The Department of the Interior’s Bureau of Reclamation constructs and operates water resource projects to provide water to arid lands in 17 western states. Construction, operation, and maintenance of these projects are financed primarily with federal funds. The Bureau provides water for irrigation purposes to state-established water and irrigation districts that obtain the water under contracts and distribute it to farmers. The Bureau also provides water for M&I, fish and wildlife habitat, recreation, and power generation purposes. Through water service or repayment contracts, the Bureau, over time, recoups a portion of the federal government’s costs of providing the water. These contracts provide for both the repayment of construction costs and O&M costs allocated to water supply. The Bureau’s costs of constructing, operating, and maintaining its projects are classified as either reimbursable or nonreimbursable. Reimbursable costs are recovered from customers; nonreimbursable costs are borne by the federal government. Generally, costs associated with supplying water for agriculture, M&I, and hydroelectric generation purposes are reimbursable. Costs related to flood control, recreation, and fish and wildlife enhancement generally are nonreimbursable. While the Bureau recovers costs from water customers through rates, cost recovery for power generation is done by the Department of Energy’s Power Marketing Administrations (PMAs). Water marketing costs are charged to customers as part of the Bureau’s total O&M costs. The Bureau defined the O&M activities associated with its projects in a 1998 report to Congress by describing its complex mission and by providing examples of the widely varied activities it conducts. The report stated that the Bureau is “responsible for the O&M of an extensive infrastructure of constructed facilities, including diversion and storage dams, pumping plants, powerplants, canals and laterals, pipelines, and drains.” Further, it said that the Bureau is “also responsible for management of the federally owned lands on which these facilities are located and for the natural and cultural resources of those lands.” The water marketing component of the Bureau’s O&M reflects this diversity. Water marketing costs are the result of many different distinct activities. The CVP, located in California’s Central Valley Basin, is the one of the Bureau’s largest multiple purpose water projects. The CVP is technologically complex, consisting of numerous dams, reservoirs, canals, and pumping and power-generating facilities. Historically the CVP has provided about 6 million acre-feet of irrigation water each year to approximately 3.8 million acres of cropland. Water used for irrigation purposes represents about 85 percent of the total water available through CVP; the remainder is used for M&I, fish and wildlife, and recreation. CVP water is also used to generate power. The Bureau enters into contracts to provide water to irrigation and M&I customers. These contracts establish a rate for each acre-foot of water with the intent to recover the CVP construction costs allocated to water supply as well as the annual O&M costs. The Bureau annually sets rates for both M&I and irrigation water customers. The rate depends upon the extent and type of services provided to the customer by the Bureau, and consists of a number of rate components (or cost pools) which correspond to the water services provided. The rate components generally are water storage: the cost of facilities (primarily dams and reservoirs) associated with the collection and storage of water; and water marketing: the costs incurred for monitoring, administering, and negotiating water service contracts; record-keeping and accounting; developing annual water rates; conducting environmental studies; and performing other related activities. Other costs involved in delivering water to customers include conveyance (associated with facilities such as canals used for transporting water), conveyance pumping (associated with facilities such as pumping plants used to pump water through the project to more than one customer), and direct pumping (associated with plants that pump water exclusively for specific customers). “Project Use Energy” costs are primarily associated with conveyance pumping and direct pumping. Direct pumping costs are paid by customers through the direct pumping rate component charged by the Bureau. Since fiscal year 1998, conveyance and conveyance pumping costs are typically not charged to customers through O&M rates, but instead are direct billed to those customers using these services. As a result, these costs are not included in our analyses of water marketing costs and their impact on O&M costs. The Bureau sets rates based on projected water deliveries and estimated costs. Typically, the Bureau uses its budget request data in determining its estimated costs. After allocating the total estimated costs to irrigation, M&I, and the other uses, the O&M rate for each component is then calculated by dividing the component’s estimated total annual cost by the applicable estimated water deliveries. After the actual water deliveries and the Bureau’s actual costs have been determined, the customers’ payments are applied against the Bureau’s costs as specified by the CVP ratesetting policies. The Bureau’s budget, ratesetting process, and application of payments are graphically