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City Council
Staff Report
From: City Manager
Report Type: CONSENT CALENDAR
Lead Department: Utilities
Meeting Date: December 1, 2025
Report #:2506-4908
TITLE
PUBLIC HEARING: Finance Committee Recommends City Council Adopt a Resolution Approving the 2026 Natural Gas Cost of Service Analysis Report, Amending Rate Schedules G-1 (Residential Gas Service), G-2 (Residential Master-Metered and Commercial Gas Service), G-3 (Large Commercial Gas Service) and repealing G-10 (Compressed Natural Gas Service). CEQA Status: Not a Project under Public Resources Code Section 21065.
RECOMMENDATION
The Finance Committee recommends that the City Council adopt a resolution (Attachment A) that:
1. Approves the 2026 Natural Gas Cost of Service Analysis Report (Exhibit 1 to Attachment A); and
2. Amends Rate Schedules (Exhibit 2 to Attachment A) effective for gas usage beginning February 1, 2026 (FY 2026):
a. G-1 (Residential Gas Service)
b. G-2 (Residential Master-Metered and Commercial Gas Service) c. G-3 (Large Commercial Gas Service)
3. Repeals Rate Schedule G-10 (Compressed Natural Gas Service) 1
EXECUTIVE SUMMARY
Staff revised the Natural Gas Cost of Service Analysis from the version reviewed in May and June 2025 in collaboration with the Utilities Advisory Commission as directed by the City Council. Council approval of this report and resolution would approve the 2026 Natural Gas Cost of Service Analysis Report (2026 Report) shown in Exhibit 1 to Attachment A and adopt 1 Rate Schedule G-10 (Compressed Natural Gas Service)
https://www.paloalto.gov/files/assets/public/v/10/utilities/rates-schedules-for-utilities/city-facility-utility-rates/g- 10-effective-2025-07-01.pdf
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revised gas rate schedules shown in Exhibit 2 to Attachment A, resulting in revised Gas rates for customers effective February 1, 2026.
The 2026 Report does not propose any budget or overall revenue increase; instead, the focus of the 2026 Report is on a proportional rebalancing through rate design changes. Specifically, updates to the allocation of costs among customer classes and a refined G-2 rate schedule better reflect the cost to serve customers with different meter capacities. The proposed rate adjustments are designed to ensure equity among rate classes, maintain compliance with cost- of-service principles under California law, and align with the City’s financial and policy objectives for affordability, transparency, and long-term sustainability. The proposed rate adjustments are also consistent with the City Council-approved design principles.3 The Gas Utility implemented an across-the-board rate increase on July 1, 2025 to meet the higher costs of providing service to its customers. These rebalanced rates are proposed to be effective on February 1, 2026, and the 2026 Report also provides the analytical basis for allocating costs among classes to meet revenue requirements in future years. In summary, key changes from the last cost of service study adopted by City Council in 2020 include:
1) Updating the weighted meter cost - the 2026 Report refreshes the Gas Utility’s rates with the best possible cost information, which is necessary to achieve fair and cost- based rates.
2) Updating the Average & Excess (A&E) Method – the 2026 Report’s cost allocation approach better aligns rates with how the distribution system is designed and built in light of declining average gas use. Infrastructure is sized based on energy usage and peak demand which supports the A&E classification as both “demand” and “energy.” This change is necessary to develop a fair and appropriate allocation of expenses across customer classes.
3) Applying the Base & Excess Method for Residential Tier Rate – the 2026 Report’s calculations present the best method for the G1 tiered rate design because the usage profile supports measuring excess demand using the highest peak month and because system infrastructure is designed to meet a single January peak. 4) Refining the G-2 (Multi-family Master-Metered and Commercial) Rate Schedule – the 2026 Report recommends separating this class into three meter capacity groupings by Standard Cubic Feet per Hour (scfh), because the larger meters require a higher cost to serve. This refinement results in a higher monthly service charge for larger capacity meters to better reflect customer-related fixed costs in the fixed monthly service charge.
3 Staff Report 2507-4958, September 15, 2025 outlines the five design principles:
https://cityofpaloalto.primegov.com/api/compilemeetingattachmenthistory/historyattachment/?historyId=043ab d5a-f59f-4702-ad04-845541a8133f
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The overall bill impact to the median use residential customer from the recommendations in the 2026 Report is an 8% increase, while the bill impact for commercial customers ranges from a 58% decrease for small commercial customers to a 7% increase for the largest G-2 commercial customers. Table 6 below shows additional bill impact details.
