D( REPLY

RZPE~ TO:440

832.

MAY United States Department ofthe Interior 1~ATER & POWER

RESOURCES SERVICE

WATER AND POWER RESOURCES SERVICE Mid-Pacific Region

WASHn~GTON, D.C. 20240

~ MAY 1981

Memorandum

To: Regional Director, PN, j~, UC, LC, SW, UM, LM

From: Commissioner

A. Definition of M&I Water

Surns~e

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Subject: Municipal and Industrial Water Marketing and Repayment Policy

A December 29, 1978, memorandum set forth new irrigation contracting policies

for use by us. As a follow—up to those policies, a need exists to reaffirm,

update, and expand our current policies on contracting for municipal, industrial, and miscellaneous (M&I) water.

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Our agency has evolved from being almost exclusively concerned with the

development of agricultural water supplies to support reclamation of arid

lands to an organization concerned with multipurpose water demands (e.g.,

irrigation, municipal and industrial use, etc.), flood control, power

~ production, fish and wildlife, and recreation. Increasingly, water for M&I

purposes is taking a significant role in our program. For example, two new

major starts last year, the McGee Creek Project and the Fountain Valley

Conduit, are primarily being constructed for M&I purposes. __

We may expect that as fewer opportunities present themselves for developing

projects for irrigation purposes, we will move to development of projects

for primarily M&I purposes. Of the definite plan reports currently being

w-ritten for authorized projects, many have some sort of M&I demand identified.

The following represents the basic policies to be followed in contracting

for M&I water. These basic policies may be expanded upon in regional

policies for particular projects or in individual situations which arise.

Occasionally, there arises a question as to what constitutes “M&I” water.

Obvious uses include service of water to industrial concerns, municipalities,

or housing developments. In the past, not so obvious situations have arisen

concerning water service to golf courses, small tracts (non—farm irrigation),

duck clubs (flooding of waterfowl areas), etc. Most of these latter questions.

have been dealt with in one manner or another over the years.

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Section 9(c) of the Reclamation Project Act of 1939 refers to furnishing

water for “municipal water supply or miscellaneous purposes.” In view of

this languagi and the history of our program, we believe that “M&I” water

service~s everything but service of water to farms requiring irrigation

water,1~ On farm domestic and related livestock use of water will continue as a legitimate agricultural water use. It may not be administratively

practicable to differentiate between agricultural and M&I water service using

the definition of a “farm” found in WPI 198.2.6A. Therefore, identification

of an M&I function should be done in concert with the parameters established

under WPI 192.1.4.

B. Establishment of Water Charges or Periodic Payments

(1) The following parameters define the boundaries for establishment

of rates or periodic payments:

(a) Minimum cost of service — The minimum cost of service to a

contractor will be that water rate or periodic payment necessary to recover

all allocable annual operation, maintenance, and replacement (OM&R) costs

and allocable capital costs, plus interest, over the maximum authorized repayment period. In other words, if the maximum authorized repayment period

is 50 years, then capital and interest costs would be amortized over that

period and OM&R costs would be paid annually.

(b) Least—cost alternative — The least—cost alternative to the

Federal water supply goes beyond just ider~tifying the dollar cost of constructing a non—Federal project. It means identifying a valid and comparable alternative amount of water over a comparable period of time using

non—Federal financing. From this information, it should be possible to

project what the annual payment or water rate would be to amortize the

costs of the non—Federal project.

(2) For most existing projects and projects authorized but not yet built

or which are under construction, the minimum cost of service will be the basis

for establishing M&I water rates or levels of repayment. This basic policy

may be modified in consideration of the following factors:

1/ The following definition of a “farm” is taken from WPI 198.2.6.A. “A farm

is any place from which $1,000 or more of agricultural products, including

livestock, yere sold or normally would have been sold, during the census year.

Farms are to be reported as operatorships, i.e., it is all the land on which

some agricultural operations are performed by one person, either by his own

labor alone or with the assistance of members of his household. The land operated by a partnership or corporation is likewise considered a farm. A ‘farm’

may consist of a single tract of land, or a number of separate tracts, and the

several tracts may be held under different tenures, as when one tract is owned

by the farmer and another is rented by him. This includes all of the land

without respect to the size of the operation.”
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(a) When M&I water service is intended for an industrial or

commercial contractor, consideration should be given to negotiating a

water rate that approaches the per acre—foot charge for the least—cost

alternative. Depending on the financial and legal parameters of the

project, revenues may be used to accelerate repayment of the M&I function,

assist repayment of the irrigation function, or assist in the repayment of

other projects.

