NO. 82-175 INTHE SUPREME COURT OF THE STATE OF MONTANA 1983

THE MONTANA POWER COMPANY, Plaintiff and Appellant,

vs. DEPARTMENT OF PUBLIC SERVICE



### . REGULATION, MONTANA PUBLIC SERVICE COMMISSION etal., Defendants and Respondents.

Appeal from: District Court of the Second Judicial District, In and for the County of Silver Bow Honorable Mark Sullivan, Judge presiding. Counsel of Record: For Appellant: Crowley, Haughey, Hanson, Toole and Dietrich,

Billings, Montana George C. Dalthorp argued, Billings, Montana Corette, Smith, Pohlman and Allen, Butte, Montana Hjort, Lopach and Tippy, Helena, Montana For Respondents: James C. Paine argued, Helena, Montana Eileen E-Shore argued, Helena, Montana

Submitted: March 1, 1983 Decided: May 31, 1983 Filed:

## MAY

## 31

## 1983Honorable James B. Wheelis, District Judge, delivered the Opinion of the Court. Montana Power Company (MPC) appeals from a judgment entered in the Silver Bow County District Court, the Honorable Mark P. Sullivan presiding, affirming an order of the Public ServiceCommission (PSC)which set allowable electric rates.In April 1980 MPC filed an application for electric rate increases with the PSC. In its request MPC asked the PSC toaccept, asa part of the ratebase, money expended by the company in obtaining coal from Western Energy Company (Western Energy). Western Energy is MPC's wholly-owned subsidiary and supplies 100 percent of the coal need for MPC's coal-fired generators in Colstrip and Billings. MPC accounts for approximately 15 percent of Western Energy's annual coal sales with the remaining 85 percent of sales being made toother utilitiesand manufacturing concerns. During the hearing on the rate increase request, the PSC heard testimony on two differentmethods for monitoring the reasonableness of the price MPC pays for its coal. First, MPC suggested the use of the "market price" method:

an examination of the price charged in the marketplace for similar sales in comparison to those being charged by the subsidiary to the parent; if a favorable comparison is found, the price is deemed reasonable and no adjustment is necessary. Second, the Montana Consumer Counsel suggested the "rateof return" method, which called for an examination of the returnbeing earnedby the subsidiaryon its salesto the parent; an excessive rate of return requires an adjustment. In support of the "market price" method, MPC submitteda study prepared by Arthur D. Little, Inc., a firm of national prominence in the field of coal supply contracts. MPC requested Arthur D. Little, Inc., to solicit and evaluate bids from coal suppliers. After receiving bids from nine companies, Arthur D. Little, Inc., found that Western Energy's price was the lowest price available to MPC's Billings plant. The Colstrip plants were not included in the study because the existingcontractshad not expired. In support of the "rate of return" method, the Consumer Counsel's expertwitness, John W. Wilson, presented evidence that compared Western Energy's profits with those of other coal companies. Wilson's approach characterized Western Energy's profitability of more than 20 percent on equity capital as excessive when computed to the 13.5 percent average for the other coal companies used in his comparison. In December 1980, after analyzing the evidence presented, the PSC chose to rely on the "rate of return" method suggested by the Consumer Counsel and rejected the "market price'' method suggested by MPC. The PSC found 13.5 percent to be a reasonable rate of return on coal sold by Western Energy toMPC and ordered $900,730 of MPC's request be disallowed. An appeal of the PSC order was taken to the District Court by MPC. After review, the court held that: (1)the evidencepresented tothe PSC showed thatthe rateof return established by the PSC compares closely to other coal companies; (2)MPC offered no substitute forwhat it thought the return figure should be, nor did it offer any evidence tosupport a higher rateof return; (3)MPC, initsrebuttalof Consumer Counsel's witness Wilson, offered no evidence that Wilson's comparable coal industry earnings exhibitwas faulty; and, (4)MPC did not sustain its burden of proof 

