Water Markets: Increasing Federal Revenues Through Water Transfers
(Letter Report, 09/21/94, GAO/RCED-94-164).

Most water in the arid western United States delivered through federal
projects is used for agriculture, but the demand for water for urban,
recreational, and environmental uses is growing. The federal government
plays a role in water management in the arid West mainly through water
resource projects. Water transfer, in which rights to use water are
bought and sold, is seen by many resource economists as a way to
reallocate scarce water to new users by allowing those who place the
highest economic value on it to purchase it. Those who want more
water--such as municipalities--often are willing to pay considerably
higher prices for it than the current users, and irrigators who receive
subsidized water from federal projects may want to transfer this water
to a municipality at a profit. At the same time, these transactions may
allow the Bureau of Reclamation to share in the profits. This report
examines (1) whether water transfers will boost revenues, (2) how the
Bureau could increase its revenues from transferred water, and (3) what
issues the Bureau should consider in setting prices for transferred
water.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED-94-164
     TITLE:  Water Markets: Increasing Federal Revenues Through Water 
             Transfers
      DATE:  09/21/94
   SUBJECT:  Water resources development
             Water supply management
             Construction costs
             Interest rates
             Civil engineering
             Economic development
             Fees
             Public works
             Water rights
IDENTIFIER:  Bureau of Reclamation Emery County Project (UT)
             Colorado River Storage Project
             
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Cover
================================================================ COVER


Report to the Chairman, Subcommittee on Water and Power, Committee on
Energy and Natural Resources, U.S.  Senate

September 1994

WATER MARKETS - INCREASING FEDERAL
REVENUES THROUGH WATER TRANSFERS

GAO/RCED-94-164

Increasing Federal Revenues Through Water Transfers


Abbreviations
=============================================================== ABBREV

  IDC - interest during construction
  O&M - operation and maintenance

Letter
=============================================================== LETTER


B-256761

September 21, 1994

The Honorable Bill Bradley
Chairman, Subcommittee on Water and Power
Committee on Energy and Natural Resources
United States Senate

Dear Mr.  Chairman: 

While over 80 percent of the water in the arid western United States
is used for agricultural purposes, the demand for water for urban,
recreational, and environmental uses is growing.  The federal
government plays a role in water management in the West primarily
through water resource projects.  Using federal funds, the Department
of the Interior's Bureau of Reclamation plans, constructs, and
operates these projects to provide irrigation water to arid and
semiarid lands in the 17 western states.  The Bureau's projects also
provide water for municipal and industrial purposes; hydroelectric
power generation; recreation; and what are termed fish and wildlife
purposes, such as providing habitat.  The Bureau provides most of its
irrigation water to water and irrigation districts that obtain the
use of the water through contracts.  Through service or repayment
charges to water contractors, the Bureau, over time, recoups a
portion of the federal government's investment in providing the
water. 

Water transfers, in which rights to use water are bought and sold,
are seen by many resource economists as a mechanism for reallocating
scarce water to new users by allowing those who place the highest
economic value on it to purchase it.  Those who want more water--such
as municipalities--often are willing to pay considerably higher
prices for it than the current users.  Irrigators who receive
subsidized water from federal projects may want to transfer this
water to a municipality at a higher price if they can profit from the
transaction.  At the same time, such transactions may allow the
Bureau of Reclamation to share in the profits, thereby reducing the
costs to the government of providing the subsidized water. 

In response to your request, we have examined how federal revenues
might be increased through market transfers of water provided from
the Bureau's projects.  Specifically, we examined (1) whether water
transfers will increase revenues, (2) how the Bureau could increase
its revenues from transferred water, and (3) what issues the Bureau
should consider in establishing how much to charge for transferred
water.  We did not examine how additional revenues should be used. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Water transfers from irrigation to municipal and industrial uses can
increase federal revenues because municipal and industrial users pay
rates based on their full share of the project's construction costs
plus interest.  In contrast, many irrigators pay only a portion of
their share of the construction costs and are exempt from paying
interest.  Revenues may not increase when water is transferred for
irrigation, fish and wildlife habitat, or recreation because users do
not usually pay the full share of the project's construction costs
for these purposes. 

The Bureau's current guidance does not specify how charges for
transferred water will be determined.  The Bureau could use several
methods to increase its proceeds from transfers to municipal and
industrial uses, which better reflect the government's costs of
providing the water.  Under existing law, the Bureau can (1) charge
interest at current Treasury borrowing rates in some cases, (2)
compound interest charges, (3) recover subsidies associated with
irrigation water that is transferred to municipal and industrial
uses, (4) recover costs throughout the useful life of the project,
and (5) charge amounts that are higher than necessary to recover
costs or charge transfer fees.  In addition, changes in reclamation
law could allow the Bureau to charge new municipal and industrial
users interest at current Treasury borrowing rates even when a lower
interest rate is specified in the water project's authorizing
legislation. 

The key issue in deciding how much the Bureau should charge for
transferred water is the need to balance increasing federal revenues
with retaining incentives for water transfers to occur.  Increasing
federal revenues will reduce the net benefits to the buyers and
sellers, thereby discouraging some transfers.  Charges that
discourage transfers therefore preclude any gains in the efficiency
of water use and economic efficiency made possible by the transfers. 
Because the factors affecting transfer incentives vary for each
transaction, the amount that can be charged without discouraging
transfers will differ case by case. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Under the Reclamation Project Act of 1939, as amended, (43 U.S.C. 
485h) the Bureau allocates a federal water project's construction
costs among the project's uses, including irrigation, municipal and
industrial uses, power generation, fish and wildlife purposes, and
flood control.  Different users are required to pay different amounts
of the construction costs allocated to their purpose.  Under section
9, the act provides two options for users to pay for the
water--repayment contracts and water service contracts.  Repayment
contracts require the repayment of construction costs within the
contract period.  Under water service contracts, the Bureau can set
water charges at levels that will produce revenues at least
sufficient to recover an appropriate share of the annual operation
and maintenance (O&M) costs and an appropriate share of fixed charges
that the Secretary deems proper.  Both contracts cannot exceed 40
years in length, but water service contracts can be renewed at the
end of the contract period.\1

Some irrigators have transferred water provided from the Bureau's
projects to other users.  As discussed in our May 1994 report,\2
water markets facilitate voluntary transfers of water by providing
users with financial incentives for reallocating water.  Buyers will
enter into transactions only if they provide a less expensive supply
of water than alternative sources, and sellers will enter into
transactions only if they provide greater net income than the current
uses of the water.  Markets increase economic efficiency by allowing
those who place the highest economic value on the water to purchase
rights to use it. 

