are also emissions-reducing, such as municipal electrification or local resiliency.
FY 2026 Proposals for Use of Cap and Trade, LCFS, and Public Benefits Charge Reserves and Revenues
Staff has submitted budget and rate proposals in FY 2026 consistent with the following strategies:
•Focused climate spending on programs that are Council Priority Objectives and in the 2023- 2025 S/CAP Work Plan, with initial budgets large enough for scalable “proof of concept” with the recognition that staff may return to Council to request additional funds through budget amendments based on need and program effectiveness. •Continued funding of the City’s renewable portfolio from Electric Cap and Trade revenues, which helps maintain the City’s lower utility rates compared to surrounding cities, thereby improving the cost-effectiveness of electrification.
•A distribution of single year gas climate credits to gas residential customers (at a cost of $1.6 million). The proposed credit is recommended in the FY 2026 Gas Utility Financial Forecast by the Utilities Advisory Commission (UAC), and was reviewed by the Finance Committee on April 15, without action taken.
Staff is proposing a strategy focused on shorter-term proposals to allow discussions planned in 2025 on strategies for scaling up climate action to take place, in line with Council‘s 2025 Climate Action and Adaptation & Natural Environment Protection Priority Objective 28.
Preliminary results from the S/CAP Funding Study performed to support this objective are showing community electrification to be a net benefit, even on the accelerated time scales of the 80x30 and other S/CAP climate goals, though costs and benefits vary among customers, time frames, and equipment types.3 But various factors mean creativity will be needed to design programs to realize that net benefit. For example, the costs and the benefits are different depending on the technology and across different groups of community members.
Also, the savings in household expenses from electrified equipment are realized over time, 3 For more information, please see the April 4 Climate Action and Sustainability Committee report on this topic:
https://cityofpaloalto.primegov.com/meetings/ItemWithTemplateType?id=7672&meetingTemplateType=2&comp iledMeetingDocumentId=13682
while the up-front cost of the equipment can be higher than the cost of gas equipment replacements.
The S/CAP Funding Study has given staff the modeling tools needed to design creative program proposals, and staff intends to bring alternatives to policymakers over the coming year. But these programs may need significant funding to pilot. In the long-term, staff anticipates the need to design these programs to attract outside capital to cover the higher up-front costs of electrification improvements. But to prove the program models work, pilots would be needed with funding to cover the up-front costs.
Cap and Trade, LCFS, and Public Benefits are good sources of funding for pilot programs, and for meeting State-mandated Renewable Portfolio Standards without devoting General Fund money. Therefore, staff is following a strategy in the FY 2026 budget of balancing spending of these revenue sources, targeting climate programs, new renewable energy power purchase agreements, and short-term natural gas rate relief to give the City Council time to develop its priorities for Climate Action programs in the 2026-2027 time period. This approach also gives time to better understand the economic climate. With this information in hand, decisions about longer-term program commitments can be made through the FY 2027 budget process.
The following sections outline some of the potential opportunities and tradeoffs staff considered in developing its FY 2026 proposals organized in the following sections:
•Opportunities for climate programs to support 80x30 and S/CAP climate goals •Opportunities for State and Regional regulatory support •Opportunities for utility bill competitiveness
•Opportunities to support other community goals.
Investment levels in each of these choices are not binary decisions, rather a blend of opportunities could be pursued among the priorities though stability for customers and programs is something to consider. However, every mix of policy choices involves tradeoffs. In its FY 2026 budget proposal staff has attempted to strike a balance between these various goals, and will continue to do so in future fiscal year proposals.
Opportunities for climate programs to support 80x30 and S/CAP climate goals To -date, the City has been pursuing a three-phase strategy in scaling up climate action:
•First, run early pilots and do studies to support expanded pilots; •Second, run large pilots focused on early adopters; and •Third, use the lessons learned from large pilots to develop scalable programs to serve the majority of Palo Altans.