Staff worked closely with guidance from the Utilities Advisory Commission Gas COSA Subcommittee on developing the recommendations in the 2026 Report. Staff appreciates the extensive efforts of the Subcommittee members including meeting four times between August and October 2025. Gas COSA Subcommittee members provided a verbal report to the full UAC at the November 5, 2025 meeting. Ultimately, after much discussion, a majority of the UAC recommended approval of the resolution and corresponding rates (5 approved, 1 dissent, 1 absent). On November 18, 2025 the Finance Committee reviewed the 2026 Report, heard a verbal report from a UAC Gas COSA Subcommittee member, and unanimously recommended that the City Council adopt a resolution approving the 2026 Report and revised rate schedules.
BACKGROUND
In June 2025, the City Council (Council) approved the overall gas utility rate increase for FY 2026 but deferred approval of the Cost of Service Analysis (COSA) pending further UAC review.5 On July 9, 2025, the Utilities Advisory Commission (UAC) considered Design Principles for the Gas and Electric Cost of Service Rates and voted to move forward with Proposition 26 as the Gas COSA design principles and to form a UAC Subcommittee to work with staff and the consultant to develop a new 2026 gas COSA and provide regular report-outs to the full UAC.6 Subsequently, staff worked closely with the UAC Gas COSA Subcommittee to review key study assumptions and recommendations.
On September 15, 2025, the Council directed staff to follow the reasonable-cost analysis required by Proposition 26 and to collaborate with the UAC to develop revised gas rates to be effective in 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.
5 On June 16, 2025, the City Council voted 5-1-1, (Lythcott-Haims no, Stone absent) to return the updated COSA to the UAC for further review. See June 16, 2025 action minutes for action item 22, Gas Utility item e:
https://cityofpaloalto.primegov.com/Public/CompiledDocument?meetingTemplateId=16148&compileOutputType =1
6 July 9, 2025, UAC voted 6-1 with Gupta voting no; see action minutes https://cityofpaloalto.primegov.com/api/compilemeetingattachmenthistory/historyattachment/?historyId=40dc6 4ea-7e0c-4dca-9235-61e1a6516b07
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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.
These design principles form the basis for the 2026 Gas Cost of Service Analysis Report presented as Exhibit 1 to Attachment A. Each design principle is discussed below in the “Analysis - Gas COSA Design Principles” section.
The Utilities Advisory Commission (UAC) considered this item at its November 5, 2025 meeting, agenda item 49. Ultimately, a 5-1 majority of the UAC recommended Finance Committee and City Council approval. The UAC Subcommittee reported that staff and the cost-of-service consultant had met multiple times over several months, and answered every question the UAC Subcommittee members had, which built confidence in the process and resulted in a clear and transparent staff report and cost-of-service report that achieves a reasonable cost allocation.
Additionally, the UAC Subcommittee members noted that by updating the mechanics of the cost-of-service analysis, the resulting rates are more affordable for residential customers than if the mechanics of the 2020 cost-of-service study were retained. The UAC Subcommittee members also approved of the fact that the use of “green” funds10 are no longer being proposed to subsidize gas service. The UAC Subcommittee members raised a question for discussion in the context of future potential gas decommissioning about what the reductions in the G2 service charges means for the city’s decarbonization and electrification efforts. A minority of commissioners articulated concern with a lack of understanding of reducing the small G2 meter charge by approximately 80% and one commissioner expressed a concern that this disincentivizes electrification measures for small businesses. A representative from the UAC Subcommittee will be available to aid in the Finance Committee discussion as well.
ANALYSIS
This project is a study to update the City’s Natural Gas Cost of Service Analysis (2026 Report), which provides the analytical foundation for and recommends adopting new City gas rates that continue to be fair and legally compliant. The 2026 Report evaluates the gas utility’s revenue requirements, allocates costs among customer classes based on cost-causation principles, and proposes updated rate designs for each class based on the most up-to-date information available to the City.
9 November 5, 2025 UAC meeting item 4,
https://cityofpaloalto.primegov.com/Portal/Meeting?meetingTemplateId=17466 10 By “green” funds the Commissioner was referring to Cap and Trade auction revenue. 7 6
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The 2026 COSA includes an updated financial forecast (consistent with the Council-approved FY2026 Gas Utility Financial Forecast),13 refined cost allocation methodologies, and new meter capacity groupings for the G-2 rate schedule. The proposed rate changes ensure rates are aligned with actual service costs.
Natural Gas Cost of Service Analysis
The Gas Utility’s rates are evaluated and implemented in compliance with cost-of-service requirements set forth in the California Constitution and applicable statutory law. Staff engaged the services of EES Consulting (EES) to review and revise the Gas Utility’s Cost of Service (COS) for FY 2026.14 A copy of the FY 2026 COS study titled “City of Palo Alto 2026 Natural Gas Cost of Service Analysis Report,” (2026 Report), November 2025 is included as Exhibit 1 to Attachment A to this report. The study examines and allocates the Gas Utility’s costs to each rate class to develop proposed FY 2026 distribution rates and includes a recommendation to refine the G-2 rate schedule as explained below.
