CC 11-02-2021 Item No. 12. Cupertino Municipal Water System - Amended Staff Report - Redline
CITY COUNCIL STAFF REPORT
Meeting: November 2, 2021
Subject
For the future operations of the Municipal Water System, consideration of: 1) Key Lease
Terms for a new Long‐Term Lease; 2) First Amendment of the Current Lease Agreement
with San Jose Water Company to extend the term up to three years; and 3) Request to
increase Public Works Administration – Special Projects Budget Allocation.
Recommended Actions
1. Provide input on Key Lease Terms for a new Long‐Term Lease;
2. Conduct a Public Hearing to consider a First Amendment to extend the term of
the Current Lease Agreement with San Jose Water Company for lease of the
Cupertino Municipal Water System up to three years;
3. Adopt Resolution 21‐XXX (Attachment A), approving a First Amendment to the
Current Lease Agreement for lease of real property (Water System) with San Jose
Water Company; and
4. Approve Budget Modification #2122‐170 increasing appropriations in Public
Works Administration – Special Projects (100‐80‐800 750‐071) by $31,500 for the
Municipal Water System Project.
Background
Cupertino has three water service areas as shown in the Water Service Map (Attachment
B).
The orange area is served by a water system owned and operated by San Jose
Water Company (SJWC).
The green area is served by a water system owned and operated by California
Water Service Company.
The purple area is served by Cupertino municipal water system infrastructure.
This infrastructure is owned by the City of Cupertino and operated by SJWC
pursuant to its Lease Agreement with the City. This area is the subject of this staff
report.
The lease with SJWC began in October 19977 and runs for a term of 25 years, expiring on
September 30, 2022.
As the lessee of the City’s water system infrastructure (system), SJWC is responsible for
all operations including repair, maintenance, operation, customer service/billing,
emergency service ,water quality testing and rate‐setting.
On December 17, 2019, City Council approved an amended and restated lease (Current
Lease) (Attachment C). The Current Lease caps the amount SJWC can charge customers
of the Municipal Water System to an amount less than or equal to the amount SJWC
charges its own customers within Cupertino (the orange area on Attachment B), as
determined by the California Public Utilities Commission (CPUC) and their Public
Advocates Office. The Current Lease also requires SJWC to deposit $5 million of funds to
the City for the purpose of completing capital improvements to the System before the end
of the lease. These funds have been received and improvements are in process.
The Fiscal Year (FY) 2021‐2022 City Work Program includes an item to analyze and
recommend options for continued operation of the System during the remaining term of
the Current Lease with SJWC and following the termination of the Current Lease with
SJWC.
On July 20, 2021, City Council considered how the System could be operated in the future
after the Current Lease expires. Options considered by Council for future operations
included lease, sale, or City operation. After deliberation, City Council took the following
actions:
1. Authorized staff to proceed with a Request for Proposal (RFP) process for a new
Long‐Term Lease utilizing the Public Utilities Code (PUC) § 10061 process.
2. Directed staff to limit duration of a new Long‐Term Lease to twelve years or less,
with a renewal option not to exceed twenty years total.
3. Directed staff to complete an analysis of costs and resulting water rates if the
System were to be operated by City staff.
4. Directed staff to draft Key Lease Terms to be included in a new Long‐Term Lease
for further consideration by City Council prior to issuing the RFP.
Discussion
Proposed Key Lease Terms to be included in the new Long‐Term Lease have been
prepared by staff and are included as Attachment D. Council input on the Key Lease
Terms will guide final development of the RFP and the new Long‐Term Lease.
A consultant has been retained to complete an analysis of the costs and water rates if the
Municipal Water System were to be operated by City staff.
It may not be possible to transition to a new Long‐Term Lease, City operation of the
System, or sale of the System prior to expiration of the Current Lease on September 30,
2022. Therefore, the proposed First Amendment (Attachment E) includes an extension of
the Current Lease up to three years.
