Central Arizona Project: Costs and Benefits of Acquiring the Harquahala
Water Entitlement (Letter Report, 06/05/95, GAO/RCED-95-102).

Pursuant to a congressional request, GAO provided information on how the
Harquahala Valley Irrigation District became a source of water for the
Fort McDowell Indian Community, focusing on the: (1) federal
government's costs to acquire the water; (2) benefits accrued to the
parties involved in the acquisition; and (3) status of Department of
Agriculture loans made to Harquahala landowners.

GAO found that: (1) economic conditions in the late 1980s led Harquahala
landowners to sell their land and associated water rights, while the
Central Arizona Water Conservation District and the federal government
were seeking water to settle long-standing water rights claims; (2) the
Harquahala water acquisition will cost the federal government $87.6
million to $124 million in forgone receipts over the project's 55-year
repayment period, which includes the elimination of the Harquahala
District's debt for its water distribution system and project
construction costs; (3) the federal government settled the Community's
Indian water claims, the Indian community obtained a firm water supply,
the irrigation district reduced its repayments for project construction,
and the Harquahala landowners received cash and debt relief from the
sale of their water rights as a result of the water acquisition; (4) the
Department of the Interior failed to adequately protect the federal
government's interest with respect to federal farm loans held by
Harquahala landowners; and (5) although 7 Harquahala borrowers were
eligible to receive $4.5 million from the water rights sale, these
borrowers had delinquencies of $3.9 million in outstanding loans.

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

 REPORTNUM:  RCED-95-102
     TITLE:  Central Arizona Project: Costs and Benefits of Acquiring 
             the Harquahala Water Entitlement
      DATE:  06/05/95
   SUBJECT:  Water rights
             Federal procurement
             Water resources development
             Indian affairs legislation
             Claims settlement
             Delinquent loans
             Farm credit
             Water supply management
             Construction costs
             Contract costs
IDENTIFIER:  Central Arizona Project (AZ)
             Colorado River
             Harquahala Valley (AZ)
             
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Cover
================================================================ COVER


Report to the Ranking Minority Member, Committee on Resources, House
of Representatives

May 1995

CENTRAL ARIZONA PROJECT - COSTS
AND BENEFITS OF ACQUIRING THE
HARQUAHALA WATER ENTITLEMENT

GAO/RCED-95-102

Central Arizona Project


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

  CBO -
  OMB -
  O&M -

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


B-260349

June 5, 1995

The Honorable George Miller
Ranking Minority Member
Committee on Resources
House of Representatives

Dear Mr.  Miller: 

The Fort McDowell Indian Community Water Rights Settlement Act of
1990 (Title IV of P.L.  101-628) directed the Secretary of the
Interior to acquire 13,933 acre-feet\1 of water to complete the
settlement of the Fort McDowell Indian Community's (the Community)
water rights claim against various Arizona parties and the federal
government.  In accordance with an option provided in the act, the
Department of the Interior acquired the water from the Harquahala
Valley Irrigation District (Harquahala), 1 of 10 irrigation districts
that contracted for non-Indian agricultural water from Interior's
Central Arizona Project (the project).  As requested, we are
providing you with information on how Harquahala became a source of
water for the settlement, the federal government's costs to acquire
the water, and the benefits accrued to the parties involved in the
acquisition.  The report also discusses the status of U.S. 
Department of Agriculture loans made to Harquahala landowners. 


--------------------
\1 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. 


   BACKGROUND
------------------------------------------------------------ Letter :1

The project was authorized under provisions of the Colorado River
Basin Project Act of 1968 (Title III of P.L.  90-537).  Interior's
Bureau of Reclamation (the Bureau) began constructing the project in
1972 and estimates that it will be completed by 1999.  The project's
main components are a 336-mile aqueduct, water storage reservoirs, a
pumping system, and an electric power generating plant.  The project
is designed to pump as much as 2.2 million acre-feet of water
annually from the Colorado River on Arizona's western border and
transport it as far south and east as Tucson.  The project provides
water to several cities, the 10 irrigation districts, and various
Indian tribes in Arizona. 

The Central Arizona Water Conservation District (the District) is
responsible for operating the project and repaying to the federal
government the reimbursable construction costs allocated to
non-Indian agricultural, municipal and industrial water users, and
electrical power generation.  The District began operating the
project in April 1993.  The District collects revenue through a local
tax and through project water and power sales. 