### as tothe order of thePSC being unlawful or unreasonable. MPC now appeals to this Court claiming that: (1)the PSC failed togive effect tothe decision inMontana-Dakota Utilities Co. v. Bollinger (1981), Mont

# . ,632 P.2d 1086, 38 St.Rep. 1221; (2) the PSC and the District Court erred by ignoring MPC's substantial evidence which demonstrated that Western Energy's coal price 

### was the lowest available coal price under competitive market conditions; and, (3) the Montana Consumer Counsel's evidence which the PSC adopted in imposing a rate of return limitation on Western Energy's profitability is inherentlyflawed. Appellant MPC contends that the PSC should not have used the "rate of return" method because a competitive market was shown toexist and Western Energy's coal was the lowest priced coal available to MPC. It asserts the cost claimed by MPC should nothave been deemed excessive. Respondent contends that the use of the 13.5 percent profitability average was not improper. The interestof the PSC is to

### see thatMPC doesnot reapanunfair profiton its investment in its subsidiary by allowing the subsidiary to overcharge theparent for coalwhen thecoalexpensewillbe passed on tothe ratepayers. A very similar situation was presented to this Court in Montana-Dakota Utilities Co. v. Bollinger (1981), Mont. 

## , 632 P.2d 1086, 38 St.Rep. 1221. Montana-Dakota Utilities Co. (MDU) had requested an increase of its elec

### tric utility rates. In its request, MDU asked the PSC toaccept, as part of the rate base, money expended by the company in obtaining coal from Knife River Coal Company (Knife River), a wholly-owned subsidiary of MDU. The PSC used a "rate of return" method to reduce the return on investment from approximately 33 percent to 12.124 percent (the rate of return allowed to MDU on 

### its overall operation). Apparently, MPC has misunderstood our decision to remand Montana-Dakota Utilities to the PSC. MPC would interpret our decision to hold that, once 

### a competitive marketplace is established, the "market price" method must be used by the PSC. We did not so hold. We remanded that

case to the PSC, not because the PSC chose touse the "rate of return" method, but rather because thePSC did sowithout sufficient evidence tosupport its findings. Montana-Dakota Utilities, 632 P.2d 

### at 1091, 38 St.Rep. at1227. We did state a preference for "the PSC to use a marketplace cost of coal approach, if it can obtain sufficient facts for its determination, rather than using the rate of return method with allof itsdifficulttheories and computations." Montana-Dakota Utilities, 632 P.2d at 1092, 38 St.Rep. at 1228. It was, however, recognized that the PSC has the right to choose the method followed. The PSC should not be restricted to any single formula so long as the method followed and the order entered when applied to the facts and viewed as a whole do not produce an unjust or abitrary result. 632 P.2d at1091, 38 St.Rep. at 1227. The PSC isvested, by statute, with theduty tosupervise and regulate the operations of public utilitiesand to

see that 

### rates are just and reasonable. Section 69-3-330,MCA. This Court cannot substitute itsjudgment for that of thePSC. Our function is todetermine whether thePSC acted arbitrarily and unreasonably without sufficient evidence to support its findings. Mountain StatesTelephone & Telegraph

v. Dept. of Public Service Regulation (1981), Mont

# .

,624 P.2d 481, 38 St.Rep. 165. In Montana-Dakota Utilities 

### we remanded the case to thePSC with instructions to: 

# ".



# . . hold an additional hearing to determine the following: (1)if rate of return is used, a factual basis for the rate of return allowed Knife River considering its 

### assets and rateof return on a marketplace basis comparable to other coal companies; or (2) in the event market cost of coal is used, sufficient factstosupport the PSC determination of the fair market price for coal." 632 P.2d at 1092, 38 St.Rep. 