Distribution Revenue Requirement
The 2026 Report contains gas sales forecasts and estimates for Gas Utility assets and expenses (including estimated contributions to reserves). The 2026 Report allocates these assets and expenses estimates using updated classification and allocation factors to ensure that the Gas Utility’s costs are properly assigned to each rate class. The 2026 Report uses the same estimate of total distribution revenue requirement of $41.3 million for FY 2026 that was approved by Council on June 16, 2026 as part of the FY 2026 Gas Utility Financial Forecast.15 This distribution revenue requirement includes operating expenses, capital costs and reserve contributions. At current rates, projected revenues also equal $41.3 million for FY 2026, so there is no overall rate or revenue increase required as part of the 2026 Report for the Gas Utility as a whole.
However, individual customer class rates will change as a result the realignments as summarized in Table 1.
Table 1 illustrates the projected revenue collected from each customer class using current distribution rates (for the full year of FY 2025-2026 assuming the rates were effective all year) and using the rates resulting from the 2026 Report. The total revenue requirement is the same as that shown in the Council-approved FY 2026 Gas Utility Financial Forecast. This revenue requirement estimate includes distribution costs, certain supply costs (such as administrative charges allocated to gas supply), and additional reserve contributions required to restore the Gas Utility’s operations reserve to within the guideline range in FY 2026. Supply-related costs that are collected via a pass-through charge are not included. 13 Staff Report 2411-3776, June 16, 2025,
https://cityofpaloalto.primegov.com/api/compilemeetingattachmenthistory/historyattachment/?historyId=35104f 06-6925-4fe3-89c7-b0e53e6eec42;
Resolution 10232 https://portal.laserfiche.com/Portal/DocView.aspx?id=200675&repo=r-704298fc 14 Since FY 2021, the City adjusted its distribution rates annually based on the COS study for FY 2020, which was also conducted by EES.
15 Resolution 10232 https://portal.laserfiche.com/Portal/DocView.aspx?id=200675&repo=r-704298fc 7 6
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The 2026 Report updates and adjusts the cost-of-service classification and allocation factors, which leads to revenue requirements for the rate classes that differ from the projected FY 2026 revenues at current rates. The percentage of revenue increase needed varies by customer class —ranging from -10.6% for G-2 to 8.3% for G-1 and 7.9% for G-3.
Table 1: Projected Revenues, Revenue Requirement and Revenue Changes Needed Key Changes in 2026 Report
During the development of the 2026 Report, staff worked collaboratively with EES to update the Gas Utility’s costs and usage information and refresh the model inputs with current data.
Some of the key changes described in more detail below are:
1) Updates to the customer weighting factors for meter costs; 2) Updates to the Average & Excess classification and allocation factor for G2 and G3 customers, while changing some of the methods used to calculate that factor and changing some of the cost categories it is applied to for improved consistency; 3) The use of the Base & Excess Methodology to develop residential (G1) tiered rates; 4) Refinement of the G2 (Residential Master-Metered and Commercial Gas Service) rate schedule; and
5) Elimination of the supply charge ranges for the Cap-and-Trade Compliance Charge and the Transportation Charge.
During 2025 public meetings on the Gas COSA before the UAC, Finance Committee, and Council, and in letters from the public, the February 2025 draft of the Gas Utility’s cost-of- service study was critiqued, and stakeholders suggested that the 2026 Report retain prior cost- of-service calculation methods. The UAC’s Gas COSA Subcommittee guided staff and EES to examine this closely. Under this approach (retaining prior study methods and only updating costs and revenues to current levels) the median residential monthly bill would be approximately $80.88, which is $1.55 (or 2%) higher than the median bill under the 2026 Report method shown in Table 1. Staff and EES do not recommend retaining the existing rate model because it is not updated with relevant cost updates and is not updated with recent load, usage and other relevant information); it would also result in a higher median residential customer bill.
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Customer Weighting Factors for Meter Costs
The 2026 Report ensures that the fixed portion of rates more accurately reflects customer related costs, such as metering, by including the cost of each customer’s meter and accounting for it in a comprehensive calculation of weighted average meter cost. The 2026 Report updates the number of customers weighed by meter costs, which determine how certain costs are assigned among customer classes. The weighting factors are based on current replacement cost of meters, including materials and installation costs. The weighted average meter cost calculation is appropriate because it considers all of the meter types used by customers in each customer class and the total costs for each class.
Table 2 shows the meter costs used in the 2026 Report and in the prior study (May 2019) for comparison.
