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BACKGROUND Zone 7 is a separate legal entity that supplies most of the water for the City of Pleasanton, its residents, and its businesses. The City of Pleasanton City Council does not have authority to review and approve Zone 7's rates. The City passes through Zone 7's rates in the City's utility bills to its customers. The continuing drought and related water conservation is adversely affecting Zone 7's ability to cover its fixed operating costs. In FY 2015/16 Zone 7 attempted to address revenue shortfalls through a one -time Drought Surcharge (Surcharge) of $0.57 per ccf. Unfortunately, that Surcharge was insufficient to counteract the increased conservation efforts of Zone 7's retail customers. In addition, while the majority of Zone 7's operating expenses are fixed, nearly 100% of revenue recovery is volume -based (variable rates). As a result of increased water conservation efforts and Zone 7's rate structure, during the last few years, Zone 7 has significantly drawn down its operating reserves to cover operating expenses. Zone 7's operating reserves are currently $5.8 million which equals approximately 19% of Zone 7's operating expenses. To help provide stable revenues, Zone 7 is proposing to modify its current rate structure as follows: 1. Recover 35% of costs through fixed rates and 65% through variable rates. This will help stabilize Zone 7's revenues. a. The fixed rate component will be based on a 2 -year rolling average of usage by each retailer. Pleasanton would be allocated 31.1% of Zone 7's fixed costs in 2017 or $4.5 million. In addition, Zone 7 is proposing a reserve policy that would increase operating reserves to equal approximately 50% of operating expenses which would be $16.6 million in FY 2016/17. The proposed minimum reserves would be achieved by the end of FY 2018/19. In order to meet the new targets within two years, given the current volume projections the current one- time Surcharge of $0.57 per ccf would be $0.62 and $0.49 in calendar years 2017 and 2018. Assuming Zone 7 meets its reserve target by the end of FY 2018/19, the one -time surcharge will no longer be required past FY 2018/19. Zone 7 held a public workshop on September 28, 2016 to review these proposals. The Zone 7 Board is scheduled to adopt rates at their October 17, 2016 Board meeting. DISCUSSION The current Zone 7 variable rate is $3.15 per ccf including the existing Surcharge of $0.57. Assuming the Zone 7 Board approves the proposed fixed rate and new Surcharge proposals, the total new Zone 7 rate effective January 1, 2017 will be $3.70 per ccf which includes the 13% rate increase previously approved in October 2015. Thus, the combined Zone 7 rate increase would be 17.5% or 4.5% greater than anticipated. To implement Zone 7's proposed new rate fixed rate structure, the City is considering a blended rate structure. Zone 7's charges will continue to be separately identified on the City's water rate notice and the customer's utility bill. Zone 7 staff met with the retailers over the past month and the retailers provided the following comments on Zone 7's proposal: Page 2 of 3