In the 2023-2025 Work Plan, the City focused on the first phase of the strategy, including studies and small-scale pilots, in areas like small and medium business electrification, major facility electrification, and affordable housing electrification. Larger-scale pilots have been conducted for early adopters in single-family building electrification (especially the 1000-unit Advanced Heat Pump Water Heater Pilot Program and the 150-unit Whole Home Electrification Program), and a multi-family EV charging program on track to achieve EV charging in buildings representing 10% of multi-family units in Palo Alto. These pilots help the City understand community decision-making, identify barriers like permitting and utility connections, create outreach strategies, and develop scalable financial models. The second phase larger pilots, costing between $5 million and $9 million, cover the incremental up-front installation costs for many early adopters, with long-term community benefits that offset some or all of these costs, some of which accrue to the City, partially offsetting the costs of the pilots. The programs aim to find financial strategies to attract outside capital, but until those strategies are proven, funding is needed for up-front costs. This could require $25 million to $40 million in funding through 2030.
In coming years, staff anticipates the need for advanced pilots in the areas of small and medium business electrification, major facility electrification, affordable housing electrification, public EV charging, and multi-family building electrification. Lessons learned from advanced pilots in one area are not necessarily directly transferrable to other areas, since different property owners have different ownership structures and uses for their buildings, the outreach strategies vary, the types of equipment in each building can differ, and the strategies for property maintenance can differ. In FY 2026, in line with Council priority objectives and the 2023-2025 S/CAP Work Plan, staff is proposing:
•A “proof of concept” advanced pilot for small and medium business rooftop HVAC electrification.
•Smaller pilots for major facility electrification and central space and water heating in multi- family buildings.
•Expansions of the advanced pilots for single-family building electrification and multi-family EV charging to move these programs closer to a scalable program design.
California Air Resources Control Board (CARB) has provided guidance on the use of LCFS funds; CARB is expected to provide guidance on Cap-and-Trade funds in 2026. It is worth noting that some of the funding sources discussed can also be used to achieve Mobility goals to ramp up participation in alternative transportation modes and achieve transportation emissions reductions. These funding sources could be useful for pilots in the areas of micromobility and promoting bicycling and walking based on studies currently being done in those areas by the Office of Transportation.
Opportunities for State and Regional regulatory support Two regulations have the potential to significantly accelerate vehicle and building electrification – Advanced Clean Cars II and the Bay Area Air District Zero NOx standards:
•The Advanced Clean Cars II regulation requires 100% of vehicle sales in California to be emissions free by 2035.
•The Bay Area Air District’s Zero Nox standards come into effect in phases. At each phase, the sale of these appliances becomes prohibited in the Bay Area:
o2027: Residential-scale gas water heaters
o2029: Gas space heaters
o2031: Commercial-scale gas water heaters
Local agency support will help these mandates be successful, in the form of incentives, financing, and technical assistance due to the lower familiarity of the market with these technologies and the higher up-front cost. Examples of support include:
•Facilitating access to EV charging for multi-family residents, either publicly available or in multi-family parking lots. The costs of these chargers are significantly higher than in single- family homes and the logistics of installation are more complex. •Facilitating transformer upgrades for larger multi-family buildings either separately or as part of the multi-year grid modernization program.
•Providing help to homeowners and condo owners whose mandated building electrification projects are more complex. This could include technical assistance or incentives. •Providing assistance programs for those who cannot afford the increased cost of the electrified equipment.
•Financing the higher up-front costs for other homeowners may be desirable, with repayment being at least partially offset by long-term bill savings.
The cost of programs like the ones listed above is estimated to be in the range of $20 million to $30 million through 2030, though there is some overlap between these costs and the potential costs noted above for pilots to achieve the 80x30 and S/CAP climate goals.
Opportunities for utility bill competitiveness
Other agencies in the Bay Area deliver both utility services and climate programs: publicly owned utilities (POUs) and community choice aggregators (CCAs). Examples of local POUs include City of Alameda Municipal Power (AMP) and Silicon Valley Power (SVP), the electric utility for the City of Santa Clara. Nearby CCAs include Peninsula Clean Energy (PCE), Silicon Valley Clean Energy (SVCE), San Jose Clean Energy (SJCE), and Ava Community Energy, formerly East Bay Clean Energy. All of these agencies work to strike a balance between keeping bills competitive, enhancing customer programs, and reducing emissions, with different weighting on the two different types of efforts varying from agency to agency.