Table 2: Customer Weighting for Meter Costs: FY 202619
G1 G2 G3
PRIOR VALUES (MAY 2019)
Meter Costs (Materials) $72.84 $888.00 $1,505.00
Weighting $1,549,452 $2,029,080 $52,675
Resulting Allocator 42.7% 55.9% 1.5%
UPDATED VALUES (OCT 2025)
Meter Costs (Materials and Labor) $414 $1,262 $10,473
Weighting $8,761,310 $2,772,869 $308,954
Resulting Allocator 74.0% 23.4% 2.6%
The 2026 Report method is comprehensive and takes into account the current costs of labor and materials for each customer’s meter (compared to material costs only in the prior study).
The changes to the customer weighting for meter costs results in a larger share of meter values being allocated to the residential G1 customer class and a relatively smaller share of meter values allocated to the G2 commercial customer class, compared with the 2020 study. The prior approach relied on representative meter costs that did not reflect the totality of service demands of different meter sizes as fully as the 2026 COSA method.20 This customer weighting for meter costs update is one of the primary drivers for the rate rebalancing recommended in this study. This update is necessary to refresh the Gas Utility’s rates using the best available information and to reflect the latest costs so that rates remain fair and cost-based. 19 This table has been updated here and in the 2026 Report (Exhibit 1 to Attachment A) to correct a typographical error in the resulting allocator. This correction does not impact the cost allocation or rates. 20 The representative meters for the G1, G2, and G3 used in the 2020 COSA study were the CL250 House, 8C/175 Rotary and 5000 Rotary meters, respectively.
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Average & Excess (A&E) Method for G2 and G3 Rates
The 2026 Report refines and improves the A&E cost allocation methodology to better align with how the distribution system is designed and built, in light of declining average gas use. In the 2026 Report, costs assigned to A&E are classified as both energy and demand to accurately reflect how the City’s distribution system is designed and built. The Gas Utility’s capital work focuses on upgrading and maintaining aging infrastructure, rather than on expanding the system for growth. When evaluating the sizing of gas mains, City engineers examine peak demand as well as energy usage. This means that both energy and demand are important factors in considering capacity investments in the system and supports the A&E classification as both demand and energy. In previous studies, costs assigned to the A&E allocation and classification factor were distributed primarily based on demand. This is appropriate for systems experiencing growth. Now that the system is experiencing declining use, and because capacity sizing is determined based on both energy and demand, the 2026 Report A&E method modifications are appropriate and result in a fair allocation of expenses across customer classes.
Base & Excess Methodology for Residential Tiered G1 Rates The 2026 Report uses the Base & Excess methodology to calculate the Tier 1 and Tier 2 rates for Residential (G1) customers. This methodology is slightly different from the method used in the 2020 Study. While both studies use a measurement of baseline (or average) and excess demand to apportion demand costs to the Tier 2 rate, the studies differ in the calculation of the demand/excess portion.
The 2020 study allocated a share of distribution demand costs to Tier 2 based on the Average & Excess calculation. The A&E excess portion was based on a measurement of average and excess (peak) use in all 12 months. Alternatively, this study uses the Base & Excess method to assign 79% of the demand costs to the Tier 2 rate based on a single annual peak. The details of how this calculation is computed is in the 2026 Report (Exhibit 1 to Attachment A) described in Section
4.1.1 and illustrated in Tables 4-3 and 4-4.
The shift to the Base & Excess method is appropriate for two reasons. The first is that the usage profile for G1 supports an apportionment based on a single annual peak rather than all 12 months. Because the usage profile shows that there is significant difference in seasonal use, this supports measuring excess demand using the highest single peak rather than summing 12 monthly peaks, as was done with A&E. Second, the Base & Excess method is supported by how City engineers design the system. The engineers design the system capacity to meet annual customer demands during a single January peak. Therefore, using Base & Excess is the best method for the G1 tiered rate design as reflected in the high-demand winter month and in how the system capacity is determined.
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Refinement of G-2 (Residential Master-Metered and Commercial Gas Service) Rate Schedule The G2 customer class includes a wide range of customer types including restaurants, other types of small business, office space and master-metered multi-family properties. This class includes a wide range of meter types and capacities. Based on a review of existing G-2 services’ meter capacities, associated costs and recorded sales, the Study recommends refining the rate schedule into three meter capacity groupings using Standard Cubic Feet per Hour (scfh), with a higher monthly service charge for larger meter capacity. The larger meters require a higher cost to serve because generally they have higher average use, require larger service lines to connect the meter to the distribution system, and impose greater demand on the system. This meter capacity grouping refinement will better reflect customer-related fixed costs in the fixed monthly service charge. The volumetric distribution charge is the same for all G-2 customers.
Table 3 presents the meter capacity groupings recommended for G-2 monthly service charge application. EES analyzed average consumption for various meter capacities in the G-2 rate class and developed three meter capacity ranges and customer-related costs for each range.