Moreover, as water becomes more valuable and prices rise, markets
provide water users with incentives to conserve water, thereby
freeing up water for other uses.  The conservation of irrigation
water can also reduce environmental degradation caused by
agricultural runoff and drainage.  Environmental quality can be
protected if those concerned, such as government agencies and private
conservation groups, can purchase water rights for this purpose. 
However, water transfers can cause adverse economic, social, and
environmental impacts on parties not involved in the transfers by
changing water use patterns.  For example, rural agricultural
economies may decline if significant amounts of water are transferred
from irrigators to cities.  Existing laws and procedures may not
fully protect third parties from these impacts.  We discuss these
issues and impediments to transfers in our May 1994 report. 

Transfers of water provided from federal projects must be approved by
the federal government.  Many transfers of Bureau-provided
water--particularly long-term transfers--will require amending
contracts.  For example, if an irrigation contractor agrees to
transfer water to a municipality, the Bureau would modify the
irrigation contract to reduce the deliveries to the irrigator and
establish a new contract to deliver water to the city purchasing it. 
The new contract would include the amounts to be paid to the
government for the municipal and industrial water.  In addition to
the amounts owed to the government, the purchasing city would also
likely pay the irrigation contractor for giving up contractual rights
to the water--otherwise, the irrigation contractor might have no
incentive to give up these rights. 

In December 1988, Interior issued its principles governing voluntary
transfers of water that involve facilities it owns or operates.  The
principles indicate that Interior will serve as a facilitator for
water marketing proposals between willing buyers and sellers if the
proposals satisfy certain conditions.  The principle relating to
repayment obligations to the federal government states that the
agency will not burden a proposed transfer with extra costs, but will
ensure that the government is financially, operationally, and
contractually in the same or a better position once a transfer is
made.  This principle indicates that Interior will try not to
discourage transfers through extra costs owed the government, which
would increase the costs to the buyers and reduce profits to the
sellers.  The Bureau issued criteria and guidance to implement
Interior's principles in 1989. 

The Bureau is currently reviewing the principles to identify barriers
to the transfer process and to ensure that its guidance is consistent
with administration policies. 


--------------------
\1 Irrigation contracts allow for a development period of up to 10
years in addition to the contract period. 

\2 Water Transfers:  More Efficient Water Use Possible, If Problems
Are Addressed (GAO/RCED-94-35, May 23, 1994). 


   REVENUES WILL OFTEN INCREASE
   THROUGH TRANSFERS TO MUNICIPAL
   AND INDUSTRIAL USES
------------------------------------------------------------ Letter :3

Under existing reclamation law and the Bureau's procedures, in many
cases federal revenues will increase when water is transferred from
irrigation to municipal and industrial uses because municipal and
industrial users are required to pay higher rates based on their full
share of the project's construction costs plus interest.  If water is
transferred from one irrigation contractor to another, or for
recreation or fish and wildlife habitat, then revenues may not
increase.  The revenues to the federal government change because the
Bureau charges different costs for different uses of the water. 


      MUNICIPAL AND INDUSTRIAL
      USERS GENERALLY PAY MORE FOR
      WATER FROM THE BUREAU'S
      PROJECTS
---------------------------------------------------------- Letter :3.1

As figure 1 illustrates, irrigators pay an allocated portion of a
project's construction costs that is based on a determination of
their ability to pay.  By law, irrigators within specified acreage
limitations pay no interest charges.  Because of this, irrigation
water is considered to be subsidized.  In contrast, municipal and
industrial users pay all of the construction costs associated with
water they use and pay interest charges.  Revenues generated through
the sale of hydroelectric power produced by federal projects are used
to pay not only the construction costs and interest associated with
power generation, but also the portion of the irrigators'
construction costs deemed beyond the irrigators' ability to pay. 
This amount, referred to as power assistance, is paid without
interest generally in the final year of the project's repayment
period.\3 Irrigators, municipal and industrial users, and power users
also must pay annual O&M expenses.  Other purposes of water projects,
such as providing recreation, fish and wildlife habitat, and flood
control, often are nonreimbursable in whole or in part--that is, the
associated costs are not repaid by project users. 

   Figure 1:  Typical Repayment
   Obligations for the Users of
   the Water From Federal Projects

   (See figure in printed
   edition.)

\a IDC is interest during construction. 

\b These costs are paid at the end of the repayment period.  All
other costs are paid on an annual basis. 

When water is transferred from irrigation to municipal and industrial
uses, the Bureau charges the higher amount owed for the water, which
increases federal revenues in many cases.\4 The Bureau has indicated
in its criteria and guidance governing water transfers that subsidies
associated with the original use of the water are not transferable to
a different use of the water.  That is, the irrigation subsidies of
the power assistance and the waived interest charges cannot be
applied to water once it is transferred to municipal and industrial
uses.\5 However, water transferred from one irrigation use to another
would retain the subsidies associated with irrigation, and federal
revenues would not increase. 

If water is transferred for fish and wildlife habitat or recreation,
then revenues may not increase.\6 The Bureau's transfer criteria and
guidance indicate that when a change in use occurs from a
reimbursable use, such as irrigation, to a nonreimbursable use, such
as providing fish and wildlife habitat, unless special legislation is
enacted, the new contracts must ensure that the repayment to the
government will be no less than before the transfer.  According to
Bureau officials, however, to increase federal revenues, the Bureau
may negotiate a price with water purchasers who are willing to pay
more. 


--------------------
\3 For some projects, similar assistance is provided by municipal and
industrial users. 

\4 Under the Reclamation Reform Act of 1982, as amended, (43 U.S.C. 
390aa to zz-1), however, irrigators who exceed specified acreage
limitations are required to pay full cost for their irrigation water,
which includes construction costs and O&M deficits with interest.  In
these cases, the amounts charged for water transferred to municipal
and industrial uses may not increase federal revenues. 

\5 Water that is transferred to electric utilities is considered
municipal and industrial water.  Power as described here refers to
power generated by the project that is sold directly to federal
contractors, rather than water that is transferred to electric
utilities. 

\6 Water generally would not be transferred for flood control because
water is not needed to meet this purpose. 


      THE EMERY COUNTY PROJECT'S
      TRANSFERS INCREASED FEDERAL
      REVENUES
---------------------------------------------------------- Letter :3.2

We reviewed two transfers that took place in the Bureau's Emery
County Project in Utah, which was built primarily to deliver 28,100
acre-feet\7 of water per year for irrigation.  The first transfer
involved 6,000 acre-feet of irrigation water transferred to the Utah
Power and Light Company in 1972.  The second transfer involved 2,576
acre-feet of irrigation water to the same company in 1987.  In both
cases, the Bureau charged new amounts for the water that included
interest payments and an adjustment in the power assistance. 