(b) Unless prohibited by legislation, water rates for M&I service

should consider the opportunity costs associated with foregone hydropower

production or other quantifiable factors. Consideration of such costs are

particularly important if the provision of M&I water supply will lower the

present net worth of expected revenues to the United States and/or there is

no practical opportunity to reallocate costs among project functions.

(c) For projects where water service contracts are periodically

renewed, consideration should be given to assigning part of the irrigation

costs to M&I water users for repayment. Such a policy also could be introduced gradually into other existing projects where water service contracts

are used, or could be used, and when there exists a significant potential

for M&I contractors to help repay a project’s irrigation function.

Th future planning documents and when we have the opportunity to comment on

proposed authorizing legislation, the possibility of a shorter repayment

?eriod for a project’s M&I function and/or repayment assistance to the project’s

irrigation function should not be precluded but should be specifically recognized

in the same manner as the role of the power function. Within the parameters of

cost of service and’the least—cost alternative, project authorizations should

allow the M&I function to assist in the repayment of the irrigation function.

Depending on these parameters, irrigation costs can be assigned for repayment

by M&I water users as well as power users, perhaps on a proportionate basis.

C. Adjustment of Water Rates

Repayment contracts will not contain provisions for periodic adjustment of

a contractor’s obligation unless the adjustment mechanism is associated with

account charge provisions in combination irrigation/M&I contracts. Water

service contracts will always contain provisions for periodic review and

adjustment of water rates at least every 5 years.

Adjustment of rates under minimum—cost—of—service contracts shall reflect

the changes in OM&R and power costs, and variances in expected amortization

of the repayment obligation due to historical or projected changes in water

deliveries an& cost allocations. However, if historical water deliveries

have accelerated the repayment of capital costs, then the water rate should

not be lowered.
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Adjustment of water rates in contracts based on criteria other than minimum

cost of service should ensure that the expected repayment period and/or

assistance to irrigation are maintained. For example, if the original water

rate was negotiated to return 150 percent of the minimum cost of service,

this percentage should be maintained. Again, a downward adjustment of water

rates would be precluded.

In the event that a project’s M&I function is repaid, or that the entire

project is repaid, then the M&I pricing policy will be established in light

of legal and financial parameters, e.g., authorizing legislation, assistance

required by companion projects, etc.

D. Quantity and Buildup Requirements

Within this determination is the requirement that water conservation be made

a condition of Federal water service. There is some justifiable concern that

buildup schedules for water use which require increasing use and payment for

water will conflict with water conservation goals which encourage less use of

water. It is possible that if water conservation is encouraged and followed,

then we may be in a position of charging higher rates for less water. This,

of course, serves to discourage water conservation.

‘ Mitigating against this potential scenario are several factors. First, in

many situations, the demand for water is relatively inelastic with respect )

to price, i.e., a change in price will involve a relatively small change in

the quantity of water demanded. Also, the.price of raw water may be of

relatively little importance to an industrial or commercial contractor in

relation to its other factor inputs to its production process. (It should

also be noted that water pricing as a conservation tool would be ineffective

under the above assumptions.)

Second, careful evaluation of present and future efficient uses and demand for

water will automatically take into account water conservation. Therefore,

there may not be ihuch of a need to adjust water rates if slower—than—expected

buildup in the use of water is not experienced and the repayment of costs allocated to the M&I water service function does not suffer.

Third, a decreased demand for M&I water could be recognized in a reallocation

of costs to another project function and/or marketing of water to another water

user.

Overall, the exact terms regarding the quantity of water the United States will

be obligated to make available to a particular contractor should be influenced

primarily by.the supply and demand for water. If the supply of water is expected

to be rather tight in the future, then the contractual provisions regarding

interim buildup and ultimate use should be fairly exact and stringent. This

would help to ensure that the contractor’s needs are met to the greatest extent

practicable and, perhaps, reserving water for future customers. )
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Alternatively, a situation where much water is available but little demand iB

evidenced c6uld allow more flexible terms to be placed in the contract. For

example, instead of targeted minimum quantities of water which a contractor

must pay for, a minimum and maximum quantity of water could be specified within

which the contractor could vary its annual use and payment. However, it may

be prudent to limit the term of the water service contract (e.g., 20 years) in

case significant demands are placed on the water supply in the future. This

could ensure that unused water supplies can be beneficially reallocated. Also,

recognition should be given to the needs of the contractor in setting the term

of the contract. A municipality may have a bond issue tied to the securing of

an adequate water supply for a certain number of years. An industrial concern

may only need a water supply for the useful life of its facilities.