### at 1228. 

### We did not hold that the PSC must use a "market price" method if a competitive marketplace can be established; the choice of methods is lefttothePSC. Inthe instant case, thePSC chose toapply 

### a "rateof return" method in an effort to determine the reasonableness of the price paid by MPC for Western Energy coal. Our inquiry 

### is limited to determining whether substantial evidence was presented tosupport the PSC's decision or if the decision

### was unjust or arbitrary. On appeal, MPC contends the PSC's reliance upon the testimony of Montana Consumer Counsel witnessJohn W. Wilson is erroneous. MPC claimsWilson's study is not an accurate study of the entire industry. Wilson found Western Energy earned a 20 percent return on equity capital every year since 1974. Wilson testified that the industry average equals 13.5 percent. MPC now 

### claims Wilson collected arbi-trary data which does not accurately reflect the coal industry. In its rebuttal testimony at the PSC hearing, however, MPC did not challenge the accuracy or probative value of that testimony. MPC, in rebuttal, merely reasserted its original position that the PSC should rely on MPC's testimony. No foundation objections were made by MPC concerning the exhibitsused by Wilson. MPC 

### is essentially challenging Wilson's testimony for thefirsttime on appeal. The MPC is offeringthisCourt an invitation to judge the credibility and weight of factual evidence which 

### is not part of the record which MPC itself ignored, overlooked, or misinterpreted atthe administrative level--the PSC hearing. This 

### we will not do. This Court has previously recognized that limited judicial review strengthens the administrative process. "Limited review encourages the fulland complete presentation of evidence to theagency by the participants inthe administrativeprocess by penalizing those who attempt to add new evidence or new lines of argument atthe judicial review level." Vita-Rich Dairy, Inc. v. Dept. of Business Regulation (1976), 170 Mont. 341, 343-344, 553p.2d 980, 982. It is an axiom of utility law that a utility seeking increased rates has the burden of showing its claims are reasonable. The MPC did not object tothe foundation of the Consumer Counsel's witness's exhibit. The PSC was entitled to believe and accept the evidence aspresented by the Consumer Counsel's witness and toreject the evidence presented by MPC. So long as the record supports the decision, that judgment must stand. It is not required that a person be knocked down by a galebeforehe knows which way thewind 

### isblowing. All that is required is that the evidence is capable of being believed. In the instant case, unlike Montana-Dakota Utilities Co. v. Bollinger, supra, the record supports the decisionmade by thePSC. There was ample evidence presented by Consumer Counsel's witnessJohn W. Wilson that Western Energy profitability (20 percent) was above that of the average for the industry (13.5 percent). The PSC chose to make the necessary adjustments in the amount thatMPC was allowed topass on tothe ratepayers. MPC cannot wait until appeal tochallenge the evidence and testimony of the Consumer Counsel. MPC did not sustain its burden of proof as to the order of the PSC being unlawful or unreasonable. We hold that the PSC's decision is supported by substantial evidence and fully meets the standards and guidelines established in Montana-Dakota Utilities Co. v. Bollinger, supra. Affirmed. 

# \&bisiYa, Hon rableJames B. Wheelis, DistictJudge, sitting in pa of Mr. Justice Daniel J. Sea

We concur:

Chief Justice 

### \Justices

inplace

### Mr. Justice John Conway Harrison dissenting.

I

### dissent. I

### have tried in vain to reason with my colleaguesnot to make what 

### Iview to be a further confusion in the law of utility regulation in the State of Montana. The result of themajority holdingwill, inmy opinion,not only increase the cost of electricity to the consumersof Montana, but, in addition, increase the cost of coal to purchasers of Western energy

## -- which will in turn be passed on to the consumers. The economic result of the majority holdingwill force Montana Power to purchase its coal from more expensive sources and sell the 15 percent it contracted forwith Western Energy to a better market. To so hold does not, inmy opinion,make economic sense. Taking the uncontroverted facts presented to us, it is evident thatMontana Power Company (MPC) studied our opinion in Montana-Dakota Utilities Co. v. Bollinger (1981), Mont

# . I 

### 632 P.2d 1086, 38 St.Rep. 1221,and decided that in cases where coal is purchased from a wholly-owned subsidiary,the steps necessary to make the purchasewould be carefully adhered to, and that the holding of that opinion was controlling as to the proper method to be used by the Public Service Commission (PSC) in determining themethodology tobe used. 