We compared the 1993 present value\8 of the government's revenues if
all the water had remained in irrigation with the present value of
revenues resulting from the transfers, based on the amounts actually
charged by the Bureau for the water transferred to municipal and
industrial uses.\9 If the transferred water had remained in
irrigation and irrigators had continued repaying the construction
costs allocated to them without interest for the entire 50-year
repayment period, the government's financial loss on its initial
investment would have been about $76.8 million, with less than 8.6
cents being paid back for each dollar spent by the government.  With
the transfers to municipal and industrial uses, the government's loss
was reduced to $67.7 million of its initial investment--$9.1 million
less--with about 19.5 cents being repaid for every government dollar
spent.  Our calculations are explained in more detail in appendix I. 


--------------------
\7 An acre-foot is the amount of water needed to cover 1 acre of land
to a depth of 1 foot--or about 326,000 gallons. 

\8 All reported values are calculations based on the 1993 present
value, unless otherwise indicated, using interest rates on 10-year
Treasury bonds.  Present value is used to compare dollar values over
time because it recognizes the value that money earns over time as it
is invested.  The present value was calculated at annual discount
rates equal to the 10-year Treasury bond rates through 1993.  After
1993, we used a forecast of the same rate as given by Data Resources
Incorporated in Review of the U.S.  Economy:  Long-range Focus
(Winter 1992-93), pp.  a100-a101.  This approach results in the
equivalent of a variable rate loan based on a 10-year Treasury bond
rate. 

\9 We based our calculations of repayment on the Bureau's initial
figure for construction costs, $11,255,678, which includes
$10,583,526 in construction costs at the time of the project's
completion in 1970 plus interest during construction.  The present
value of these construction costs in 1993 dollars is about
$84,044,000.  We did not include in our estimate additional
construction expenditures incurred in later years. 


   THE BUREAU COULD FURTHER
   INCREASE FEDERAL REVENUES
------------------------------------------------------------ Letter :4

The Bureau's current guidance on water transfers limits cost recovery
and does not specify how charges for municipal and industrial water
will be determined.  Under current law, the Bureau could enhance
revenues by charging amounts that better reflect the costs to the
government of providing the water.  The Bureau could do this by (1)
charging interest rates based on Treasury borrowing rates in some
cases, (2) compounding interest charges, (3) recovering past
subsidies associated with transferred water, (4) recovering costs
throughout the useful life of the project, and (5) charging amounts
higher than necessary to recover costs or charging transfer fees. 
Changes in reclamation law would be needed to charge current Treasury
borrowing rates for projects whose authorizing legislation specified
certain interest rates for repayment.  The Bureau has stated in its
guidance that it will avoid charges for costs owed the government
that might cause financial or economic disincentives to transfers. 


      REVENUES CAN BE INCREASED
      USING WATER SERVICE
      CONTRACTS
---------------------------------------------------------- Letter :4.1

Under the Reclamation Project Act, the Bureau has two options for
contracting municipal and industrial water that affect the amounts it
can charge.  Section 9(c)(1) of the act authorizes the Bureau to
enter into repayment contracts to recover costs allocated to the
municipal and industrial purpose and limits the interest rate in such
contracts to 3.5 percent per year.  In contrast, section 9(c)(2)
authorizes the Bureau to enter into water service contracts and set
water charges at levels that will produce revenues at least
sufficient to recover an appropriate share of annual O&M costs and an
appropriate share of fixed charges that the Secretary deems proper. 
It is at the discretion of the Secretary to determine what form of
contract is used.  However, because of the flexibility provided under
water service contracts, the Bureau can increase revenues in the
following ways: 

1.  Charging higher interest rates.  Interior's Solicitor has
indicated that section 9(c)(2) does not set a limit on the interest
rates that can be charged in water service contracts.\10 As a result,
under water service contracts, the Bureau can charge current Treasury
borrowing rates, which better reflect the government's costs--these
rates have been between 6 and 10 percent (nominal)\11 since
1986--rather than the 3.5 percent charged under repayment contracts. 
The Bureau's transfer guidance does not indicate when repayment
contracts, with their fixed interest rate, or water service
contracts, with no specified interest rate, should be used for
transferred water.  Regarding interest rates, the guidance simply
indicates that a current repayment interest rate should be used,
unless otherwise provided by law, but the guidance does not define
what is meant by a current repayment interest rate. 

The interest rate the Bureau uses in determining charges can greatly
affect federal revenues.  For example, the Bureau used the authorized
interest rate of 3.046 percent, compounded, in calculating the amount
charged for Emery County water transferred in 1972.  We calculated
the increased revenues that the federal government would have
received if the Bureau had used a more current interest rate for
repayment.  If the amounts charged had been based on a 7-percent
interest rate, the government would have received about $8.35 million
more (in 1993 present value) than it will receive from the actual
charges. 

Low interest rates may be justified on the grounds that federal water
projects result in benefits that extend beyond the direct benefits to
the water users.  For example, historically, water projects were an
essential part of settling the arid western states and promoting
economic development.  However, current national interests, such as
water conservation, environmental protection, and federal cost
recovery, raise the question of whether low interest rates should be
maintained for water transferred to new users. 

2.  Compounding interest charges.  The Bureau's guidance does not
indicate when or whether interest rates should be compounded. 
Compounding interest rates can significantly increase federal
revenues and better reflect the government's actual costs in
constructing water projects.  Interest charges are compounded if they
are added to the principal periodically and future interest charges
are then based on this larger principal.  Compounding more accurately
represents the government's costs than simple interest because
interest is routinely compounded in the private sector--federal money
spent on a federal project could have been reinvested elsewhere, such
as in a bank, and earned compound interest.  Moreover, in cases in
which the government borrows money to construct a project, it has to
pay compound interest to the lenders. 

In the 1987 transfer in Emery County, the Bureau made a one-time
charge based on Treasury borrowing rates, but the amount charged was
not based on compound interest.  To demonstrate the effect of
compounding interest rates, we calculated how much the government's
charge for the 1987 transfer would have been if it was based on
compound instead of simple interest.  Our calculations show that
federal revenues would have been about $2.8 million more than the
actual charge of $2.9 million--about $4.44 million more in 1993
present value.\12 Since there is no legal limit on interest charged
through water service contracts, compounding interest, which
increases the interest costs, is permissible under the Reclamation
Project Act of 1939. 