The federal government has financed most of the $3.2 billion spent to
construct the project.  Under the Colorado River Basin Project Act,
project construction costs allocated to Indian irrigation water use
are nonreimbursable, that is, they are borne by the federal
government.  The reimbursable costs allocated to municipal and
industrial water use and power production are to be repaid with
interest while those allocated to non-Indian agricultural water use
are to be repaid without interest.  Water users also pay for the
operation and maintenance (O&M) costs incurred by the District in
operating the project.  In addition to their water use charges, the
non-Indian agricultural water users are required by contract to pay
the fixed O&M expenses associated with project water allocated to but
not used by the Indian and municipal and industrial users, even if
the non-Indian agricultural users choose not to use the water--the
so-called "take or pay" provision.\2

In 1908, the U.S.  Supreme Court in Winters v.  U.S., 207 U.S.  564,
declared that Indian reservations in the West had federal reserved
water rights.  The federal government, as the trustee for the
nation's Indian tribes, is responsible for ensuring that Indian water
rights claims are settled in the tribes' best interest.  Disputes
about the quantity of water covered by these rights have been
resolved by court decrees, legislation, and agreements among the
affected parties.  The project has become a major source of water for
settling Indian water rights claims in Arizona.  These settlements,
achieved in part through reallocations of the project's non-Indian
agricultural water to Indian use, decrease the reimbursable costs the
District is required to pay to the federal government.  The
settlements are negotiated by Interior and authorized or confirmed by
legislation. 


--------------------
\2 In early 1995, the District and Interior reached tentative
agreement whereby the take or pay provision will no longer be in
effect. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

During the late 1980s, economic events led to the willingness of
Harquahala landowners to sell their land and associated rights to
project water.  At the same time, the United States was interested in
obtaining water to settle the Community's long-standing water rights
claims.  The ensuing legislation and negotiations between the various
parties allowed the Harquahala landowners to receive financial help
and the federal government to acquire the needed water. 

The water acquisition will cost the federal government $87.6 million
in forgone receipts over the project's 55-year repayment period. 
Included in this cost are Interior's elimination of Harquahala's
federal water distribution system debt, payment to Harquahala
landowners for the project water entitlement, and a reduction in
construction cost reimbursements from the District.  Furthermore, the
cost could increase to $124 million, depending on water use.  The
cost estimates presented to the Congress were significantly
understated because a cost element was omitted and two others
developed subsequent to the estimates. 

Many parties benefited from the acquisition.  The federal government
settled the Community's outstanding claims and acquired water for
other settlements.  The Community resolved its claims and obtained
the water.  The District's repayment obligation for project
construction costs associated with the water was reduced.  Harquahala
landowners received a cash payment and debt relief for the sale of a
water entitlement for which they paid nothing.  The landowners
continue to farm their land using project water obtained at a
substantially lower rate than prior to the sale and delivered through
their debt-free distribution system. 

Interior did not adequately protect the federal government's
financial interests with respect to federal farm loans held by
several Harquahala landowners.  Had the proceeds the landowners
received from the sale of their project water entitlement been
applied to these loans, a substantial amount of the delinquencies on
these loans could have been made current. 


   HOW HARQUAHALA BECAME INVOLVED
   IN THE FORT MCDOWELL SETTLEMENT
   AGREEMENT
------------------------------------------------------------ Letter :3

During the 1980s, Interior began negotiations to settle the
Community's water rights claims and provide the Community with a
secure source of water.  By 1990, the various parties to the
settlement had agreed on the amount of water due the Community and
the contributions each party would make.  Although the amount of
water to be contributed by the federal government had been
determined, the source of the water was uncertain. 


      HARQUAHALA VALLEY IRRIGATION
      DISTRICT--A POTENTIAL WATER
      SOURCE
---------------------------------------------------------- Letter :3.1

Harquahala is located about 65 miles west of Phoenix.  Harquahala
comprises about 38,000 acres, approximately 33,000 of which are
eligible to receive project water.  (See fig.  1.) In 1983,
Harquahala signed a contract with the Bureau and the District
agreeing to pay the share of the project construction costs
associated with an entitlement to 7.67 percent of the project's
annual non-Indian agricultural water supply.\3 In 1984, Harquahala
also contracted with the Bureau for the construction of a $34.5
million distribution system to transport water from the project
aqueduct to the farmers' fields.  Construction was financed by a
$26.1 million noninterest-bearing loan from the Bureau and $8.4
million in municipal bonds. 

