Water usage may be plummeting in the Palo Alto and other cities that draw their supply from the Hetch Hetchy system, but water bills are flowing in the opposite direction.

The drop in water usage may please conservationists, but it creates a difficult dilemma for city officials across the region, said Councilman Larry Klein, who represents Palo Alto on the Bay Area Water Supply and Conservation Agency. The agency, which comprises 26 cities and towns, buys its water from the San Francisco Public Utilities Commission, which gets most of its supply from the Hetch Hetchy.

Klein said water usage in the SFPUC system dropped from about 175 million gallons per day in 2006 to about 140 million gallons per day in the current year -- the lowest level since 1992. As a result, water agencies that were previously concerned about meeting the area's water demand are now worried about how to keep the water system financially sustainable. The plummeting water usage, Klein said, is a "great mystery" to water officials across the region.

"It's not clear at all if this is due to a recession, to various conservation measures or to anything else you want to name," Klein said. "There's no unanimity for why this very significant reduction has taken place."

Lower usage has not, however, resulted in lower water bills. The SFPUC is in the midst of a $4.6 billion effort to upgrade the aged reservoirs and pumping stations in the Hetch Hetchy system. The effort has prompted the commission to increase the wholesale price of water by about 37 percent. In Palo Alto, this will likely result in a 12.5 percent increase to the average water bill.

The council on Monday briefly discussed the proposed water increase, which is due to take effect in July, and will likely approve it next week as part of its approval of the 2012 budget. While dozens of customers have written letters protesting the rate increase, the council limited its discussion to a few technical questions about staff's methodology.

Palo Alto already has some of the highest water bills on the Peninsula. Its average bill of $72 is 16 percent higher than the average bill in Redwood City, 33 percent higher than Mountain View's and 47 percent higher Santa Clara's. Only Menlo Park boasts higher water bills, with the average bill at $73.

The proposed increase would add about $8.23 to the average water bill in Palo Alto, bringing it from about $72.01 to $80.24. The smallest residential customers would see their bills go up by about $3, while the largest would see an increase of about $27.

The increase would add $3.4 million in revenues to the Utilities Department's Water Fund and help close a projected shortfall of $6.2 million. The balance would come from reserves.

Staff is also projecting rate increases of 17 percent, 16 percent and 8 percent in fiscal years 2013, 2014 and 2015, respectively.

Palo Alto's water customers aren't the only ones who could soon be hit with higher water rates. Klein noted that San Francisco plans to raise rates by 15 percent every year for the next six years.

The council also discussed City Manager James Keene's proposed budget, which would keep all existing services intact and assume $4.3 million in concessions from the city's police and firefighter unions.

Keene noted in his presentation that the council had already trimmed about $14 million in annual expenditures from the city budget over the past two years and had trimmed staff by about 10 percent. Given the recent cuts, he has proposed to close this year's relatively modest gap through public-safety concessions.

"We've got to make structural changes and we really need to be able to distribute those equitably in the organization for the welfare of the city," Keene said.

The council is scheduled to vote on the budget on June 20.