Basically, each contract will need to be tailored to fit the specific water

supply situation. The limiting factors will be that (1) permanent water

deliveries will not be authorized beyond those specified by the Congress or

those identified in the applicable planning documents, and (2) except where

otherwise provided by law, the requirement in subsection 9(c) of the Reclamation Project Act of 1939 that, “no contract relating to municipal water

supply for miscellaneous purposes . . . shafl be made unless, in the judgment

- of the Secretary, it will not impair the efficiency of the project for irrigation purposes. . .“ shall be observed.

E. Short—Term Water Service Contracts

There is a continuing need to make available water supplies on a short—term

basis. Usually, these water supplies are necessary (1) to accommodate

potential long—term contractors during the negotiation and approval of such

long—term contracts; (2) to supply long—term contractors with water in excess

of the maximum contractual entitlements; or (3) to accommodate contractors,

such as road construction companies, who have short—term water needs. The

following principles shall be observed in negotiating such short—term contracts.

At a minimum, short—term M&I water service rates will be set to recover the

minimum cost of service. Depending on the contracting policy for the project,

the following factors also should be considered in establishing short—term

water rates:

(1) The short—term water rate should be set as close as possible to

the long—term water rate;

(2) For those entities, such as construction companks, which only

require a small amount of water for a short time, a minimum charge should

be imposed plus a fair rate for water service in excess of a quantity which

equates to the minimum charge (this assures that administrative costs are

covered);

(3) Recovery of any deficit under a long—term contract.
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Short—term water service contracts with entities having existing long—term

water service or repayment contracts shall not substitute for those contracts

in authorizing delivery of water. Necessary changes in long—term contracts

shall be in the form of amendments to the long—term contracts.

In accordance with current Water and Power Instructions, short—term M&I water

service contracts in excess of 500 acre—feet annually, and/or for more than

1 year’s duration, shall be submitted to this office and the Solicitor’s Office

for review, and approval by the Assistant Secretary — Land and Water Resources,

or the Secretary.

In conjunction with short—term irrigat-ion water marketing programs, each region

will prepare an annual report which identifies all short—term M&I water service

contracts executed during the calendar year and which summarizes the terms of

each contract, e.g., water rate, water quantity, length of contract, and purpose

of contract. A consolidated report will be submitted to the Secretary on, or

before, December 31 of each year.

F. Option Contracts

Potential industrial or commercial contractors are often faced with the

necessity of securing adequate water supplies for their proposed projects

(as a prerequisite to approval or construction of a project. As energy

projects are proposed in the future, it would seem reasonable to expect

that option contracts will become more prevalent. (Note that option contracts also require appropriate environmental documentation under NEPA.)

The period of time a contractor may keep an option open may extend for the

maximum contract period authorized by law as long as the option contract

provides for marketing of the reserved water to an entity which is willing

to put such water to immediate use and pay full price. The option contractor

should be provided the opportunity to initiate full payment for the reserved

water in the event another entity requests immediate water service.

Regarding the option charge, the minimum charge should be that necessary to

return interest, at the authorized project rate, associated with the reserved

water supply. The project water marketing policy may be designed to establish

an appropriate option charge in excess of this criterion. For example, the

option charge may be based on a percentage of the long—term water rate, or may

be set to recover interest and allocated operation, maintenance and replacement

costs.

No credit will be afforded a contractor for past payments of the option charge

except that the option charge paid in the year that initial water use occurs

may be credited to the full water rate on a per acre—foot basis.
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C. Contracting Alternatives

The two typel of contracts that are used in marketing M&I water are usually

referred to as “repayment” and “water service” contracts. A repayment contract requires fixed annual installments over a given number of years. A

water service contract requires payments based on a charge for each acre—foot

of water used during a period. Authorization for the repayment—type contract

is provided in subsection 9(c)(l) of the Reclamation Project Act of 1939.

Subsection 9(c)(2) of the act provides authorization for the water service—

type contract. The Water Supply Act of 1958 allows the Secretary to negotiate

repayment or water service contracts to achieve the return of costs associated

with the provision of M&I storage in reservoirs constructed by the Corps of

Engineers or us.

The following guidelines should be observed in selecting the type of contract

to be used:

(1) When a project has a substantial M&I function but little or no

irrigation function, there is no opportunity to assist in the repayment

of other project costs, and there is only one contracting entity, then

repayment contracts will be us~d (e.g., the McGee Creek Project).