   Figure 1:  The Project Service
   Area Showing the Harquahala
   Valley Irrigation District and
   Fort McDowell Indian Community

   (See figure in printed
   edition.)

Economic circumstances in the late 1980s led Harquahala landowners to
consider selling their land and the accompanying groundwater.  Many
landowners were facing bankruptcy because of declining cotton prices,
failing crops due to insect infestation, increasing project water
costs, and debts associated with their land and the distribution
system.  To compound their problems, the landowners were faced with
having to pay additional fixed O&M costs when the take or pay
provision contained in their project water service contract took
effect in January 1994. 

In 1989, the District and several local municipalities were
interested in acquiring land in the Harquahala Valley for use as a
water farm--a tract of land acquired for its future use as a
municipal groundwater supply.  Aware that the federal government was
interested in obtaining water for settling Indian water rights claims
and recognizing the possibility of reducing its cost of acquiring the
Harquahala land, the District joined with Interior to acquire
Harquahala.  In return for financially assisting the District in
completing the acquisition, the federal government would obtain the
rights to Harquahala's project water entitlement for use in settling
Indian water rights claims.  The proposal subsequently became the
basis for the provision in the act designating Harquahala as a
potential water source. 


--------------------
\3 Because the repayment period was not scheduled to begin until more
than a year after Harquahala sold its water entitlement to Interior,
no payments were made. 


      THE FORT MCDOWELL INDIAN
      COMMUNITY WATER RIGHTS
      SETTLEMENT ACT OF 1990
---------------------------------------------------------- Letter :3.2

The act confirmed an agreement between the Community, the federal
government, the state of Arizona, and others for settling the
Community's long-standing water rights claims.  The agreement
quantified the Community's right to an annual supply of 35,223
acre-feet of water in exchange for its waiver and release of all
past, present, and future claims to water for its reservation lands. 
The agreement also identified the contributors and sources of the
water supply, including 13,933 acre-feet to be contributed by the
federal government. 

The act directed Interior to acquire pursuant to contract the 13,933
acre-feet of project water permanently relinquished by Harquahala
and/or the city of Prescott.\4

The act also provided that if the water could not be acquired from
these sources, Interior could acquire any water available in Arizona
at its disposal. 

The act did not appropriate funds to acquire Harquahala's project
water supply.  Instead, in consideration for the fair value of the
relinquished water, the act authorized Interior to eliminate an
appropriate share of Harquahala's distribution system debt and, if
the fair value of the relinquished water was greater than the debt
relief, to credit the District's annual repayment obligation for the
project's construction costs by that amount. 

The act provided that Harquahala's non-Indian agricultural priority
water could be converted to Indian priority water at the rate of 1
acre-foot for each Harquahala acre eligible to receive project water. 
This provision was necessary because non-Indian agricultural water
deliveries are reduced or curtailed before municipal and industrial
or Indian priority water deliveries if shortages occur in the project
system.  Interior officials believed that the Community would not
have agreed to a settlement without the higher-priority water.  The
act also specified that any water acquired in excess of the amount
needed to complete the Fort McDowell settlement could be used only
for settling certain Indian water rights claims in Arizona. 

After the act was passed, the District opted not to acquire the
Harquahala Valley land as a water farm; therefore, Interior was
unable to acquire Harquahala's project water supply as planned. 
Interior considered acquiring water from the city of Prescott as
authorized in the act but concluded that due to environmental and
financial factors, it would not be able to obtain the necessary water
from this source.  Interior then proposed to acquire Harquahala's
project water entitlement without the District acquiring the land. 
Although no longer interested in buying Harquahala Valley land, the
District agreed to provide the funds necessary to finance the federal
acquisition of Harquahala's project water entitlement.  Interior's
Office of the Solicitor has concluded that the act provided
sufficient authority for the District to advance the necessary funds
to complete the transaction and in exchange to receive a credit
against its annual repayment obligation.  In effect, this
interpretation allowed Interior to borrow the necessary funds from
the District and to pay interest on them. 

In December 1992, Harquahala agreed to relinquish its entire project
water entitlement to the federal government for $34.9 million.  This
yielded 13,933 acre-feet of water to complete the Fort McDowell
settlement and an additional 19,318 acre-feet for use in settling
other Indian water rights claims.  In January 1993, the Fort McDowell
Indian Community Water Settlement Agreement was signed by the various
parties. 


--------------------
\4 The city of Prescott option refers to project water available to
the city, two water companies, and two Indian tribes. 


