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You need to remove the power steering pump and brackets in front of the left (driver side) cylinder head. You may be able to unbolt the pump and set it out of the way without disconnecting the lines. Just make sure it doesn't lay against the radiator fins or it will bend them over.There's no longer any question of whether you had water in the oil - the proof is in the mayonnaise.
That's not the original motor. What's the mileage on the odometer? Did you check timing chain play before tear-down? What was the engine oil pressure? Aside from the oil/water emulsion, the valley appears relatively clean. Mop up the mocha and wipe the valley down with clean rags. Augment the cleanup with a little carb spray if you like. I'll try to help you get your arms around this....Before you dump any money into machine work, remove and inspect the valve lifters one-at-a-time, keeping them strictly in order so each can be reinserted into the same lifter bore from which it was removed. You absolutely do not want to mix the lifters up between bores/cam lobes or you'll destroy an otherwise good cam! The lifter feet should appear slightly convex-to-flat and show no signs of pitting or galling. If the lifter feet are concave, pitted or galled, they are worn out and you should add the cost of a replacement cam, lifters and double roller timing chain set to your shopping list.Similarly, keep the valve pushrods and rocker arms in order. Wash the pushrod center holes with carb spray followed by compressed air. Check the pushrods for straightness by rolling across a table or other flat surface; inspect the pushrod ends for uneven wear. Inspect the wear surfaces of the rocker arms.Post a few clear, close-up pics of the cylinder walls with the pistons down. Are there vertical striations (scuffs) in the cylinder walls? Do the walls appear shiny and polished? Look very closely for cracks in the walls. Are there concentric grooves around the tops of the cylinders? If there are problems with the cylinder walls you should seriously consider installing a crate engine rather than rebuilding yours.Talk to your machine shop and explain what happened then request an estimate from them for cylinder head repair that includes hot-tanking, magnafluxing, surfacing, grinding the valves and seats, checking the guides, and installing press-on Viton valve guide seals in addition to any recommendations they make as a result of their tear-down.If the engine had good oil pressure before you tore it down, the bottom end is probably still okay with an oil and filter change. If not, you've essentially escalated into a major overhaul. You get the idea? Do your best to determine overall engine condition and get a complete picture of what you are facing, so you can take the best repair approach for minimal cost. There is a point beyond which you are money ahead to install a new motor that carries a warranty. So, take the time to perform a complete evaluation before committing your cash.