They are probably using desalinization. "Depending on local energy prices, 1,000 gallons of desalinated seawater can cost around $3 or $4." http://www.livescience.com/environment/070625_desalination_m... Even still adding ~1.5 cents per gallon of gas equivalent is not really expensive.
However, the connection charge is just highway robbery if you are really paying that per gallon. They might also be adding the sewer system charges based on your water usage.
PS: The average American uses ~90 gallon /day * 0.3 = 27cents per day * 365 = 100$ / year which is hardly breaking the bank.
For the water bill that I'm looking at, the connection charge (which is determined by the pipe diameter) is $15/month and taxes are about $3. This household is using about 40g/day/person and its monthly cost for the water is about $15.
> However, the connection charge is just highway robbery if you are really paying that per gallon.
San Jose city govt uses services to pay off various folk.
> They might also be adding the sewer system charges based on your water usage.
I just looked - the sewage charge is on the property tax bill.
The "water source" report that they send every year mentions ground and well water. It does not mention desalinization.
The marginal price of water in San Jose is around 0.3 cents/gallon. However, the "connection charge" and various taxes and fees end up doubling the "as delivered" cost.