   COST OF THE ACQUISITION TO THE
   FEDERAL GOVERNMENT
------------------------------------------------------------ Letter :4

The Harquahala water acquisition will cost the federal government
$87.6 million in forgone receipts over the projects's 55-year
repayment period.\5 Interior's implementation of the act eliminated
Harquahala's $25.5 million debt for the water distribution system and
in effect paid Harquahala $28.7 million for its project water supply. 
The District's contractual project repayment obligation was reduced
by $30.5 million when the water was reallocated to nonreimbursable
Indian use.\6 Interior also incurred $2.9 million in interest charges
when the District financed the transaction.  Furthermore, the cost
could rise to $124 million because Interior has tentatively agreed to
incur $36.4 million in fixed O&M costs associated with the Harquahala
water.  Table 1 shows the federal costs of the transaction, including
the present value of each aspect of the transaction. 



                           Table 1
           
            Federal Cost of Acquiring Harquahala's
                  Project Water Entitlement

                    (Dollars in millions)

                                                     Present
Type of transaction                           Cost     value
----------------------------------------  --------  --------
Elimination of Harquahala's distribution     $25.5      $6.7
 system loan
Payment to Harquahala by the District         28.7      28.7
Reduction in the District's repayment of      30.5       6.7
 project construction cost
Interest charged by the District on            2.9       2.9
 $28.7 million payment to Harquahala
============================================================
Total                                        $87.6     $45.0
Fixed O&M costs                               36.4    12.3\a
============================================================
Grand total                                 $124.0     $57.3
------------------------------------------------------------
\a Present value expressed in 1992 terms except the amount related to
fixed O&M costs, which was calculated to 1995 present-value terms and
adjusted for inflation back to 1992. 


--------------------
\5 This amounts to $57.3 million expressed in 1992 present-value
terms. 

\6 The $30.5 million reduction in the District's repayment obligation
is the amount of the nonreimbursable project construction cost less
the increased interest income.  (See p.  11.)


      DISTRIBUTION SYSTEM DEBT AND
      OTHER FINANCIAL
      CONSIDERATIONS
---------------------------------------------------------- Letter :4.1

In December 1992, Interior and Harquahala agreed that Harquahala
would relinquish its entitlement to 33,251 acre-feet of project water
for $34.9 million.  As authorized by the act, Interior deducted
Harquahala's federal distribution system debt from the purchase price
to determine how much additional compensation would be required to
complete the transaction.  Interior determined that Harquahala's
$25.5 million distribution system debt, which was to be repaid
without interest over the succeeding 34 years, had a 1992 present
value of $5.8 million.  Interior also deducted about $0.5 million for
miscellaneous expenses owed the government, leaving a balance of
$28.7 million due to Harquahala. 

The District provided $28.7 million to Harquahala to complete the
transaction.  A condition of the District's agreeing to finance the
water sale was that it would not lose money on the transaction.  The
District charged Interior $2.9 million to replace forgone investment
income resulting from the payment to Harquahala.  Interior credited
the District's 1994 and 1995 project repayment obligations by a total
of $31.6 million that the District incurred for financing the
transaction.  Figure 2 shows the financing of the acquisition. 

   Figure 2:  The Federal
   Government's Financing and
   Payments for Harquahala's
   Project Water Entitlement

   (See figure in printed
   edition.)

Note:  Numbers do not add because of rounding. 


      INAPPROPRIATE DISCOUNT RATE
---------------------------------------------------------- Letter :4.2

In March 1994, Interior's Office of Inspector General reported that
Harquahala's $25.5 million distribution system debt was
inappropriately discounted.\7 The Inspector General determined the
discounting to be inappropriate because (1) the act's legislative
history raised concerns about the act's impact on the federal deficit
and (2) general federal Reclamation law and Interior policy does not
provide for discounting a stream of payments included in a repayment
contract.  The Inspector General also pointed out that the
8.5-percent discount rate applied to the distribution system debt was
excessive. 

We believe that the concept of discounting a debt that is to be
repaid over time is appropriate.  The act's legislative history
indicates that discounting to obtain present value was considered a
method that Interior could use.  Deducting the present value of the
distribution system debt from the purchase price would satisfy
Interior's repayment obligation, provided the proper discount rate
was used. 