Table 3: G-2 Service by Maximum Meter Capacity23
G-2 Service by Maximum
Meter Capacity Range # of
Services
G-2: ≤ 220 scfh Less than 220 standard cubic feet per hour (scfh) 1,134 G-2: > 220 and < 4,000 scfh More than 220 scfh and less than 4,000 scfh 942 G-2: ≥ 4,000 scfh 4,000 scfh and above 116
Review of Multi-Family Analysis
Staff and EES analyzed whether separating multifamily customers from existing G-1 and G-2 rate classes would improve cost alignment. The analysis found limited justification for creating a new class at this time. Usage patterns, load factors, and service characteristics among multifamily customers were not sufficiently distinct to warrant separate treatment. Therefore, no additional subclassification is recommended.
Supply Charge Ranges
There are four pass-through supply charges: 1) Commodity Charge (monthly market based), 2) Cap-and-Trade Compliance Charge, 3) Transportation Charge and 4) Carbon Offset Charge.
While the focus of the 2026 Report is the gas distribution charges, staff is proposing some administrative modifications to the two of the gas supply pass-through costs that vary based on external factors and market conditions. The 2026 Report recommends continuing to pass through the Cap-and-Trade Compliance Charge and the Transportation Charge but eliminating the range mechanism for each. There are no rate impacts of this change. 23 Meter capacities in this staff report are all at an assumed pressure of 7 inches of water column (equivalent to
0.25 pounds per square inch).
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The Cap-and-Trade Compliance Charge recover the costs of the City’s obligation under the California Air Resources Board’s Cap-and-Trade Program to purchase allowances for all greenhouse gas emissions associated with natural gas use within the City’s service territory.
Because these costs are regulatory, nondiscretionary, and beyond the City’s control, maintaining a range is unnecessary.
Similarly, the Transportation Charge represents the amount the City pays Pacific Gas and Electric Company (PG&E) to transport gas from the PG&E Citygate to the City’s distribution system. These charges are entirely outside the City’s control and lack alternative suppliers.
Removing the ranges simplifies billing and aligns with cost transparency goals.
Proposed Rates
Table 4 shows the current and proposed monthly service charges, while Table 5 shows the volumetric charges related to distribution for all rate schedules. As previously noted, supply- related charges are pass-through charges that update periodically. The latest charges are shown in the City’s Rates website25. The proposed rates reflect the 2026 Report adjustments. 25 City’s Rates Website https://www.cityofpaloalto.org/files/assets/public/v/25/utilities/rates-schedules-for- utilities/residential-utility-rates/monthly-gas-volumetric-and-service-charges-residential-3.pdf 7 6
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Table 4: Current and Proposed Monthly Service Charges
Rate Schedule Current Rates
(as of 7/1/25)
Proposed Rates
(effective
2/1/26)
Change
($)
Change
(%)
G-1 (Residential) $18.40 $19.58 $1.18 6%
G-2 (Residential Master-Metered and Commercial)
G-2 (≤ 220 scfh) $170.55 $29.24 $(141.31) (83%)
G-2 (> 220 and < 4,000 scfh) $170.55 $94.56 $(75.99) (45%) G-2 (≥ 4,000 scfh) $170.55 $419.08 $248.53 146%
G-3 (Large Commercial) $780.34 $1,712.36 $932.02 119%
Table 5: Current and Proposed Gas Distribution Charges
Rate Schedule Current Rates
(as of 7/1/25)
Proposed Rates
(effective 2/1/26)
Change
($)
Change
(%)
G-1 (Residential)
Tier 1 Rates ($/therm) $0.8944 $1.0456 $0.15 17%
Tier 2 Rates ($/therm) $2.2873 $2.5203 $0.23 10%
G-2 (Residential Master-Metered and Commercial)
Uniform Rate $1.1749 $1.2204 $0.05 4%
G-3 (Large Commercial)
Uniform Rate $1.1633 $1.1874 $0.02 2%
Bill Impacts
Table 6 shows the impact of the proposed February 1, 2026 rate changes on the median monthly residential bill for representative average winter and summer bills, excluding supply- related cost changes.
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Table 6: Bill Impacts of Proposed Rebalancing and Rate Design in 2026 Report Monthly Bill1
Rate Schedule Monthly Usage (Therms) Current
Rates
Recommended
FY2026 Rate
Bill
Impact
RESIDENTIAL
Summer: 10; Winter: 30 $50.78 $54.73 8%
Summer: 17; Winter: 51
(median)
$73.44 $79.33 8%
Summer: 30; Winter: 80 $127.24 $134.60 6%
G-1
Summer: 45; Winter: 150 $247.31 $263.50 7%
COMMERCIAL AND RESIDENTIAL MASTER METER
Small: 35 $242.74 $103.05 (58%)
Medium: 280 $739.59 $676.33 (9%)
G-2
Large: 2,648 $5,558.74 $5,927.83 7%
G-3 20,834 $42,696.69 $44,131.74 3%
The annual gas bill for the median residential customer is projected to be 8% higher due to the cost-of-service adjustments. The actual impact may be different because customer gas usage varies and commodity price changes monthly.