3.  Recovering subsidies associated with irrigation.  The Bureau
could increase federal revenues by charging the full interest and
power assistance costs associated with water transferred from
irrigation to municipal and industrial uses.  In August 1992,
Interior's Inspector General reported\13 that the Bureau was not
fully recovering the costs associated with water that was converted
from irrigation to municipal and industrial uses in part because it
only charged interest from the date the water was transferred, rather
than from the date of the project's completion.  The Bureau's
guidance states that the Bureau will only include interest charges on
transferred water for the remaining years of the project's repayment
period; it will not recover interest associated with the transferred
water for the time it was used for irrigation.  The Bureau has
indicated that it does not intend to recover subsidies originally
allocated to the transferred water during the time it was used for
irrigation.  The Inspector General recommended that the Bureau's
guidance be revised to recover an equitable share of the financing
costs incurred from the date of a project's completion.  The Bureau
currently is examining this issue at the request of Interior's
Assistant Secretary for Policy, Management, and Budget. 

Before Interior's principles were issued in 1988, the Bureau charged
the purchaser in the 1987 transfer from the Emery County Project an
amount that included simple interest at current Treasury rates as
well as the power assistance amount associated with the transferred
water, calculated from the date of the project's completion rather
than the date of the transfer.  If the Bureau's guidance had been in
place at the time of this transfer, and the Bureau had not charged
interest on the power assistance amount from the date of the
project's completion but from the date of the transfer, we estimate
that the federal government would have received $566,000 less in 1987
than it did from the transfer--about $888,000 in 1993 dollars. 

Figure 2 summarizes the impact of each of the different rate-setting
methods discussed above on federal revenues received for the Emery
County Project.  The first bar shows how much revenue the government
has received for repayment for the Emery County Project, which
includes the actual charges for the 1972 and 1987 transfers.  The
second and third bars show, respectively, how much more revenue could
have been obtained had the Bureau used a higher interest rate in the
1972 transfer and had compounded interest charges in the 1987
transfer.  The fourth bar presents revenues that would have been
received had the Bureau not recovered interest and power assistance
charges for the time the water was used for irrigation.  The last bar
presents how much revenue the government would have received if no
transfers had occurred. 

   Figure 2:  Differences in
   Federal Revenues From Different
   Rate-Setting Methods for the
   Emery County Project

   (See figure in printed
   edition.)

4.  Recovering Costs After the Repayment Period.  In its August 1992
report, Interior's Inspector General explained that the Bureau does
not recover any of the government's financing costs related to
municipal and industrial uses when changes to these uses occur after
the repayment period for the project.  The Bureau limits its cost
recovery in these instances to O&M expenses. 

The Inspector General suggested that when transfers occur after the
repayment period is complete, financing charges should be based on
the useful life of the project--typically 100 years--rather than be
limited to the repayment period.  Under this approach, interest
charges would be based on the proportion of all water delivered for
municipal and industrial uses over the project's useful life.  If,
for example, 10 percent of the water delivered was used for municipal
and industrial purposes, then interest costs for 10 percent of the
water should be charged, starting from the first day of the project's
completion. 

The Bureau currently is examining various approaches for determining
charges for water transferred to new uses after the end of the
repayment period.  According to the Bureau, using water service
contracts to charge beyond the initial repayment period is
permissible under existing law.  We agree that this appears
permissible under the broad authority of the Reclamation Project Act,
so long as there is a reasonable basis for the charges and contracts
are not prohibited by specific projects' authorizing legislation. 

5.  Assessing higher charges and transfer fees.  Under existing law,
the Bureau could also obtain additional revenues by charging amounts
that are higher than necessary to recover project costs or by
charging a fee as a condition for approving a transfer.  In some
cases, irrigators may realize large profits by transferring federally
subsidized water.  Charges for transferred water other than those for
project cost recovery are one way for the Bureau to receive a portion
of such profits.  Such charges could also be viewed as a means of
addressing the adverse impacts of transfers on local economies and
the environment. 

Interior's Solicitor has indicated that the Reclamation Project Act
of 1939 does not set a limit on how much can be charged for municipal
and industrial water under water service contracts so long as there
is a reasonable basis for the amount.\14 As a result, the Bureau can
charge amounts for municipal and industrial water that are higher
than necessary to recover construction costs plus interest and O&M
costs.  However, the law does limit how these revenues can be used. 
According to the Solicitor, these additional revenues can be used to
accelerate the repayment of the costs allocated to municipal and
industrial uses,\15 assist the repayment of the costs allocated to
irrigation, or be used for other purposes in cases in which there is
a basin account, as there is for the Colorado River Storage
Project.\16 In addition, the Secretary has general authority under
which the Secretary might require that profits received by water
users who resell their water be paid to the Bureau for deposit into
the reclamation fund\17

as a condition for approving a transfer--in effect, charging a
transfer fee.\18

Charging new water users fees for transfers is not unprecedented. 
The Congress, in passing the Central Valley Project Improvement Act
in 1992, included an annual charge of $25 per acre-foot to be applied
to all transfers of water from the project to municipal and
industrial users who did not receive water from the project prior to
the date of the act.  The fees will be deposited in a fund to be used
for restoring fish and wildlife habitat. 


--------------------
\10 Memorandum from the Associate Solicitor, Energy and Resources, to
the Commissioner, Water and Power Resources Service, Oct.  15, 1980. 

\11 Nominal interest rates are not adjusted for inflation. 

\12 The Bureau offered Utah Power and Light a price that included the
Bureau's calculation of compounded interest rates, to be paid over 30
years rather than in a lump sum.  However, this price was offered
after the Bureau and the utility had negotiated a price that included
simple interest, and the utility protested the change.  The water was
sold to the utility for the price that included simple interest. 

\13 Repayment of Municipal and Industrial Water Supply Investment
Costs, Bureau of Reclamation, U.S.  Department of the Interior Office
of Inspector General, Rpt.  No.  W-IN-BOR-005-91 (Aug.  1992). 

\14 Memorandum from the Assistant Solicitor, Water, to the
Commissioner of Reclamation, Sept.  27, 1974. 

\15 Current municipal and industrial charges typically are based on
costs amortized over a 40-year repayment period.  Higher charges can
allow these costs to be recovered in a shorter time. 

\16 A basin fund was established for projects authorized as part of
the Colorado River Storage Project.  Revenues collected in connection
with the operation of this project and all participating projects are
credited to the fund and can be used to defray the costs of
operation, maintenance, and replacement, as well as repay costs and
interest charges allocated to power and municipal and industrial
users for participating projects and costs allocated to irrigation. 

\17 The reclamation fund is a fund in the Treasury established under
43 U.S.C.  391 to be used for the construction and maintenance of
projects for the storage, diversion, and development of water in the
western states. 

\18 See 43 U.S.C.  373 for the Secretary's general authority under
which the Secretary might place conditions for approving transfers. 
Under 43 U.S.C.  392a, known as the Hayden-O'Mahoney amendment, when
not contrary to law or contract, revenues received by the Bureau in
connection with irrigation projects are to be deposited in the
reclamation fund. 