We agree with the Inspector General that the 8.5-percent interest
rate used to discount the distribution system debt was excessive.  We
determined that a 7.5-percent rate better reflects the government's
borrowing costs during the 1992 negotiation of the water entitlement
acquisition.  On the basis of this lower interest rate, we calculated
that the present value of the $25.5 million debt was $6.7 million, or
$0.9 million more than computed by Interior.  Had the 7.5-percent
rate been applied, the cash required to pay Harquahala would have
been less and would have reduced the amount borrowed from the
District by $0.9 million plus interest. 

Interior officials told us that they were required to use the
8.5-percent rate because it was the fiscal year 1992 plan formulation
and evaluation rate used in long-term planning of water projects. 
Our review showed, however, that Interior was not required by law or
regulation to use this rate because the transaction in question did
not involve the construction of a water project but rather the
calculation of forgoing future streams of income from the repayment
of existing debts.  Also, the 8.5-percent rate did not reflect the
long-term borrowing rate in effect at the time of the negotiations. 
Therefore, we believe that it would have been more appropriate to
have used the 7.5-percent rate to calculate the present value of the
distribution system loan. 


--------------------
\7 Acquisition of the Harquahala Valley Irrigation District's Water
Allocation, Central Arizona Project, Bureau of Reclamation, Report
number 94-I-424, Mar.  1994. 


      PROJECT REPAYMENT OBLIGATION
      REDUCED
---------------------------------------------------------- Letter :4.3

The act authorized Interior to convert Harquahala's non-Indian
agricultural priority water to Indian priority.  Under the project's
authorizing legislation, construction costs associated with water
allocated to Indian irrigation use are nonreimbursable, that is, they
are borne by the federal government.  Bureau officials have
calculated that as a result of the water-use conversion, $67.8
million in construction costs became nonreimbursable.  However, this
reduction in reimbursable costs caused the District's project
interest costs to increase by $37.3 million over the project
repayment period.\8 The net effect of the water-use conversion is a
$30.5 million reduction in the District's repayment obligation to the
federal government. 


--------------------
\8 While the conversion reduced the District's overall repayment
obligation, it also reduced its annual payment and the amount applied
to the interest-bearing portion of the repayment obligation.  Over
the project repayment period, Bureau officials calculate that this
change will generate $37.3 million more in interest because the
interest-bearing portion of the District's repayment obligation is
reduced at a slower rate. 


      FIXED O&M COSTS
---------------------------------------------------------- Letter :4.4

By tentative agreement between Interior and the District, water
reserved by Interior is assessed a fee for its share of the fixed O&M
costs incurred by the District annually to operate the project. 
Under the tentative agreement, Interior will reserve 687,000
acre-feet of water.  This amounts to 48.6 percent of the fixed O&M
costs, or $751.9 million in forgone receipts over the project
repayment period.  Currently, the 13,933 acre-feet of Community water
and the 19,318 acre-feet of water Interior has available for future
Indian water rights settlements are reserved.  We calculate that
$36.4 million of the $751.9 million represents the fixed O&M costs
associated with the 33,251 acre-feet of water from the Harquahala
acquisition.  Should any of the reserved water be used, the water
user would be responsible for paying the fixed O&M costs, and the
federal cost would be reduced accordingly. 


      COST OF THE ACQUISITION WAS
      UNDERSTATED TO THE CONGRESS
---------------------------------------------------------- Letter :4.5

The Congressional Budget Office's (CBO) and the Office of Management
and Budget's (OMB) estimates of the cost of the Harquahala water
option in the proposed legislation presented to the Congress were
significantly understated.  One cost was not included in the
estimates, and two other costs did not become known until after the
estimates were made.  We calculate that these three costs represent
$69.8 million of the total $124 million in forgone receipts
associated with the Harquahala water acquisition, or $21.9 million of
the $57.3 million expressed in 1992 present-value terms. 

While including some of the revenue losses associated with the
acquisition, neither agency included the loss of federal receipts
resulting from the conversion of the water from non-Indian
agricultural use to Indian irrigation use.  CBO and OMB officials
said this cost element was omitted because Interior officials did not
inform them of this cost or the need to include it in the estimates. 
The omission amounts to $30.5 million in forgone receipts over the
project's repayment period, or $6.7 million expressed in 1992
present-value terms. 