For the median Palo Alto electric utility customer, Palo Alto bills are lower than all other agencies in the Bay Area but one, ranging from 8% lower to 50% lower. SVP, which has a far larger share of revenue-generating industrial loads than other utilities, has lower rates. All utilities and CCAs except SVP, SJCE, and Ava maintain 100% carbon free electricity from renewable, hydroelectric, and nuclear sources in their base rates. SVP allocates its carbon free energy to its residents, who make up about 6% of its load, and its natural gas and unspecified market power to its commercial customers. Ava (previously East Bay Clean Energy) also purchases some market power from unspecified sources.
Table 1: Electric Bill Comparison
Agency
Est. Monthly Electric Bill
at Palo Alto Median
Electric Usage
Palo Alto Bill %
Higher or Lower
% Carbon Free
Energy
City of Palo Alto $83.73 100%
PCE $164.97 -49% 100%
SVCE $165.57 -49% 100%
AMP $91.27 -8% 100%
SVP $69.02 21% 100% (Res)
53% (Comm)
Ava $159.57 -48% 89%
PG&E $167.97 -50% 100%
Chart 1: Electric Bill Comparison
Most other Bay Area agencies are providing significant funding for climate programs. PCE, SVCE, and Ava maintain rates close to PG&E, above what is needed to recover their cost of providing energy, and part of this revenue is used to fund customer programs. Like Palo Alto, AMP has dedicated all of its Cap and Trade revenue and revenue from renewable energy credit exchanges for climate programs and purchases of renewable energy resources. SVP uses it for renewable energy resources, energy storage projects, customer rebates (solar, storage, EV charging incentives) and higher discounts to low-income customers and uses allowances to cover its emissions compliance requirements in a similar way that Palo Alto uses allowances to cover its gas utility compliance requirements. PG&E uses its public purpose funds for energy efficiency and building electrification, among other purposes. $0.00
$20.00
$40.00
$60.00
$80.00
$100.00
$120.00
$140.00
$160.00
$180.00
City of
Palo Alto
PCE SVCE AMP SVP Ava PG&E
If the City, rather than expending funding on climate pilots to advance 80x30 and S/CAP climate goals, instead focused on electric rate competitiveness and supporting State and regional regulations, there would be an opportunity to reduce rates about 2% through 2030, equal to about $1.67 per month on the median residential bill. Some of the funding sources that would need to be used for this reduction do not extend past 2030. Various State leaders have stated an intent to extend the Cap and Trade program, but it is still unclear what revenues would be allocated to publicly owned utilities in that extension.
The City maintains comparable rates to PG&E for most gas customers, with the exception of some commercial customers. This is true despite the fact that PG&E uses its Gas Cap and Trade revenue to provide climate credits to residential and small business customers. The Council has expressed a policy preference for the use of Gas Cap and Trade revenues for emissions reduction rather than climate credits, but if it were to adjust that policy there would be an opportunity to reduce gas rates about 7% to 8% through 2030, which would be equal to about $5 to $7 per month on the median residential gas bill. Gas Cap and Trade revenues do not extend past 2030, so rates would need to be increased again unless the State extended this revenue source for the City.
Opportunities to support other community goals
These funding sources can be deployed to achieve other community goals as well, such as municipal electrification or resiliency projects. And, of course, as noted above, City alternative transportation projects that reduce emissions are also eligible uses of funds.
There are already incentives available for electrification of City facilities via the City’s commercial electrification incentive programs, and the City is taking advantage of those incentives wherever possible. But heavy-duty vehicle electrification, both the chargers and the vehicles themselves, represent a unique City need. These funding sources could likely be used for this purpose, with the understanding that while these programs would yield emissions reductions, they would not yield scalable program results since the City is one of the only heavy fleet operators in Palo Alto, and is perhaps the only one, unless new facilities (e.g. for rideshare or transit agencies) are built. The City is still working to determine the systemic cost of fleet electrification, so no cost estimates are included here, but there is an upcoming purchase of a low-emissions fire vehicle that is expected to cost $700,000 more than a comparable internal combustion version.
Local resiliency, both short-term (outages under 24 hours) and long-term (outages lasting for days or weeks), is an important consideration if the community continues to pursue an electrified future. Investing in local solar and storage projects can be more expensive than investing in utility-scale projects outside Palo Alto, but if located within the community, these projects could also provide resiliency. The City currently supports these projects via its net energy metering program, which enables residents to reduce their utility bills by connecting solar and storage behind the meter, and its Palo Alto CLEAN program, which pays solar and storage owners for every kWh of energy delivered to the City’s electric system. These solar and storage systems, if configured as microgrids, can be connected to specific circuits within buildings to provide additional resiliency during short-term or longer-term outages. If the City wanted to increase its support to local microgrid projects, these funding sources could be used as an alternative to the use of ratepayer funds (as were used for the Palo Alto CLEAN). Staff is currently analyzing various strategies to achieve the community’s resiliency goals as part of its implementation of the Reliability and Resiliency Strategic Plan and does not yet have cost estimates.