Bill Comparisons/Competitiveness
Table 7 presents the median residential bills for Palo Alto and PG&E customers from FY 2022 to FY 2026. The bill calculations for PG&E customers are based on PG&E Climate Zone X, an area which includes Palo Alto’s surrounding communities.
In FY 2025, the estimated annual gas bill for the median Palo Alto residential customer was about 16% lower than that of a PG&E customer with equivalent consumption. With the implementation of the 2026 Report, Palo Alto median residential bills are expected to be about 8% lower than PG&E bills in FY 2026. This projection assumes PG&E does not implement additional rate increases between now and July 2026.
Table 7: Residential Annual Natural Gas Bill Comparison ($/year) Time Period Median Usage Palo Alto PG&E Zone X % Difference FY 2022 $657.83 $724.24 (9%)
FY 2023 $891.89 $845.03 6%
FY 2024 $753.28 $764.70 (1%)
FY 2025 $836.93 $991.24 (16%)
FY 2026 Current $881.31 $1,040.18 (15%)
FY 2026 Recommended
Annual
(374 Therms)
$952.02 $1,040.18 (8%)
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Table 8 presents the median commercial bills for Palo Alto and PG&E customers from FY 2022 to FY 2026. Palo Alto bills have been higher than PG&E’s bills over the years, mainly due to higher customer charges. With the recommendations from the 2026 Report, commercial customer charges have been adjusted downward for the majority of commercial customers, making bills more competitive with PG&E. With the implementation of the 2026 Report and the proposed rate increases, Palo Alto median commercial bills are expected to be about 16% higher than PG&E bills in FY 2026, assuming PG&E does not implement additional rate increases.
Table 8: Commercial Annual Natural Gas Bill Comparison ($/year) Time Period Median Usage* Palo Alto PG&E Zone X % Difference FY 2022 $6,507.57 $5,602.19 16%
FY 2023 $ 8,844.11 $6,506.91 36%
FY 2024 $ 7,426.78 $6,022.59 23%
FY 2025 $ 8,395.81 $6,734.69 25%
FY 2026 Current $8,875.07 $6,989.03 27%
FY 2026 Recommended
Annual G-2
(3,356
Therms)
$ 8,115.89 $6,989.03 16%
*Calculated based on G-2 with meter capacity of >220 and <4,000 scfh Gas COSA Design Principles
The following discussion outlines each of the Council’s adopted Gas COSA Design Principles and addresses how the 2026 Report addresses the Design Principles.
Design Principle 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.
The 2026 Report uses actual costs and adopted budgets, applying industry-accepted allocation methods to assign fixed and variable costs based on each class’s use of the system.
Design Principle 2: The COSA should involve a review of all existing rate schedules for applicability in the COSA.
All existing rate schedules were reviewed for relevance and cost alignment. Customers with similar usage characteristics remain grouped together, and the study recommends refining the G2 class as described earlier. The study reviewed the separation of multifamily from G1 and the separation of master-metered multifamily from G2 and did not find a strong basis for splitting these groups further.
Staff also reviewed the G10 rate schedule, which applies to gas sold at the City’s Compressed Natural Gas refueling station at the Municipal Services Center. This facility does not utilize the 7 6
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distribution system, rather it is directly connected to the City’s intertie with PG&E. Since the sole customer is the Public Works department, it is more efficient to recover fueling costs via an interdepartmental cost recovery transfer than a separate rate schedule, and the City is separately developing a cost-based fee for service administration.27 Changes in this fee do not materially impact the COSA results.
Design Principle 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.
The study evaluated rate impacts on low-income residential customers. Approximately 400 customers participate in the City’s low-income program which is ratepayer funded, consistent with Public Utilities Code Sections 890 and 898, with average monthly usage of 30 therms. Most customers would see bill impacts under $5 per month, and the total cost to mitigate all bill impacts of the 2026 Report on low-income customers who are enrolled in the Low-Income Rate Assistance program or the Low Income Home Energy Assistance Program would be approximately $30,000 per year.
Design Principle 4: Determine the proper allocation of fixed and variable costs and how those can be implemented in various rate designs.
