Faced with outrage from the public and criticism from its own Utilities Advisory Commission (UAC), Palo Alto has scaled back plans to hike utility rates and revised its method for transferring money from the Utilities Department to the city's general fund.

The city-owned utilities should not be "a piggy bank for the general fund," one commissioner said during a contentious UAC meeting Wednesday night. But city staff denied that the transfers were designed to fill an $8 million city budget gap.

The UAC narrowly supported new staff recommendations for a gas-rate reduction, electric and water/wastewater increases and a reduced transfer amount.

If the City Council accepts the commission's recommendation, transfers from utilities to the general fund in fiscal year 2010 would be limited to $15.8 million, 5 percent more than in 2009 and about $1 million less than staff planned to transfer and millions less than the record $19.6 million staff had listed earlier as a possible transfer total.

The UAC also supported staff recommendations to lower the city's natural gas rates by 10 percent in July, and raise water and wastewater (sewer line) rates by 5 percent.

But members failed to reach a consensus on a staff proposal to raise electricity rates by 10 percent and withdraw $9.4 million from the "Calaveras Reserve" to avert a steeper rate increase. The reserve fund currently has a $32 million surplus and commissioners agreed last year that they want the money to fund a major capital project that would offer long-term savings to utilities customers.

Commissioners John Melton and Marilyn Keller argued against using the reserve money to lower electric rates. Commissioner Asher Waldfogel wanted to delay voting on the electricity-rate adjustment so the commission could get a more detailed explanation of the budget figures used by staff. Chairman Dexter Dawes sided with the staff recommendation, but no one could muster enough votes to pass a motion.

Instead, they decided to leave the question of electricity rates in 2010 to staff and the City Council. If the council approves all staff-recommended rate adjustments, utility bills would remain essentially unchanged, Utilities Director Valerie Fong said Wednesday. The most heated debate at Wednesday's meeting centered on staff's methodology for transferring money from utilities reserves to the general fund, a longstanding policy that allows the city to collect returns on its investment in utilities. Surplus revenue transfers have occurred each year since 1909-1910, starting with more than $22,000.

Staff originally considered transferring $19.6 million in fiscal year 2010, but later modified its formula and reduced the proposed transfer amount to $16.8 million still about $1.7 million more than was transferred in 2009.

The commission ultimately voted 3-1, with Keller abstaining and Rosenbaum dissenting, to support the staff's formula. But commissioners added a few tweaks, include taking operating working capital and next year's capital projects out of the formula and imposing a "collar" of 5 percent to make sure the transfer amount wouldn't exceed or trail the previous year's transfer by more than 5 percent.

The transfer amount was based on a recent revision in the city's methodology. For most of the past decade, staff simply increased the transfer amount by 3 percent every year to account for inflation. The new formula, developed by consultant R.W. Beck, automatically grants the city a 6.5 rate of return on its investments, with exact amounts based on values of current utility assets and capital projects. Under the formula, the city would transfer a total of $16.8 million from utilities to the general fund, which is facing an $8 million shortfall in revenues in 2010.

UAC member Dick Rosenbaum Wednesday night blasted the proposed transfer methodology and accused city officials of relying too much on utility ratepayers to fund general services. The department should be run like a business, not like a "piggy bank for the general fund," he said.

"It's really hard to escape the feeling that all of this started a month and a half ago because the city felt it was facing a deficit and was looking around for new revenue," Rosenbaum said. "In my view that's the long and short of it."

"This is a blatant attempt to milk the utility to make up for loss of revenues in other areas," he later added.

Keller said she's been hearing complaints from residents about high bills and the planned transfer.

"Perception is that the city is trying to fill its coffers with ratepayer money," Keller said. "Perception is often as important as what's really happening."

The transfer methodology has become a hot topic since early February, when staff projected increasing the transfer amount by more than $4 million from the 2009 level, to an all-time record of $19.6 million.

At Monday night's City Council meeting, Keene defended the transfer policy, calling it a common practice for cities seeking returns on their investments.

He emphasized that the money would be used to support crucial city services.

"The city's general fund is not some offshore corporation, but it's us," Keene said. "It's the fund that funds police, fire, libraries, streets, parks and recreation."

On Wednesday, Administrative Services Director Lalo Perez also defended the transfer formula and disputed Rosenbaum's assertion that the city is using utilities to fill its projected $8 million budget hole. The whole idea of having a set rate of return is to make sure the city gets a consistent, transparent and easily calculated return on its investment, regardless of the budget situation, he said.

"The bottom line is we're not trying to balance the general fund by using the transfer," Perez said. "If we wanted to balance that, we'd come back with a number to match that."

Staff's proposal to lower the natural gas rates by 10 percent also passed by the slimmest margin, with Dawes and Rosenbaum and Waldfogel supporting it.

The new rate would trim $17.07 off an average residential gas bill in the winter and $5.51 in the summer, according to staff projections. The average monthly residential bill would be $146.26 in the winter and $52.59 in the summer, staff estimated in a report.

The average Palo Alto residential customer currently pays about 38 percent more for natural gas than a PG&E customer in neighboring communities, according to staff. No one can say how next year's rate would compare to PG&E because of heavy monthly fluctuations in the PG&E gas rate, according to staff.

Meanwhile, a 10 percent increase in electricity rates would raise an average residential bill by $6.97, bringing it up to $76.33, according to staff estimates.

The electricity rate would remain 22.8 percent below PG&E, the report states.