Subsequent to their estimates, two other costs arose that added to
the cost of the transaction.  First, the District charged Interior
$2.9 million in forgone receipts for interest.  This cost was not
included in the estimates because it had not been determined at that
time that a finance charge would be applied to the transaction. 
Second, the federal government's share of the annual fixed O&M
expense incurred by the District for the operation of the project
subsequently became an issue.  In early 1995, the District and
Interior tentatively agreed that the federal government will be
responsible for 48.6 percent of these expenses.  On the basis of
discussions with Interior officials, it is reasonable to attribute a
proportional share of the fixed O&M costs to the acquisition cost of
the Harquahala water.  We calculate this cost at $36.4 million in
forgone receipts over the project repayment period, or $12.3 million
expressed in 1995 present-value terms adjusted for inflation back to
1992. 


   MANY PARTIES BENEFITED FROM THE
   HARQUAHALA WATER ACQUISITION
------------------------------------------------------------ Letter :5

Interior's acquisition of Harquahala's project water entitlement
provided the following benefits to various parties involved in the
transaction: 

  Interior obtained the water necessary to complete the Fort McDowell
     settlement, which was carried out on January 15, 1993.  As part
     of the cost of the Harquahala transaction, Interior also
     acquired 19,318 acre-feet of high-priority project water for use
     in settling certain Indian water rights claims in Arizona. 

  The Community obtained 13,933 acre-feet of project water from the
     Harquahala acquisition.  When combined with the 21,290 acre-feet
     of water from other sources outlined in the settlement
     agreement, the Community obtained a firm annual water supply of
     35,223 acre-feet, thereby resolving its long-standing water
     rights dispute. 

  The District's contractual project repayment obligation was reduced
     by $30.5 million as a result of converting Harquahala's
     non-Indian agricultural priority water to Indian priority. 

  Harquahala landowners received multiple benefits for the sale of a
     water entitlement for which they paid nothing.  After retiring
     $3.8 million of municipal bond debt on its distribution system
     and other expenses associated with relinquishing its project
     water entitlement, Harquahala had $24.6 million available for
     distribution to its landowners.  As of October 27, 1994, 62
     Harquahala landowners had received payments, ranging from $2,116
     to $3,075,436, based on their share of project eligible acres.\9
     In addition, the landowners were relieved of their obligation to
     pay the federal distribution system debt and the additional
     fixed O&M charges associated with the take or pay provision. 
     The landowners continue to own their land and the underlying
     groundwater resources and continue to use their debt-free
     distribution system.  Due to the District's restructuring of its
     non-Indian agriculture water rates, the landowners now farm with
     project water purchased at prices significantly lower than what
     they paid prior to relinquishing their project water
     entitlement.\10


--------------------
\9 Payments have been withheld from 10 landowners pending resolution
of disputes between landowners, lienholders, and government agencies
as to who is entitled to the proceeds. 

\10 Harquahala landowners have access to other project agricultural
water for as little as $28 an acre-foot, or $24 per acre-foot less
than the $52 an acre-foot charge imposed prior to the project water
relinquishment. 


   OPPORTUNITY MISSED TO APPLY
   SALE PROCEEDS AGAINST
   DELINQUENT FEDERAL LOANS
------------------------------------------------------------ Letter :6

Under the terms of the Harquahala transaction, $24.6 million in sale
proceeds were available for distribution to individual landowners. 
At the time of distribution, several landowners were overdue on
millions of dollars of loans made by the U.S.  Department of
Agriculture's Farmers Home Administration (FmHA).\11 If applied to
these loans, sale proceeds could have made current a substantial
amount of these delinquencies.  However, Interior did not consider
the FmHA loans in its negotiations for the acquisition of the
Harquahala water entitlement, and the majority of the delinquencies
remain. 

Since 1979, FmHA has made loans to various Harquahala landowners for
rural housing, farm ownership, economic emergency, and natural
disaster emergency purposes.  According to FmHA officials, collateral
for the loans generally was the Harquahala land, the value of which
was based in part on the project water entitlement.  As of October
28, 1994, 11 borrowers owed FmHA $9.8 million.  Our review of FmHA's
records indicates that seven borrowers have past due payments
totaling $3.9 million on $9 million in outstanding loans.  These
seven borrowers were eligible to receive a total of $4.5 million from
the sale proceeds less deductions for overdue taxes.  However, FmHA's
records identify loan payments of only $27,653 on the borrowers'
various loans since the distribution of proceeds.\12

FmHA officials consider Harquahala's sale of its project water
entitlement as a disposal of FmHA's collateral for the $9.8 million
in loans.  As such, the officials believe that the sale proceeds
should have been applied to the borrowers' FmHA loans.  The officials
told us that had they known the details and timing of the
acquisition, they could have taken actions to better protect FmHA's
interest.  For example, the officials said that they could have
foreclosed on certain loans, thereby making FmHA the landowner of
record at the time of the distribution of proceeds.  A second option
could have been for Interior to have required as a condition of the
sale that the proceed checks be made payable to the landowner "and
all lien holders." The officials said that such a payee stipulation
would have put FmHA in a better position to require delinquent
borrowers to bring their accounts current. 