      CHANGES IN RECLAMATION LAW
      COULD FURTHER INCREASE
      FEDERAL REVENUES
---------------------------------------------------------- Letter :4.2

While the Secretary has wide discretion in setting rates, reclamation
law can restrict the Secretary's flexibility to increase federal
revenues.  For some projects, the authorizing legislation specifies
the interest rate the Bureau can use in charging water users.  Often
established decades ago, these rates typically are lower than current
Treasury borrowing rates.  In these cases, the Secretary can only
mandate that the authorized rate be charged.  Changes in the law
would be needed to charge current Treasury borrowing rates for
transfers from some projects. 


   BALANCING INCREASING FEDERAL
   REVENUES WITH RETAINING
   TRANSFER INCENTIVES AND
   CONSIDERING IMPACTS ON WATER
   USERS
------------------------------------------------------------ Letter :5

Increasing charges for transferred water can discourage some
transfers by decreasing buyers' and sellers' net gains--that is, the
benefits buyers realize from paying less for water and the profits
sellers realize from selling the water.  Eliminating the net gains
removes the incentives for transfers, and transfers do not occur, so
there are no gains in economic efficiency, water is not used more
efficiently, and federal revenues are not increased.  Even if some
incentive remains, by charging higher amounts for transferred water
the federal government may increase the price that municipal and
industrial users pay for water and reduce the profits to irrigators. 
Determining municipal and industrial charges that will increase
federal revenues without discouraging transfers is difficult because
the factors affecting buyers' and sellers' incentives vary case by
case. 

The amount the government can charge for transferred water without
discouraging transfers falls between (1) the maximum amount the buyer
is willing to pay for the water and (2) the minimum amount the seller
will accept.  The maximum amount a buyer is willing to pay is
determined by the least-cost alternative--the buyer will be better
off purchasing the transferred water rather than finding an
alternative source only if the transferred water costs less than the
alternative.  The minimum amount the seller will accept is determined
by the net value of the water in its current use, such as crop
production--the seller will be better off selling the water only if
it generates more revenue through sale than in its current use. 

Even if some incentive remains for a transfer, higher charges can
require municipal and industrial users to pay more for federally
provided water and can reduce the profits realized by irrigators. 
The buyer, the seller, or both are always better off because of a
transfer; otherwise, the transfer would not occur.  This means that
if a transfer occurs, new water users are receiving water at the
least expensive price available.  However, the lower the amount the
government charges, the better off the buyer and seller are. 
Policymakers need to balance (1) the desire to increase federal
revenues from transfers and (2) the incentives for transfers to occur
and the impacts on water users. 


      OPTIONS FOR ESTABLISHING
      MUNICIPAL AND INDUSTRIAL
      CHARGES
---------------------------------------------------------- Letter :5.1

The amount that can be charged for transfers to municipal and
industrial uses without discouraging them varies case by case because
the cost of alternative water supplies and transaction costs can vary
greatly and because the returns on the water from crop sales vary by
crop, by farm, and by year.  Therefore, establishing such a charge
would require determining the value of alternative water sources, the
value of crop production, and transaction costs for each transfer. 
Such determinations can be difficult and time-consuming. 

While it is not feasible to determine how much the government can
charge without discouraging transfers in every case, we identified
three general approaches the Bureau can choose from to establish
municipal and industrial charges that minimize potential losses in
efficiency while increasing federal revenues.  These approaches are
(1) case-by-case negotiation of individual transfers, (2) a set rate
or rate formula based on estimates of the factors affecting the
incentives for transfers, and (3) a set rate or rate formula based on
a predetermined level of cost recovery or fee.  The most appropriate
approach will vary depending on the transfer and the information
available about the buyers' and sellers' incentives.  These options
are discussed in more detail in appendix II. 


      ESTABLISHING CHARGES FOR
      TRANSFERS TO USES OTHER THAN
      MUNICIPAL AND INDUSTRIAL
---------------------------------------------------------- Letter :5.2

The amount that the Bureau can charge for transfers from one
irrigator to another or from an irrigator to use for fish and
wildlife habitat or recreation varies case by case as well.  However,
the factors affecting the incentives for these transfers often differ
somewhat from those affecting transfers to municipal and industrial
uses, and the amounts purchasers are willing to pay will vary. 

Municipal and industrial users often place a high economic value on
water, and therefore the price they are willing to pay for water is
often high.  Irrigators may not be willing to pay as high a price
because the transferred water may generate less economic value in
agriculture than in municipal and industrial uses.  Therefore,
transfers from one irrigator to another are more likely to be
discouraged by higher charges than transfers from irrigators to
municipal and industrial users.  Under current reclamation law and
the Bureau's guidance, water transferred from one irrigator to
another would retain the subsidies associated with irrigation.  In
this way, charges remain low and fewer transfers are discouraged. 
Federal revenues may not increase in these cases, but gains in
efficiency will still be realized. 

Natural resource agencies and nonprofit conservation groups are the
likely buyers of water for what are termed instream uses, such as
providing fish and wildlife habitat, providing recreation, and
ensuring water quality.  As with irrigators, however, these
organizations are not likely to realize the financial gain from water
transfers that municipal and industrial users can.  Rather, these
organizations often provide public goods that benefit others, and the
water may have nonmarket value.  Therefore, the price these
organizations are willing to pay may be less than the market value of
the water to municipal and industrial users, so high charges may also
discourage these transfers. 

Water used for fish and wildlife habitat and recreation often does
not carry any repayment obligations.  However, the Bureau's guidance
on transfers indicates that when a change in use occurs from a
reimbursable function, such as irrigation, to a nonreimbursable
function, contracts must ensure that the repayment to the government
will be no less than before the transfer.  As a result, new instream
users will have to pay the irrigators' share of the costs that are
subsidized by power assistance.  This occurs because power assistance
can only be paid for irrigation under existing law, not for other
purposes.  Therefore, for projects with power assistance, the amounts
charged to instream users would be higher than those charged to
irrigators. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

Water transfers are not only a valuable tool for improving the
efficiency of water use and environmental quality, but transfers from
irrigation to municipal and industrial uses are a promising way to
increase federal revenues for water development projects.  Current
reclamation law provides the Secretary a great deal of discretion in
establishing municipal and industrial charges to recover some of the
costs of constructing the projects.  However, Interior's principles
governing water transfers and the Bureau's implementing guidance do
not encourage increasing federal revenues as much as possible.  They
focus on placing the government in the same or a better financial
condition after a transfer is made and facilitating transfers, rather
than on charging the highest amounts possible without discouraging
transfers.  Moreover, the guidance does not specify how the rates for
water transferred to municipal and industrial uses will be
determined, leaving a crucial factor affecting the profitability of
transfers unclear to potential buyers and sellers.  The Bureau's
current review of the principles provides an opportunity to consider
ways to further increase federal revenues while retaining incentives
for transfers. 