All rate classes include a fixed monthly charge to recover customer-related costs such as metering, billing, and service connections. The 2026 Report recommends a scaled fixed charge in the G-2 customer class to reflect the diversity within that class. The G-1 class includes a tiered variable rate structure that distributes capacity costs between Tier 1 and Tier 2 using the base and excess method to appropriately collect demand costs from customers impacting system capacity costs. The G-2 and G-3 classes recover capacity costs through uniform volumetric charges, maintaining simplicity while reflecting consistent cost drivers.
Design Principle 5: Review non-rate revenue sources that may be available for rate discounts or rebates
The 2026 Report also reviewed non-rate revenue sources that could potentially fund rate discounts or rebates. In FY 2025, an estimated $0.399 million in interest income was available for this purpose. At the end of FY 2025 there was $15.046 million available in the gas utility’s Cap & Trade Reserve. The Cap & Trade Reserve holds revenues from the auction of freely allocated Gas Utility greenhouse gas emission allowances. Cap & Trade reserve funds must be spent in accordance with California Air Resources Board regulations as well as with the City Council’s policies in Resolution 9487 and 10077.28 CARB’s regulations require that the City utilize the auction sale proceeds exclusively for the benefit of the City’s natural gas retail ratepayers and consistent with the goals of AB 32.29 The City Council’s policy allows for the use 27 The CNG station has a public station that is currently non-operational and a CNG station for refueling City vehicles. Both portions of the station are operated by the Public Works department. 28 Resolution 9487 https://portal.laserfiche.com/Portal/DocView.aspx?id=10165&repo=r-704298fc; Resolution 10077 https://portal.laserfiche.com/Portal/DocView.aspx?id=38224&repo=r-704298fc 29 Title 17 California Code of Regulations Sections 95892 (d)(2) and 95893 (d)(3). 7 6
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of Gas Cap and Trade revenue for investment in energy efficiency programs for the natural gas portfolio and retail customers, purchases or investment in cost-effective renewable biogas resources for the gas portfolio, fuel switching from natural gas to electricity that reduces greenhouse gas emissions, investment in other carbon reduction activities for the natural gas utility, including system maintenance or replacement to reduce fugitive gas emissions; and rebates to natural gas retail ratepayers. The policy expresses a preference for greenhouse gas reduction activities over rebates.
FISCAL/RESOURCE IMPACT
There is no increase to the City’s revenues as a result of the implementation of the 2026 Report.
STAKEHOLDER ENGAGEMENT
The UAC reviewed staff’s proposals for the Electric and Gas utilities at its April 2, 2025 meeting.
Regarding staff’s 2025 COSA and Gas Utility proposal, the UAC recommended approval of staff’s proposal with a 5-1 vote, with one abstention. The Commissioner who voted against the staff proposal expressed concern about the cost-of-service study results and in particular the increase in rates for the residential (G-1) customer class. The UAC also recommended through a 6-1 vote to recommend to the Finance Committee and Council to approve the use of approximately $1.6 million of Cap-and-Trade allowance auction proceeds to provide a one-time flat climate credit of $73.20 to each residential (G-1) customer only in FY 2026.33 The Commissioner who voted against the climate credit option said that green funds should not be used to subsidize the use of fossil fuels. The video of the meeting is available on the City’s website at the following link: https://www.youtube.com/watch?v=021zJQHLADI The Finance Committee reviewed staff’s proposals for the Electric and Gas Utilities at its April 15, 2025 meeting. The Finance Committee did not take any action on the Gas Utility proposal and continued the discussion of that proposal to May 7, 2025. During the discussion of the Gas Utility proposal on April 15, Finance Committee members expressed concern about the bill impact to median and low usage residential (G-1) gas customers resulting from the 2025 Natural Gas Cost of Service and Rate Study.34
Finance Committee members requested additional information on whether the Gas Utility could continue to rely upon the 2020 Natural Gas Cost of Service and Rate Study for another year, what would a higher one-time climate credit look like for G-1 customer bills and whether it is possible to spread the one-time climate credit across customer bills for a year. Committee members requested additional examples and cost drivers. On May 7, 2025 staff presented 33 The Gas Utility is a covered entity under California’s Cap-and-Trade program. California Air Resources Board’s Cap-and-Trade regulations authorize utilities to distribute Cap-and-Trade auction proceeds to some or all ratepayers in a non-volumetric manner. (See CA. Code of Regs. Tit. 17 Sec. 95893(d)(3)(C)). 34 Staff presented the 2025 City of Palo Alto Natural Gas Cost of Service and Rate Study to the UAC and Finance Committee.