New Long‐Term Lease of System
Leasing the System has provided customers with comparable water service and rates to
those provided to other Cupertino residents served by SJWC or Cal Water’s privately
owned systems. System customers are charged rates consistent with SJWC’s other
customers (the orange area on Attachment B). With a new Long‐Term Lease, the City
continues to own a valuable asset and to receive a return on the public investment in the
System. Also, operation of the System by an experienced lessee may provide expertise in
operations and an economy of scale that could not be achieved if the City operated the
System directly.
The Key Lease Terms included in the new Long‐Term Lease are more rigorous and
comprehensive than the terms included in the Current Lease. The intent of the new terms
is to ensure that the System is operated and maintained to all applicable standards.
Examples include: increased access to operation records, benchmarking of current best
practices for operation and maintenance, and specific requirements for capital investment
in the System. These provisions will ensure that System customers receive high quality,
reliable water service. They also reflect Council’s recent direction to limit the initial term
to 12 years with an option for a renewal that could extend the total lease period to 20 years.
If the RFP and award process proceed as currently projected, a new Long‐Term Lease
could be executed prior to expiration of the Current Lease. However, unforeseen issues
could potentially delay the process beyond the September 30, 2022 (expiration of the
Current Lease). If issues arise, they make take up to six months to resolve. This would
require the Current Lease to have a six‐month term extension to March 2023.
In anticipation of the new Long‐Term Lease, staff has contacted several water operators,
including the City of Sunnyvale, City of Santa Clara, Valley Water, California Water
Service Company, SJWC, and Veolia North America. The RFP will be open to proposals
from any qualified water operator.
City Operation of System
City operation would involve the City using its own staff to operate the System. Taking
over operation of the System would transfer all risk and all costs for operation of the
System to the City. This would include the costs of maintenance, and could result in
increased costs to ratepayers, subject to constitutional limits. A consultant is preparing an
analysis of these costs that will be available at a Public Hearing tentatively scheduled for
February 2022. If the System is operated by the City, water rates would be authorized by
City Council and could be less, equal to or greater than the rates charged to other water
customers within Cupertino, depending on the expenses calculated to operate the System.
This alternative is estimated to take up to 30 months to implement, including time to
recruit and hire additional City staff, and obtain necessary equipment and regulatory
approvals. This would require the Current Lease to have a two‐year term extension to
October 2024.
Sale of the System
Sale of the System is the remaining alternative if the City does not enter into a new Long‐
Term Lease or transition to City operation of the System. The sale alternative could require
three years or more to fully complete (including a required election and CPUC approval)
and would require a three‐year extension of the Current Lease, to October 2025.
First Amendment of Current Lease to Extend Term
If City Council authorizes a new Long‐Term Lease with a water utility operator after
evaluation of proposals received in the RFP process, it is possible that an extension of the
Current Lease will not be needed. This assumes that the RFP and award process proceed
on an expedited basis as outlined below.
If the RFP, award, or transition process is delayed due to unforeseen circumstances, the
City could direct a six‐month extension of Current Lease. If direction is received to operate
the System with City staff, a two‐year extension of the Current Lease term would be
exercised to allow time for the City to prepare for City staff operation. Alternatively, if the
City Council chooses to sell the System, a three‐year extension would be requested.
Any extension of the Current Lease term requires SJWC to complete annual System capital
improvements. The required expenditures for System capital improvements are $350,000,
$1,600,000, and $2,500,000 for, respectively, a six‐month, two‐year, or three‐year
extension. The 2019 System Asset Management Plan recommends an annual capital
improvement amount of $1.5 million. Staff attempted to negotiate this amount for each of
the extension options, but due to insufficient time for SJWC to amortize the various annual
costs, the above amounts are reasonable in relation to the duration of each extension
alternative. No other terms of the Current Lease are changed. SJWC has agreed to the
terms of the attached First Amendment of the Current Lease.
Next Steps
After receiving City Council input on the Key Lease Terms of the new Long‐Term Lease,
staff will issue the RFP and new Long‐Term Lease documents in November 2021.