Changes in reclamation law would further enhance the Secretary's
ability to increase revenues through water transfers.  Many
reclamation projects have specified interest rates in authorizing
legislation that limit interest charges below current levels. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :7

The Secretary of the Interior should direct the Commissioner of the
Bureau of Reclamation, in reviewing the principles governing water
transfers, to examine ways in which federal revenues may be increased
while retaining incentives for transfers.  In examining ways in which
federal revenues may be increased, the Secretary should direct the
Commissioner to consider charging amounts that (1) are based on
Treasury borrowing rates, (2) include compound interest, (3) recover
interest and power assistance subsidies, (4) recover costs throughout
the useful life of the project, and (5) are higher than necessary to
recover costs or constitute transfer fees, when such amounts are
consistent with current law, are appropriate, and will not discourage
transfers.  The Secretary should also direct the Commissioner to
consider the factors affecting the incentives for transfers, to the
extent feasible, and consider various approaches for determining
charges, including case-by-case negotiation and set rates and rate
formulas. 


   MATTER FOR CONGRESSIONAL
   CONSIDERATION
------------------------------------------------------------ Letter :8

To allow the Bureau of Reclamation greater flexibility in recovering
the costs of federal water projects, the Congress should consider
allowing the use of current Treasury borrowing rates in establishing
charges for transferred water, regardless of the interest rates
included in some authorizing legislation. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :9

As requested, we did not obtain written agency comments on this
report.  However, we discussed the factual information in the report
and the implications of these facts with Bureau and Interior
officials, including the Bureau's Chief, Division of Program
Analysis, and representatives from Interior's Office of the Solicitor
and the Assistant Secretary for Water and Science.  In general, the
officials said the information was accurate and concurred with the
statements in the report.  They noted, however, that the Bureau
currently is reviewing Interior's principles governing water
transfers to identify barriers to the transfer process and to ensure
that the Bureau's guidance is consistent with the administration's
policies.  They also stressed that the Bureau is working with the
Assistant Secretary, Office of Policy, Management and Budget, to
develop a pricing policy for municipal and industrial water in
response to the Inspector General's recommendations.  We incorporated
changes where appropriate. 


   SCOPE AND METHODOLOGY
----------------------------------------------------------- Letter :10

We reviewed reclamation law, Interior's principles for approving
water transfers, the Bureau's criteria and guidance for implementing
the principles, and the Bureau's rate-setting guidance.  We also
reviewed repayment obligations resulting from transfers of water in
the Emery County Project and estimated changes in federal cost
recovery resulting from different rate-setting practices.  We met
with officials from the Bureau's Upper Colorado and Mid-Pacific
Regional Offices.  We also reviewed reports completed by the
Department of the Interior's Inspector General, the Western
Governors' Association, and the Natural Resources Law Center at the
University of Colorado and discussed rate-setting options with
authors of these and other reports on water markets. 

Our work was conducted between September 1992 and June 1994 in
accordance with generally accepted government auditing standards. 


--------------------------------------------------------- Letter :10.1

Copies of this report are being provided to the Secretary of the
Interior, the Commissioner of the Bureau of Reclamation, and other
interested parties. 

If you or your staff have any questions, please contact me on (202)
512-7756.  Major contributors to this report are listed in appendix
III. 

Sincerely yours,

James Duffus III
Director, Natural Resources
 Management Issues


ESTIMATING INCREASES IN FEDERAL
REVENUES FOR THE EMERY COUNTY
PROJECT'S TRANSFERS
=========================================================== Appendix I

To evaluate the impact of water transfers on the federal revenues
received for repayment of investment costs in the Bureau of
Reclamation's projects, we analyzed actual transfers of water from
irrigation to municipal and industrial uses in Utah's Emery County
Project.  Our analysis estimated federal revenues if transfers had
not occurred, estimated revenues under the actual terms of the
transfers, and estimated revenues had the Bureau used alternative
methods of calculating charges for the transferred water. 


   GENERAL BACKGROUND
--------------------------------------------------------- Appendix I:1

The Bureau's water projects often serve many purposes, including
irrigation, flood control, recreation, hydroelectric power
generation, and municipal and industrial uses.  In determining the
repayment of project capital costs, the Bureau estimates the portion
of the total project capital costs attributed to each of the
functions that a particular project serves.  It then calculates
repayment rates owed by project users on the basis of the costs
attributed to each purpose.  Different project users are treated
differently with respect to repayment depending on how they use the
water. 

The costs associated with some purposes, such as recreation, flood
control and fish and wildlife purposes, such as providing habitat,
are nonreimbursable.  The costs associated with irrigation and
municipal and industrial uses are reimbursable, but repayment costs
owed by water users differ.  Irrigation rates are considered to be
subsidized.  In determining irrigation rates, the Bureau does not
include interest costs during construction, and in some cases,
construction costs are reduced on the basis of the Bureau's
determination of irrigators' ability to pay.  The Bureau also does
not include interest on the construction costs owed. 

When irrigation costs are reduced because of irrigators' inability to
pay, power users are required to pay the remaining portion of the
capital costs allocated to irrigation.  This is generally referred to
as the power assistance.  Power users generally make this payment in
one lump sum, without interest, at the end of the repayment period. 
This payment is separate from those for the capital costs that are
attributed to the electric power generation function, which power
users pay in annual installments, with interest, over the project's
repayment period.  Municipal and industrial users are required to pay
all of their capital costs with interest, including the interest
during construction (IDC). 

In some cases, the Bureau has allowed voluntary transfers of a
project's water from irrigators to municipal and industrial users. 
In such a transfer, the municipal and industrial purchaser may pay
the irrigator to stop receiving a certain quantity of water, which
the Bureau then delivers to the new municipal and industrial user. 
The Bureau no longer is paid an irrigation rate for the water
transferred, but charges users a higher municipal and industrial
rate.  This results in greater revenues for the government.  The
extent to which the government's revenues increase depends on the
following factors: 

1.  The interest rate chosen for the calculation of the municipal and
industrial rate.  The higher the interest rate, the higher the
repayment obligations of the municipal and industrial purchaser to
the government. 

2.  Whether simple interest or compound interest is used.  Compound
interest results in higher repayment obligations for the purchaser. 

3.  The treatment of past subsidies associated with the water in its
previous use in irrigation.  If the value of the interest and power
assistance subsidy for the period from the date of the project's
completion through the date of the transfer is included in the rate
for transferred water, then the government's revenues will be higher. 