depicted in appendix II. In recent years, some Bureau irrigation and M&I water customers have raised concerns about O&M rates charged for CVP water. The rates have been increasing faster than inflation, and the customers have expressed concern about the impact of these costs on their businesses. The rate component causing much of their concern relates to activities categorized by the Bureau as “water marketing.” The water marketing component of rates has increased significantly over the past decade and CVP customers have voiced concern, saying that they do not understand the underlying reasons for the increases. For each of the four objectives of this report, we were asked to address specific issues. Regarding the activities and costs that comprise water marketing, we were asked to (1) determine the general types of activities that were historically categorized as water marketing, compared to the types of activities categorized as water marketing today; and (2) provide detailed information on water marketing activities and costs for fiscal years 1998 and 1999 and obtain the projections for future years, if available. Regarding the trend in water marketing costs, we were asked to determine annual increases or decreases in the water marketing component of rates charged under water service contracts for fiscal years 1990 through 2000, and identify reasons for any significant trends. Regarding the legal basis for these costs, we were asked to determine the Bureau’s legal basis for charging the costs of water marketing activities to water customers. Regarding the information provided to water customers, we were asked to determine generally what information is provided to customers about water marketing activities and costs, including information pertaining to fiscal year 2000 and any projections for future years. We were also asked to identify options that would enable the Bureau to provide customers with better information. To determine the activities and costs that comprise water marketing and determine the trend in water marketing costs (objectives 1 and 2), we reviewed and analyzed various Bureau documents. We analyzed historical water ratesetting books showing budgeted amounts for fiscal years 1990- 2001, actual water marketing amounts for fiscal years 1992-1999, ratesetting policy manuals, and Mid-Pacific Region files pertaining to water marketing activities at CVP. We also interviewed Mid-Pacific Region officials. To determine the legal basis for charging the costs of water marketing activities to water customers (objective 3), we analyzed Reclamation law, project-specific legislation, and authorizing legislation applicable to selected activities. We also reviewed Office of Management and Budget (OMB) Circular A-25 and federal accounting standards for federal guidance as to what constitutes the full cost of an agency’s provision of goods and services. To determine the information provided to water customers, and identify options for improving it (objective 4), we analyzed examples of documents provided to customers and reports prepared by customer groups. We also interviewed Bureau officials and representatives of CVP water customers. We conducted our review from June 2000 to March 2001 in accordance with generally accepted government auditing standards. We performed audit work at the Bureau’s Mid-Pacific region, which manages and operates CVP. We also interviewed officials from the CVP Water Association, which represents customers of CVP. We did not verify the accuracy of all the data we obtained and used in our analyses. Most of the data presented in this report relate to budget projections; it was beyond the scope of the assignment to verify linkage of budget data to the audited financial statements. We have considered written comments from the Department of the Interior and revised our report, as appropriate. The department’s comments are reproduced as appendix III. The department also provided technical comments, which we incorporated as appropriate but did not reproduce. Appendix I describes our objectives, scope, and methodology in detail. Our analysis concluded that CVP water marketing costs stem from two general categories of activities: system-wide activities and contract administration activities. Water marketing traditionally consisted of contract administration activities but the category has grown to include a variety of others, as represented by the system-wide category. System-wide activities are categorized as “water marketing” in order to be “spread” to all customers for repayment. Some system-wide costs arise as new mandates are passed that the Bureau must implement, such as costs stemming from the CVP Improvement Act (CVPIA), which was passed in 1992. Other system-wide costs, such as those classified as general expense, have been reclassified as water marketing to assure that each CVP customer pays a proportionate share of the cost involved. In addition, some water conservation costs, which the Bureau had previously treated as nonreimbursable, have been reclassified as water marketing and charged to water customers. As shown later, when comparing the amount paid for water marketing in fiscal year 1996 to the amount paid in fiscal year 2001, the general expense reclassification accounted for about 12 percent of the total increase for irrigation customers and about 15 percent of the increase for M&I customers.