### Ibelieve the PSC misread our holding in arguing thatwe held in Bollinger (supra) that the "marketplace price of the coal"was controlling. What

we held was: "'As amatter of 

### justice,it appears to the court that itmight be better for the PSC to use the marketplace cost of coal approach, if it can obtain sufficient facts for its determination, rather than using the rate of return method with all its difficult theories and computations. While the PSC does have the right to choose the method followed,this court did not find a factual reason for the summary rejection of themarketplace cost of coal approach.'" (emphasis added) "We therefore, vacate the judgment of the District Court and remand the case to the PSC with instructions to hold additional hearings to determine the following: (1) if the rate of return is used, a factual for the rate of

### return allowed Knife River considering its assets and rate of return on amarketplace basis comparable to other coal companies;or in the event market cost of coal is used, sufficient facts to support the PSC determination of the fairmarket price for coal.'" While we did indicateby our language in Bollinger (supra) that is our opinion the "marketprice might be the better approach,"

we did not rule out the use of othermethodology by the PSC. We noted that a parent's earnings in a subsidiary are improper if the utility earns "excessive profits" at the expense of the ratepayer. We furtherheld that sales to other customers and "evidenceof prices charged by other companies in the competitive area" are sufficient to establish the reasonableness of coalprices. Perhaps itwas this latter language that caused the MPC to follow themarket price approach in its presentation to the PSC believing, on the basis of Knife River case, that if such an approach

was taken,their evidencewould be so convincing the PSCwould be found to be arbitrary if it arrived at a differentholding. In my view, the evidence for the rate of returnmethod was soweak this case should be reversed. It is apparentMPC believed that our holding in Knife River stated that it was prefera.bleto use themarket pricemethod because the record indicates that the companywas aware that the PSC had expressed concern regarding the "captivecoal" situation of Mpntana Electric Utilities. Therefore,MPC retained an independent firm,knowledgeable in the areas of coal supply and contracts, to secure for the Corette Plant at the lowestpossible cost, a fuel supply thatwas available at the timewhen the existing contract

was expiring. The appellant company specifically informed the PSCby letter of its intention to do so. Thereafter, they secured the services of anArthur D. 

### Little, Inc., who solicited some sixteen coal companiesoperating in the Montana and Wyoming area for bids for coal supply to the Corette Plant. An advertisementwas placed in CoalWeek, a coal industry publication,and this advertisement produced five additional requests for that information. Nine bids were eventually received.

### An analysis of thebid showed that the prices as of September 1, 1979, including transportation and utilitizationcosts, for the three lowest bids were as follows: Western Energy (RosebudMine), 0.753 per million BTU;Westmoreland Resources,Absarokee (Absaloka Mine), 0.897 per million BTU;ARC0 (BlackThunderMine), 0.921 per million BTU. The remaining sixbids ranged from 0.993 to 1.346 per million BTU. It is interesting to note thatV7estmoreland's Absaloka Mine is closer to the Corette Plant than the lowest Western Energy's Rosebud mine. An additional factor consideredby Montana Powerwas its desire to secure the coal supply for a ten-year period, and further analysis was required to determinehow escalation clauses and increased transportation clauses would effect the contract prices over the ten-year period. The result of the analysis described by the independent reporter,Arthur Little, was that the cost levelized over a full contractperiod thusMr. Little calculated a $0.40 per million BTU cost advantage for the Western Energy Coal. I 

### find theArthur D. 

### Little report to be objective and conclusive evidence that competition existed,and that Western Energy appropriately received a contractas a result of its favorable contractoffer. I also find that the evidence is unchallenged and shouldhaveformed the basis for the PSC's determination to recognize the appellant's Western Energy Coal purchase expense as fully recoverable. TheArthur D. 