   BACKGROUND FOR THE CASE STUDY
   AT THE EMERY COUNTY PROJECT
--------------------------------------------------------- Appendix I:2

In order to illustrate the effect of water transfers and different
rate-setting policies on federal revenues, we analyzed the effect on
revenues of actual water transfers from irrigators to a municipal and
industrial user in the Bureau's Emery County Project.  We also
calculated how different methods of determining municipal and
industrial repayment obligations would have affected federal revenues
for the Emery County Project.  We based our analysis on the
following: 

  The Bureau completed major construction in 1966 and started
     receiving irrigation payments in 1970.  Water initially was
     allocated only to irrigation, providing 28,100 acre-feet per
     year. 

  On the basis of the Bureau's documents, we used the figure of
     $10,583,526 as the project's construction costs allocated to
     irrigation as of 1970. 

  The repayment period for irrigation is 50 years, between 1970 and
     2019, and the interest rate for the project is 3.046 percent. 

  IDC on irrigation's share of the capital costs was estimated by the
     Bureau at about $24 per acre-foot--about $672,000 for the
     project's water supply function.  This amount does not enter
     into the Bureau's calculation of irrigators' repayment
     obligation, as irrigators are exempt from paying IDC but
     represents a portion of the government's loss on its investment. 

  The Bureau determined that the irrigators' ability to pay for
     irrigation water was $2,935,000--a reduction of over 70 percent
     of the construction costs allocated to irrigation.  Irrigators
     signed a contract to repay the $2,935,000 in annual installments
     over the repayment period without interest. 

  The difference between irrigation's allocated construction costs
     ($10,586,625) and irrigators' "ability-to-pay" amount
     ($2,935,000)--about $7.7 million--was shifted to power users in
     the Colorado River Basin.  We assumed that it would be paid in
     one lump sum in the year 2013.\19

  In 1972, the Bureau approved a permanent transfer of 6,000
     acre-feet per year from a group of irrigators to Utah Power and
     Light (UP&L).  The Bureau and UP&L agreed to a schedule of
     annual payments based on the construction costs allocated to
     irrigation plus interest prorated for the amount of water
     transferred.  The Bureau used the rate of 3.046 percent,
     compounded, for calculating UP&L's repayment schedule to the
     government. 

  Some additional construction costs allocated to irrigation were
     expended after 1973--$1,730,368 (not adjusted for interest or
     inflation). 

  In 1987, the Bureau approved another permanent transfer of 2,576
     acre-feet per year from irrigators to UP&L.  In this case, UP&L
     was charged a single payment of $2,917,809 (in current 1987
     dollars).\20 The Bureau based the calculation on all capital
     costs allocated to irrigation with interest, prorated for the
     transferred amount, and reduced by the amount of money that the
     irrigators paid on the water before it was transferred.  For
     this transfer, the Bureau used the 10-year Treasury bond rate,
     which is considerably greater than the project's interest rate
     of 3.046 percent, but calculated interest on a simple basis
     rather than on a compound basis. 


--------------------
\19 This amount was later reduced because of transfers to Utah Power
and Light, which does not receive a power assistance subsidy.  By
law, the power assistance may be paid anytime within the project's
repayment period of 50 years.  As it is exempt from interest costs,
the payer has an incentive to delay payment as much as possible. 

\20 In addition to paying the federal government, UP&L paid the
irrigators an average of about $600 per acre-foot for the transferred
water and associated land. 


   METHODOLOGY AND RESULTS UNDER
   DIFFERENT SCENARIOS
--------------------------------------------------------- Appendix I:3

We compared federal revenues without the transfers to revenues with
the transfers.  We also studied the effects of alternative methods of
calculating the purchaser's obligations to the government, including
(1) using a higher interest rate, (2) using compound instead of
simple interest, and (3) deducting past subsidies associated with the
transferred water for the period before the transfer took place.  All
present value figures reported below were made using Treasury's
10-year bond rate.\21

We used the actual 10-year rate for the years 1970 to 1993.  We
relied on rates developed by Data Resources Incorporated, a leading
independent forecaster, for the years 1994 to 2019. 


--------------------
\21 We used a Treasury bond rate to reflect the government's cost of
borrowing.  The 10-year rate was chosen partly for convenience, as
the Bureau used it in calculating the amount it charged UP&L for
water transferred in 1987. 


      NO TRANSFERS
------------------------------------------------------- Appendix I:3.1

We first examined the impact on federal revenues if no transfers from
irrigation to municipal and industrial uses had occurred and all of
the water had remained in irrigation.  Irrigators were to pay a total
of $2,935,000.  We assumed payments were to be made in equal annual
installments of $58,700 between 1970 and 2019 for the use of all
28,100 acre-feet of irrigation water.  Assuming a 50-year repayment
period, this amounts to an annual payment of about $2.09 per
acre-foot for irrigation water.  We assumed that power users would
pay the balance of the irrigators' share of construction costs, about
$7.6 million, in one lump sum payment in 2013; this is the power
assistance. 

We calculated the 1970 present value of payments for the 28,100
acre-feet over the entire period of 1970 to 2019 at about $964,000. 
This corresponds to repayment of less than 8.6 percent of the sum of
the construction costs allocated to the irrigators plus IDC
($10,583,526 plus about $672,000).  This means a loss to the
government of about $10.3 million.  In 1993 present value, this
represents a loss of about $76,844,000. 


      ACTUAL TRANSFERS TO
      MUNICIPAL AND INDUSTRIAL
      USES
------------------------------------------------------- Appendix I:3.2

This scenario is based on the actual terms of the 1972 and 1987
transfers from irrigators to UP&L.  Irrigators' payments are based on
the rate of $2.09 per acre-foot per year from 1970 to 2019, but this
rate applies to less and less water as more gets transferred to UP&L,
as indicated below: 

  Irrigators pay for all 28,100 acre-feet of irrigation water for the
     first 2 years. 

  In 1972, 6,000 acre-feet are transferred to UP&L, so irrigators pay
     for 22,100 acre-feet between 1973 and 1987. 

  In 1987, an additional 2,576 acre-feet are transferred to UP&L, so
     irrigators pay for 19,524 acre-feet between 1987 and 2019. 

As a result of the transfers, UP&L pays a total of about $4.4 million
in annual installments from the period 1972 to 2013 for 6,000
acre-feet and also pays a lump sum of about $2.92 million in 1987 for
2,576 acre-feet.  Power users pay a lump sum of about $4.9 million in
the year 2013.  This is the power assistance subsidy, reduced to
reflect the amount of water transferred to municipal and industrial
uses.  (Since municipal and industrial water users do not receive
power assistance, the power assistance amount is reduced
proportionately to the amount of the transfer.)