Proposals from prospective water system operators will be submitted to the City in
January 2022. Recommendations will subsequently be brought to City Council for a
statutorily mandated Public Hearing in February 2022. At this Public Hearing, staff may
make a recommendation to enter the new Long‐Term Lease with the water system
operator determined to be “best qualified to continue to provide equal or better service to
the customers of the system” as specified in PUC § 10061. Alternatively, staff may
recommend starting the RFP process over or undertaking City operation of the System,
depending on which alternative is determined to be the best overall option. City Council
could also direct staff to proceed with sale of the System.
Public Notice
Public notice of the public hearing on the First Amendment of the Current Lease was
published in accordance with Government Code § 6066, with the first notice published in
the Cupertino Courier on October 22, 2021. No other written notices were sent. A webpage
for this item was created and can be viewed HERE. A Frequently Asked Questions (FAQ)
page can be found on the webpage. It has been prepared to help inform the public.
Additionally, a “News” article was published on the City’s main webpage to provide
information and to advise the community of the November 2, 2021, Public Hearing date.
Sustainability Impact
No sustainability impact.
Environmental Impact
Providing input on Key Terms to the new Long‐Term Lease is not a project under the
requirements of the California Environmental Quality Act (CEQA) of 1970, together with
related State CEQA Guidelines (collectively, “CEQA”) because it has no potential for
resulting in physical change in the environment, either directly or ultimately. Further,
extending the Current Lease is exempt from CEQA under CEQA Guideline section 15301,
which exempts from CEQA review any project that “consists of the operation, repair,
maintenance, permitting, leasing, licensing, or minor alteration of existing public or
private structures, facilities, mechanical equipment, or topographical features, involving
negligible or no expansion of existing or former use.” Further to the extent that providing
input on Key Terms to the new Long‐Term Lease, extending the Current Lease, and
adopting the proposed Resolution (collectively, “Action”) is a project under CEQA, it is
subject to the CEQA exemption contained in CEQA Guidelines section 15061(b)(3)
because it can be seen with certainty to have no possibility of a significant effect on the
environment. CEQA applies only to projects which have the potential of causing a
significant effect on the environment. Where it can be seen with certainty that there is no
possibility that the activity in question may have a significant effect on the environment,
the activity is not subject to CEQA. In this circumstance, initiating the PUC section 10061
lease process does not commit the City to a definite course of action as all proposals could
be rejected. Further, if the Council extends the Current Lease by adopting the proposed
Resolution or an award is made to enter a new Long‐Term Lease, doing so merely
provides for the continued operation of an existing System without an expansion in the
physical improvements or increase in the level of service, so this is not an activity subject
to CEQA. If necessary, environmental review will be conducted for any changes to the
System that may be proposed in the future.
Fiscal Impact
Providing Council input on the proposed Key Lease Terms for a new Long‐Term Lease
will not have a direct or immediate fiscal impact to the City. Funds needed to complete
the RFP process are included the Fiscal Year 2021 ‐2022 Budget on pages 465/466 in 100‐
80‐800 750‐071. There is $69,438 remaining of the $100,000 approved budget and $31,500
of additional funds are needed to continue the drafting of multiple agreements and
researching the options for operating the System with City staff. There will likely be future
fiscal impacts if a new Long‐Term Lease is authorized. Those impacts may relate to the
final terms and conditions of the RFP and negotiations of the final terms of the new Long‐
Term Lease with the selected proposer. Additional City staffing to administer the new
Long‐Term Lease may be required.
Approval and execution of the First Amendment to the Current Lease will require SJWC
to fund the following amounts for capital improvements as follows:
$350,000 for a six‐month extension
$1,600,000 for a two‐year extension
$2,500,000 for a three‐year extension.
The City Council may decide to select one of the extensions above or may determine to
forego an extension.
Prepared by: Roger Lee, Director of Public Works
Reviewed by: Dianne Thompson, Assistant City Manager
Chris Jensen, City Attorney
Approved for Submission by: Greg Larson, Interim City Manager
Attachments:
A – Draft Resolution
B ‐ Water Service Map
C – Current Lease
D – Key Lease Terms to the New Long‐Term Lease
E – First Amendment of Current Lease