### Little studydoes not include the coal supply for Colstrip's Units I

### and I1 

### because that contractat that time had expired. Therewas testimony on the record that the Colstrip contractwas negotiated jointlywith Western Energy by the Puget Sound Power and Light Company and theMPC, aspartners in ~olstrip I and 11. 

### Theprice paid for that coalwas subsequently recognized in Puget Sound's electrical rates,and therefore,Puget Sound negotiatedwith knowledge that its fuel expenseswould be scrutinized -12-

### by its home state,Washington, regulators. InWashington, Puget Sound sought a price which it could later justify. As previously noted,Washington approved Puget Sound's coal purchases from Western Energy. The cost of the appellantMontana Power and Puget Sound for Colstrip is substantiallybelow the competitiveprice at the Corette Plant,even before transportationand other expenses are considered. The Colstrip cost of $7.097 per ton compares favorablywith the $8.757 Corette cost. This comparison,made for the purpose of independently verifying the reasonableness of the Colstrip Cost level, is, inmy opinion, one of the strong points for Montana Power's position that it's claimed level 

### of coal expense is fair to the Montana Power ratepayers. In addition, the record indicates, through the testimony of Mr. Burke, thatMontana Power coal expense at Colstrip I and 11,as well as at Billings, had been accepted by the PSC in previous hearings in 1968, 1972, 1975,and 1978,as a result of rate proceedings in those years. Such facts are, inmy opinion, indicativeof the coal price at Colstrip. It is interesting to note that in those previous hearings regarding Pacific Power and Light, the expert of the Consumer Counsel,Dr. Wilson, was examined on the theory that he presented in this case by the consumer counsel and by the PSC, and in those instances the PSCdid not accept his testimony. With thisbackground, it is understandable that the appellant,IIPC, choose not to cross-examinehim because in those four cases the PSC had found his testimony unreliable or at least unconvincing. As it is above noted,Dr. Wilson has for some time been trying to sell the rate-of-return methodology as an expert witness here in Montana, and we noted in Knife River, supra, that such amethod could be acceptable so long as themethod did notproduce "an unjust or arbitrary result" and that the reasonableness of the coal purchase expenses be based on "sufficientevidence." The PSC argues sinceMPC did not challenge the testimony of J.W. Wilson it gave them license to adopt that testimonywithout even -13-

### superficial scrutiny. Then the PSC asserts that their "substantial evidence" rule applied so the court cannot substitute its judgment for that of the PSC. I do not agree with that in view of the fact that there is, inmy opinion,an arbitrary,capricious decisionmade by the PSC in adopting the testimony of J.W. Wilson. Dr. Wilson is the only witness that testified concerning the issue of earnings of other coal companies. This testimony is as follows: "As shown on page one of exhibit 22, (JW-3), the coal industry equity profits have averaged about 16 percent in this decade,with the exception of very high earnings rates in the three years immediately following the OPEC embargo. InNovember of 1973,the average earnings rates in the coal industryhave been under 12percent." He thereafter listed eight coal companies as "comparable coal industry earnings from 1970-1979." Those companies were Bates Manufacturing, Eastern Gas a.ndFuel,Fulcom Seaboard,Kaiser Resources, Kaneb Services, North American Coal,Pittstown and Westmoreland Coal. As previously noted, the appellant,MPC,had contacted twenty-one coal companies in connection with the Corette coal contract that there was only one of the companies contacted by Montana Power on both lists, that is "Westmoreland." Even that is not a sufficient identity for the same company is listed on the Arthur Little, Inc. report as "Westmoreland Resources, Inc." which operates amine in Big Horn County, Montana. All of the sixteen companies solicited by Arthur D. 