(2) Where the normal practice is to use water service contracts to

achieve repayment objectives due to practicable limitations on the use of

repayment contracts (e.g., Central Valley Project), then water service contracts should continue to be utilized.

(3) Where a project has both a significant M&I and irrigation function,

then the contracting approach should be tailored to repayment needs of the

project. For example, an optimal contracting approach may dictate that the

main storage and conveyance facilities be covered by a water service contract

while the local distribution systems be covered by a repayment contract. Water

rates and periodic repayment installments would be established accordingly for

the Mid and irrigation functions.

H. Operation, Maintenance, and Replacement of Project Facilities by Contractors

Whenever possible, the contractor(s) should assume the physical OM&R of the

project facilities instead of paying Water and Power to OM&R the facilities.

Where there are multiple contractors for a project, then this can be handled

by (a) designating one contractor to OM&R the facilities; (b) specifying, where

possible, that each contractor OM&R facilities which only serve it; (c) arrange

for a consortium or association of contractors to OM&R facilities which serve

them in coirnnon.
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I. Use of Other Contracting Authorities

The authorities under the Act of April 16, 1906 (34 Stat. 116), or the Act of

February 25, 1920, may be used when the specific situation warrants such use.

Recommendations for utilization of these authorities will be carefully reviewed

by this office and the Solicitor’s Office.

J. General Contracting Principles

The following principles shall be adhered to in the M&I contracting process:

(1) Executed and validated repayment or water service contracts are

required with appropriate organizations prior to the commencement of the

construction of facilities to serve those organizations. Operating agreements, letters of intent to repay, or other pledges shall not substitute

for firm repayment contracts. Consideration will be given to postponing

a firm repayment contract on that portion of projects costs deferred pursuant to the Water Supply Act of 1958 if such action is viewed as being a

reasonable risk.

(2) Unless otherwise specified by law, M&I repayment contracts must

expressly recover all Federal costs with interest that are allocated to

the construction and/or assigned to annual OM&R of facilities to serve

the contractor.

(3) Repayment or water service contracts shall not obligate the

United States to construct facilities that are not specified in the

authorizing statute, that are not referenced by the authorizing act in

relation to a specific feasibility report, or are not otherwise clearly

authorized by Congress. Repayment or water service contracts shall not

obligate the Federal Government to make expenditures beyond that specified by Congress in the authorizing statute. Where the estimate of total

Federal obligations exceeds the authorized cost ceiling (as indexed, if

permitted), contracts will not be approved until adequate authority has

been provided by Congress.

(4) Repayment contracts shall contain maps (attached to and expressly

made part of the contract by the text) defining and designating facilities

to be constructed to the extent possible. The contract will only provide

for the construction of those facilities identified in the appropriate

planning report or specifically authorized by the Congress. The contract

map(s) should not preclude design changes which will not have a significant

negative effect on the contractor’s repayment ability or will result in

violation bf the contractual cost or repayment ceiling. The contract also

shall state the estimated cost of the facilities beyond which no Federal

expenditures obligation will exist unless the authorizing legislation permits

indexing.
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must (5) Once executed, the terms in the repayment or water service contract

adhered to. Following contract execution, any significant changes

or proposed changes in costs or system design will be immediately reported

to the Commissioner who, in turn, will bring such changes to the attention

of the Assistant Secretary — Land and Water Resources. “Significant changes”

in this context means:

(a) Any change which results in a projected overrun of the cost

• expenditure ceiling or maximum repayment ceiling for those contracts which

do not contain expenditure indexing provisions.

(b) Any change which results in a projected overrun of the cost

expenditure ceiling or maximum repayment ceiling for those contracts which

contain expenditure indexing procedures and such change is not attributable

to indexible factors.

(c) Any change or cumulative change in system design which will

result in modification, deletion, or addition to the system by changing the

projected system cost by 10 percent or more; by changing the annual projected.

operation, maintenance and replacement costs by 10 percent or more; or by

changing the projected annual commitment of project—use power to the contractor

by 10 percent or more.

This policy is effective immediately for all new, amendatory, and supplemental

M&I water service and repayment contracts except for those proposed contract

negotiations where specific deviations from the above principles have been

approved. Any proposed departure from the .policy axpressed above should be

explicitly set forth in a proposed basis to negotiate a particular contract

and the proposed Secretarial approval memorandum for a proposed form of contract.

The above principles will be set forth and elaborated upon in Part 193 of the

Water and Power Instructions.

(Sad) RN. ~ro~dbO~R

cc: Chief, Division of O&M Technical Services, E&R Center

Chief, Division of Planning Technical Services, E&R Center