Establishing a Policy for Use of Public Benefits Funds
As noted above, the Council has approved policy documents for the use of Electric and Gas Cap and Trade and LCFS revenues. Staff recommends a similar policy document for Electric and Gas Public Benefits revenues. Staff has drafted a policy for Council feedback (Attachment C). This policy provides more specificity on how these revenues can be used in compliance with State law. A summary of the uses noted in the policy are shown in Table 2 below, though the policy does not preclude other legally compliant options:
Table 2: Proposed Council Policy: Public Benefit Programs Utility Regulatory Section Uses Noted in Council Policy Public Utilities Code Section 385, enacted in 1996, requires all POUs to collect a usage-based charge to fund investments in four areas:
(1) Cost-effective demand-side
management services to promote
energy efficiency and energy
conservation
•Energy efficiency and conservation
•Building electrification as an energy
efficiency measure
•E-bikes and other small EVs as
transportation efficiency
(2) New investment in renewable
energy resources and technologies
consistent with existing statutes and
regulations which promote those
resources and technologies
•Utility-scale renewable energy
resources
•Local renewable energy (could include
energy storage or be configured as a
microgrid)
(3) Research, development and
demonstration programs for the public
interest to advance science or
technology not adequately provided by
competitive and regulated markets
•Small pilots of emerging energy or
electrification technologies or
program delivery mechanisms
Electric
(4) Services provided for low-income
electricity customers, including, but
not limited to, energy
efficiency services, education,
weatherization, and rate discounts
•Low-income efficiency
•Low-income rate assistance
•Low-income vehicle electrification,
including EV charging
•E-bikes and other small EVs as
transportation efficiency
Gas Public Utilities Code Section 890, enacted in 2000, imposes a surcharge on all natural gas consumed in California to fund certain public purposes (listed below). Municipalities that offer programs similar to those set forth below are not required to collect the surcharge:
•Low-income rate assistance and weatherization
•Cost effective energy efficiency and conservation measures •Public interest research and development
The proposed Council policy restates these objectives without elaboration, though it would be possible to elaborate further in the policy on the types of programs the Council wants to prioritize in this area.
FISCAL/RESOURCE IMPACT
The fiscal and staffing resource impact of decisions on the use of these revenue sources will depend on the spending decisions made. The impacts of different spending decisions are included above in the description of each listed spending opportunity. In general, climate programs to further the 80x30 goal require significant staff time and resources, as noted above.
Commitments to State and Regional regulatory support require slightly lower, but still significant staff time and resources. Committing funds to new renewable energy resources to meet State RPS goals requires the least staff time and helps maintain competitive utility rates in comparison to other public owned utilities.
The fiscal impact of staff’s proposed FY 2026 Climate budget items will be provided as part of the FY 2026 budget process.
STAKEHOLDER ENGAGEMENT
Staff has not done outreach beyond public hearings (e.g. UAC, Finance, Council) on the use of these revenue sources. Staff has held numerous public hearings on the S/CAP over the past decade and holds public hearings on utility rates annually. Staff plans to continue these types of hearings in the future. The Air District has done public outreach and held hearings about its Zero NOx regulations.
ENVIRONMENTAL REVIEW
Council’s discussion of the use of these revenue sources is not a project as defined by CEQA because it does not involve any commitment to any specific project which may result in a potentially significant physical impact on the environment. CEQA Guidelines section 15378(b)(4).
ATTACHMENTS
Attachment A: Summary of State regulations and Council Policies for Cap and Trade, LCFS, and Public Benefits
Attachment B: Cap and Trade, LCFS, and Public Benefits Reserves, Revenues, and Expenses Attachment C: Proposed Policy on the Use of Electric and Gas Public Benefits Funds APPROVED BY:
Brad Eggleston, Director Public Works/City Engineer
Kiely Nose, Interim Utilities Director