### Little, Inc.,were producing coal in Montana and Wyoming. None of the companies, except Westmoreland, if that is the same Westmoreland as the Westmoreland Resources, are listed as solicited by Arthur D. 

### Little, arewithin the area of Montana and Wyoming. In comparing the testimony of Arthur D. 

### Little, Inc., and Wilson, there appears to be inadequacies on thepart of Dr. Wilson that should have drawn more attention from the PSC in evaluating his testimony. 1. According to Dr. Wilson, the

### Fulcom Seaboard showed a percentage of earnings from 1974

### - 1978 averaging 30.8 percent, which far exceedsWestern Energy's average for thosefiveyears by asmuch as 

### 7.8 percent per year. In addition, Fulcom Seaboard's figure for 1979was not used by Wilson and, therefore, ithad no input into the 13.5 percent earning figure which PSC was going to allow Western Energy. 

### 2. Next, the company givenby Wilson called "Bates Manufacturing" was liquidated by 1979,and thereforehas not had any impact

on the "average" 13.1 percent selectedby Wilson with a slight modification adopted by the Commission. 3. Wilson listed as an

"average"number at the base of each column of his exhibit. This actually is an average of the averages of each company, and does not take into consideration any proper variables. This cannotbe, inmy opinion, a true average. Further, indistorting the figure,he left out Fulcom Seaboard, which was an unusually low figure and inserted.in its place Westmoreland Coal (1percent) and Pittstown (8.6

### percent) which disotrted the so-called average figures. Including leaving out Fulcom Seaboard,which had by far the best earnings, Wilson failed tomention Bridger Coal which had a 60

### percent figure and the PacificMinerals which had 37 percent, thereby leaving two companieswith unreasonable low percentage earning figuresand therefore arriving at a fixed coal company average of 13.1 percent, a figurewhich, inmy opinion, is distorted. Had he included Bridger Coal and Pacific Minerals, there would have been a considerably higher change in his "average" figure. I 

### find Dr. 

### Wilson's testimony to be both arbitrary and 

### discriminatory in an effort to get the PSC to accept his methodology and feel that no credible evidencewas submitted to the record on rates of return on "comparable coal companies." As previously noted, 

### I find that the PSC's posture in this matter is totally inconsistentwith itsprior actionswith regard to the Pacific Power and Light Company and the MDU 

### where it refused thevery testimony thatwas given by Dr. Wilson in this -15-

### matter. In Knife River, supra, we allowed a return of 1-3.5 

### percent which is nearly identical to the rate of return of 13.45 percent allowed Montana Power on its utility operations. After

our decision in Knife River, supra, the casewas returned by the District Court to the PSC for them to consider the testimony

on a 

### competitivemarketmethodology and stayed with their original opinion supporting Dr. Wilson. Last but not least, the PSC contends thatPlontana Power had

no right at this stage of the proceedings to challenge Dr. Wilson's comparisons for the first time. They claim that the MPC had a burden of contradicting Dr. Wilson's stud.yof comparable coal companies at the hearing, and, as it standsnow, there is no evidencewhich can sufficiently rebut the testimony of Dr. Wilson. In

### pursuing the argument thatMontana Power did not cross-examine Dr. Wilson at the hearing and is not estopped from attacking the credibility of his evidence,Iwould find thatbecause the testimony of Dr. Wilson was soweak and was rebutted by the studies of Arthur D. Little, Inc., the evidence before the PSC lacked credibility and their decision to adopt his findings is both arbitrary and capricious. While the PSC citesVita-Rich Dairy, Inc. v. Departmentof Business Regulation (1976),170Mont. 34L, 553 P.2d 980, 

### for the authority that at the time at the judicial review level, the appellant,MPC was precluded from raising the issue for the first time, I do not believe that holding stands for a rule that a party cannot argue on appeal from a record that the testimony of the key witness is without substance. I

### would reverse the decision of the District Court and return the matter to the PSC for further hearings.