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additional information to the Finance Committee, including an interim alternative recommendation to continue the current FY 2025 rate structure based on the 2020 Cost Study, with rate increases to meet FY 2026 revenue requirements, and provide a climate credit to some of the G-2 small commercial customers (small and medium meter capacities), using approximately $1.1 million in funding from the City’s Cap and Trade program revenue37 If the 2025 COSA had been implemented July 1, 2025, G-2 small and medium customers would have received a reduction in their monthly service charges, as well as an increase in the distribution charge per therm. The climate credit amount was calculated to make the G-2 small and medium customer groups pay the same net amount as a result of retaining the current FY 2025 rate structure from July through December 2025, relative to what G-2 small and medium customers would have paid under the 2025 COSA rates. The total cost of this climate credit is $1.1 million. After discussion, the Committee voted unanimously to recommend the City Council: 1) Revise the proposed FY 2026 rates to retain the current FY 2025 rate structure, with rate increases to meet the revenue requirement for FY 2026 in the gas utility; 2) In FY 2026 only, apply a combination of climate credit (using Cap and Trade auction revenues) and FY 2025 gas utility interest income to G-2 customers (small and medium meter capacities) in the total amount of $1.1 million and 3) Refer staff to return to the Utilities Advisory Commission (UAC) to further review the FY 2025 Cost of Service Study (COSA) assumptions and principles.
On May 12, 2025 staff briefed the City Council on this topic and Council members asked questions and discussed the item but did not take any action.
On June 16, 2025 the City Council returned the issue of a one-time credit to the UAC to be considered at the time they review the updated COSA.
On September 2, 2025, the Finance Committee considered the UAC’s recommendation to direct staff to use Proposition 26 as the Design Principle for the Gas Cost of Service Analysis and work with the UAC on review of a recommended gas rate schedule effective by January 2026. The Finance Committee voted unanimously to recommend the City Council direct staff to follow the reasonable-cost analysis required by Proposition 26, and that staff work with the UAC on a recommendation to the Council on revised gas rates effective January 2026.
On September 15, 2025, (Staff Report 2507-4958) the City Council directed 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 37 May 7, 2025 Finance Committee Meeting
https://cityofpaloalto.primegov.com/api/compilemeetingattachmenthistory/historyattachment/?historyId=530a4f 25-5455-4cec-a95c-5190d95d9a4f; Video: https://youtube.com/watch?v=kW97GWkgaY0?feature=share; Item
2.a., 3.b. Supplemental Report https://youtube.com/watch?v=kW97GWkgaY0?feature=share; Video 7 6
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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.
Upon Council approval of the Gas rates from the 2026 Report, staff plans to conduct outreach and communication to customers about the rate increases through the utilities website, utility bill inserts, messaging on utility bills and MyCPAU online account management platform, email newsletters, print and digital ads in local publications, social media, community messaging platforms, and through direct mailings.
The Utilities Advisory Commission (UAC) considered this item at its November 5, 2025 meeting, agenda item 439. Ultimately, a majority of the UAC recommend Finance Committee and City Council approval. More details are described above in the “Background” section and a video recording of the meeting is available here: https://www.youtube.com/watch?v=1e6NrB2KDCw.
The Finance Committee considered this item during its November 18, 2025 meeting, agenda item 1. A representative from the UAC Gas COSA Subcommittee provided comments to the Finance Committee on the 2026 Report. The Commissioner reported that every question the UAC Gas COSA Subcommittee had was answered by staff and the cost-of-service consultants, that the 2026 Report is more transparent and clear and results in a reasonable cost allocation, and that controlling for underlying data, the updated mechanics of the 2026 Report leads to a more affordable result for Palo Alto residents than retaining the mechanics of the cost-of- service study used to develop the rates currently in effect. The Finance Committee members expressed appreciation for the UAC Commissioner attending the meeting and stated that staff’s work with the UAC Gas COSA Subcommittee was time well spent. The Finance Committee unanimously voted to approve the staff recommendation that the City Council adopt a resolution that approves the 2026 Report, amends rate schedules G-1, (Residential Gas Service), G-2 (Residential Master-Metered and Commercial Gas Service), and G-3 (Large Commercial Gas Service) shown in Exhibit 2 to Attachment A, effective February 1, 2026, and repeals Rate Schedule G-10.
ENVIRONMENTAL REVIEW
The Finance Committee’s review and recommendation to the Council on the 2026 Natural Gas Cost of Service Analysis Report and revised gas rate schedules does not meet the California 39 November 5, 2025 UAC meeting item 4,
https://cityofpaloalto.primegov.com/Portal/Meeting?meetingTemplateId=17466 7 6
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Environmental Quality Act’s definition of a project, pursuant to Public Resources Code Section 21065, thus no environmental review is required.
ATTACHMENTS
Attachment A: Resolution
APPROVED BY:
Alan Kurotori, Director Utilities
Staff: Karla Dailey, Assistant Director of Utilities, Resource Management Staff: Lisa Bilir, Senior Resources Planner