Interior officials told us that they were aware of the FmHA loans but
did not consider them in their negotiations with Harquahala.  While
Interior negotiated a clause in the acquisition agreement requiring
Harquahala to retire the municipal bond debt on the distribution
system to protect the federal government's interest by having the
water free and clear of this debt, no such action was taken to
protect FmHA's interest.  The officials said that in retrospect, they
could have protected FmHA's interest by alerting FmHA to Interior's
negotiations and by attempting to include a clause in the acquisition
agreement that provided for applying the proceeds to borrowers'
delinquencies. 


--------------------
\11 In 1994, the responsibility for administering U.S.  Department of
Agriculture farm loans was transferred from FmHA to the newly created
Consolidated Farm Service Agency.  Because of the general familiarity
with the agency's earlier name, we refer to FmHA in this report. 

\12 In addition to the $27,653, FmHA has also received $1 million for
releasing its liens to another creditor involved in bankruptcy
proceedings against Harquahala borrowers.  According to an FmHA
official, the bankruptcy assets include some amount of water sale
proceeds which would have been difficult for the federal government
to successfully claim.  After applying the $1 million to the
borrowers' $5 million in outstanding loans, FmHA records show the
borrowers' accounts remain $2.3 million past due. 


   CONCLUSIONS
------------------------------------------------------------ Letter :7

Interior's acquisition of Harquahala's project water entitlement
allowed the federal government to settle the Community's
long-standing Indian water rights claims.  However, the acquisition
will cost the federal government $87.6 million, and could possibly
rise to $124 million, in forgone receipts over the project's
repayment period.  This amount is significantly more than the amount
estimated by CBO and OMB because of two factors.  First, Interior did
not provide the two agencies with information on the costs of
converting the water from non-Indian agricultural use to Indian
irrigation use for inclusion in their estimates.  Second, two other
costs arose subsequent to the estimates.  Thus, when the Congress
passed the act, it was not made aware of the total federal cost of
the acquisition.  Whether the Congress would have acted differently
if the conversion cost had been presented is unknown, but we believe
that this additional information would have allowed the Congress to
make a more informed decision on the legislation. 

Many parties benefited from the Harquahala acquisition.  The federal
government settled the Community's outstanding claims and acquired
water for other settlements.  The Community resolved its claims and
obtained the water.  The District reduced its project construction
repayment obligation associated with the water.  Harquahala
landowners received a cash payment and debt relief for the sale of a
water entitlement for which they paid nothing.  Also, the landowners
continue to farm their land using the distribution system and to
receive project water at a substantially lower rate than they paid
prior to the sale. 

Interior did not adequately protect the federal government's overall
financial interests with respect to the FmHA loans held by several
Harquahala landowners.  The proceeds the landowners in effect
received from Interior for the sale of what effectively was part of
the collateral for their FmHA loans should have been applied to the
delinquencies on these loans.  Although Interior officials knew of
the loans, they did not consider them in their negotiations with
Harquahala and did not protect FmHA's interest as part of the
acquisition process.  As a result, the federal government lost an
opportunity to make current a substantial amount of the $3.9 million
that was delinquent on the FmHA loans. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :8

To ensure complete estimates of federal costs of future Indian water
rights settlements that use Bureau of Reclamation project water, we
recommend that the Secretary of the Interior and the Directors of CBO
and OMB develop methodologies to ensure that all the known costs
associated with any federal contribution of water are included in
estimates provided to the Congress. 

Because of the common link between land and water rights in
Harquahala-type acquisitions and the need to ensure that the federal
government's overall interests are protected in future Indian water
rights settlements, we recommend that the Secretary of the Interior
identify other federal agencies' interests in these settlements and
act to protect these interests in the negotiations. 