We calculated the 1970 present value of all of these payments at
about $2.19 million, which is 19.5 percent of the construction costs
allocated to irrigation plus IDC of about $11.3 million (in 1970
dollars).  In 1993 present value, this amounts to a loss to the
government of about $67.7 million. 


      USING A HIGHER INTEREST RATE
------------------------------------------------------- Appendix I:3.3

In this scenario, we calculated the difference in revenues if the
government used interest rates based on the 10-year Treasury bond
rate, instead of the project's considerably lower rate of 3.046
percent,\22 in calculating charges for the 1972 transfer.\23 Using a
7-percent interest rate would increase UP&L's payments on 6,000
acre-feet to a total of over $8.6 million in nominal dollars for 1973
to 2012.  This is twice the total amount actually paid by UP&L.  The
higher amount would raise the 1970 present value of all repayments to
the government to about $3.3 million--about 29.4 percent of the
government's total cost.  This would increase federal revenues by
about $8.35 million in 1993 present value. 


--------------------
\22 This interest rate was compounded. 

\23 We used the rate of 7 percent; the 1973 figure for the 10-year
Treasury bond rate was 6.58 percent. 


      USING COMPOUND INSTEAD OF
      SIMPLE INTEREST
------------------------------------------------------- Appendix I:3.4

In this scenario, we calculated the increase in federal revenues if
the Bureau used compound instead of simple interest in calculating
the capital cost on the water transferred from irrigators to UP&L in
1987.  In the 1987 transfer, the Bureau charged a one-time payment
instead of annual payments.  This payment was based on the full
capital cost of the 2,576 acre-feet involved, reduced by the amount
that irrigators paid on this water between 1970 and 1986.  The Bureau
used the 10-year Treasury bond rate, but applied interest on a simple
basis.  We made a similar calculation, but used the same 10-year rate
on a compound basis.  The calculation yielded a figure of about
$5,755,000 instead of the $2,917,809 (both in 1987 dollars) that the
Bureau actually charged UP&L.  Using compound interest would have
increased federal revenues by $4,444,279 in 1993 present value. 

Although the higher figure would have better reflected the
government's costs, including interest, UP&L may not have been
willing to pay such a high price.\24 The Bureau offered a price to
UP&L that included the Bureau's calculation of compound interest. 
However, this price was offered after the Bureau and UP&L had
negotiated and agreed on a lower price that included simple interest. 
UP&L protested the late change in the negotiated price, and the water
was sold to UP&L for the lower price that included simple interest. 


--------------------
\24 According to the Bureau, the higher price plus the average of
about $600 per acre-foot that UP&L paid irrigators for the
transferred water would have put the cost to UP&L higher than the
market value of water rights in the Colorado Basin. 


      CHARGING THE INTEREST
      SUBSIDY BEFORE THE TRANSFER
------------------------------------------------------- Appendix I:3.5

In this scenario, we calculated how much less the federal government
would have received if the Bureau had not included past power revenue
assistance and interest charges associated with the transferred
water.  Under the Bureau's current transfer criteria and guidance,
past subsidies associated with transferred water cannot be recovered. 
Had the Bureau not charged UP&L power revenue assistance for the time
the transferred water was used for irrigation, UP&L's payment would
have been about $403,000 less in 1987 dollars (about $632,000 in 1993
present value).  We also calculated how much less the government
would have received had it deducted the interest on irrigation
payments for the period before the transfer.  This would have lowered
UP&L's payment by about $163,000 in 1987 dollars (about $256,000 in
1993 present value). 


OPTIONS FOR ESTABLISHING MUNICIPAL
AND INDUSTRIAL RATES
========================================================== Appendix II

GAO identified three approaches for establishing municipal and
industrial charges to minimize potential losses in efficiency while
increasing federal revenues:  (1) case-by-case negotiation of
individual transfers, (2) a set rate or rate formula based on
estimates of the factors affecting the incentives for transfers, and
(3) a set rate or rate formula based on a predetermined level of cost
recovery or fee.  The most appropriate approach will vary depending
on the transfer and the information available about the buyers' and
sellers' incentives. 

Negotiation with transferring parties to determine a mutually
agreeable charge may be desirable for large, long-term transfers. 
These transfers may provide greater opportunity for significant
revenues, while leaving sufficient opportunity for buyers and sellers
to realize economic gains.  It may be worthwhile for the Bureau and
transferring parties to negotiate the terms of such significant
transactions.  However, this approach requires aggressive negotiating
skills and considerable time and effort to ensure that the government
is receiving the highest rates that it can while leaving the buyers
and sellers incentives for transfers to occur.  The Bureau is more
likely to successfully negotiate such a charge if it has information
about the factors affecting the incentives for transfers, namely, the
least-cost alternative water sources available to the buyer and the
value of the water to the seller in its current use. 

Conversely, a set rate or rate formula may be appropriate for small
and short-term transfers.\25 Negotiation may be too time-consuming
and expensive and require too much effort for frequent small
transactions.  Moreover, a set rate or rate formula allows buyers and
sellers to form secure expectations about the costs owed the
government and reduces uncertainty about the value of their
transfers. 

In some locations, reasonable estimates of the factors affecting
incentives can be determined and used to establish the amount to
charge within a certain area.  The maximum amount a municipal and
industrial buyer is willing to pay is often reflected in a local
market price for water--that is, the price that others have paid to
purchase water recently.  These figures may not be available in some
locations with little market activity but in other areas are
generally well known.  For example, for many years, the City of
Albuquerque, New Mexico, has had a standing offer of $1,000 per
acre-foot to purchase permanent water rights.  The city of Fort
Collins, Colorado, has paid about $1,800 per acre-foot for recently
acquired water.  In addition, estimates of the value of crop
production may exist or could be determined for crops commonly
produced in an area.  When estimates of the factors affecting
incentives are available, the Bureau could base charges on a set
percentage of the difference between the market price and the value
of the water in its current use, while considering likely transaction
costs.  Using estimates as the basis for charges reduces the
possibility that the amount charged will discourage many transfers. 

If estimates are not available, then the Bureau may have to establish
set rates primarily on the basis of a predetermined level of cost
recovery or a fee or surcharge.  These rates may discourage transfers
in some cases if the charge is too high and may limit cost recovery
unnecessarily in other cases.  In general, the smaller the
government's charge, the fewer transfers will be discouraged. 


--------------------
\25 The Bureau may need to be flexible in distinguishing large from
small transfers.  If there is a set cutoff amount, some large
transfers may be broken into numerous smaller transfers to avoid
negotiation. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION, WASHINGTON,
D.C. 

Amy Mathews Amos
Philip Farah
Leo Ganster

SAN FRANCISCO REGIONAL OFFICE

George Senn

OFFICE OF GENERAL COUNSEL

Stanley G.  Feinstein