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

We provided copies of a draft of this report to the Secretaries of
the Departments of the Interior and Agriculture and the Directors of
CBO and OMB for their comment.  The Acting Deputy Administrator of
FmHA, the Associate Director of OMB's Natural Resources, Energy and
Science Division, the Counselor to the Secretary of the Interior, and
a CBO Principal Analyst concurred in the report's findings and
conclusions.  While FmHA, OMB and Interior agreed with the
recommendations, CBO considered the recommendation on including all
costs in estimates provided to the Congress to be vague.  We do not
agree that the recommendation is vague.  The recommendation specifies
that all known costs, which would include the costs of converting the
water, should be included.  The recommendation also specifies the
agencies that should be involved in implementing the recommendation
but provides the agencies the flexibility of deciding the best means
of achieving this.  The agencies also made technical and editorial
comments, and we made changes in the report, as appropriate. 


---------------------------------------------------------- Letter :9.1

As arranged with your office, unless you publicly announce its
contents earlier, we plan no further distribution of this report
until 30 days after the date of this letter.  At that time, we will
send copies of the report to the appropriate congressional
committees; interested Members of Congress; the Secretaries of the
Interior and Agriculture; the Administrator, FmHA; the Directors of
CBO and OMB; and other interested parties.  We will also make copies
available to others upon request. 

Please call me at (202) 512-7756 if you have any questions about this
report.  Major contributors to this report are listed in appendix II. 

Sincerely yours,

James Duffus III
Director, Natural Resources
 Management Issues


SCOPE AND METHODOLOGY
=========================================================== Appendix I

We conducted our work at the Department of the Interior's and
Department of Agriculture's Washington, D.C., headquarters and at the
Congressional Budget Office (CBO) and the Office of Management and
Budget (OMB).  We also conducted our work at the Bureau of
Reclamation's Lower Colorado Regional Office in Boulder City, Nevada,
and its Arizona Project Office in Phoenix, Arizona; and at the
District's headquarters in Phoenix, Arizona.  At these locations, we
interviewed Interior, Bureau, FmHA, the District, CBO, and OMB
officials.  We also interviewed members of the Harquahala Board of
Directors and Harquahala's General Manager. 

To determine how Harquahala became a source of water for the
settlement, we examined the relevant legislation and supporting
documents that authorized the acquisition.  We then interviewed and
obtained pertinent documents from Interior, Bureau, the District, and
Harquahala officials who participated in the selection process and
negotiation of the water acquisition.  We also obtained a written
response from the Solicitor's Office regarding legal issues raised by
the use of Harquahala's project water entitlement in the settlement. 

To estimate the federal government's cost of the acquisition, we
reviewed the legislation that authorized the financing of the
acquisition and obtained from CBO and OMB their respective budget
estimates of the federal costs.  We also interviewed and obtained
documents from Interior, Bureau, the District, and Harquahala
officials to determine each organization's role in the acquisition,
the price paid for the water entitlement, the charges associated with
the financing, and the post-implementation costs associated with the
acquisition.  In general, dollar figures have been rounded to the
nearest hundred thousand. 

To outline the benefits accruing to the parties involved in the
acquisition, we talked with Interior, Bureau, the District, and
Harquahala officials.  We obtained pertinent documents from these
officials to verify the amount of water Interior received to
implement the agreement and future settlements, the elimination of
Harquahala's distribution system loan, the amount of water sale
proceeds made available to Harquahala landowners, the reduction in
the District's project construction repayment obligation, and other
benefits received by the various parties associated with the
acquisition. 

To determine the status of FmHA loans held by some Harquahala
landowners and the water sale proceeds that could have been applied
to their loan deficiencies, we talked with Interior, Bureau, FmHA,
and Harquahala officials.  The FmHA Arizona State Office and the St. 
Louis Finance Office provided us with information on Harquahala
landowners' loan obligations and payments.  We did not verify the
FmHA source data for this information.  We compared the FmHA loan
information to sale proceeds data provided by Harquahala officials to
determine the amount of proceeds that were due these borrowers versus
the amount of loan payments made to FmHA. 

We conducted our work between August 1994 and May 1995 in accordance
with generally accepted government auditing standards. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II


   RESOURCES, COMMUNITY, AND
   ECONOMIC DEVELOPMENT DIVISION,
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix II:1

Alan Bennett
Leo E.  Ganster
Patrick J.  Sweeney


   SACRAMENTO, CALIFORNIA
-------------------------------------------------------- Appendix II:2

Anndrea H.  Ewertsen
James E.  Hampton
George R.  Senn
Kenneth J.  Townsend


   ST.  LOUIS, MISSOURI
-------------------------------------------------------- Appendix II:3

Robert C.  Sommer


   OFFICE OF THE GENERAL COUNSEL
-------------------------------------------------------- Appendix II:4

Stanley G.  Feinstein

