NO. 89-028 IN THE SUPREME COURT OF THE STATE OF MONTANA 1990

MONTANA-DAKOTA UTILITIES CO., A Division of MDU Resources Group, Inc., a Delaware corporation, Plaintiff and Appellant,

MONTANA DEPARTMENT OF PUBLIC SERVICE REGULATION, MONTANA PUBLIC SERVICE COMMISSION, AND MONTANA CONSUMER COUNSEL, Defendants and Respondents.

APPEAL FROM: District Court of the Fifteenth Judicial District, In and for the County of Roosevelt, The Honorable M. James Sorte,Judge presiding.

COUNSEL OF RECORD: For Appellant: JohnAlke;Hughes, Kellner, Sullivan &Alke, Helena, Montana Lester H. Loble, 11; Montana-Dakota Utilities, Bismarck, North Dakota For Respondent: Mary Wright; Montana Consumer Counsel, Helena, Montana Denise Peterson; Public Service Commission, Helena, Montana

Filed: Submitted: April 10, 1990 Decided: July 13, 1990Justice R. C. McDonough delivered the Opinion of the Court.

Montana Dakota Utilities Co. (MDU) appeals an order of the Fifteenth Judicial District, Roosevelt County, which affirmed an administrative rate order of the public Service Commission (PSC). In that order, the PSC denied full recovery of costs incurred by MDU, through a purchase of firm power from the Antelope Valley Station I1 (AVS 11) power plant. We affirm. The sole issue on appeal is: Was theDistrict Court correct inaffirming the PSC 

### sdecision to reprice, forratemaking purposes,the amount of the expense that MDU could recover from its Montana ratepayers for power purchased fromAVS II? MDU is a regulated public utility providing natural gas and electric service inMontana, South Dakotaand Wyoming. Tomeet its customersv demand for electric service, MDU owns, either individually or in partnership with other utilities, a number of generating stations located in or near its service territory. It is also a member of the Mid-Continent Area Power Pool (MAPP) from which it can acquire power under certain limited circumstances. MDUvs membership inMAPP iscontractual,and it isconditionedupon MDU having its own generating capacity equal to customer demand plus a reserve of fifteenpercent. MDU is experiencing a steadily increasing demand for electricity. To meet that demand, MDU has been acquiring modest amounts of generating capacity as it becomes available. In 1986, pursuant to a contract made in 1981, it purchased forty-onemegawatts of firm power fromAVS 11, a power plant which is owned by Basin Electric. Firm power is power which the seller is obligatedtoprovide fora fixednumber ofyears. Correspondingly, the buyer is obligated tomake the purchase. The contractbetween MDU and Basin Electric provided the firm power purchases would be made over a ten year period. In addition to the AVS I1purchase, MDU acquired additional power through purchases of additional generating resources. In order to recover costs associatedwith these acquisitions, MDU filed an application with the PSC seeking authorityto increase its electric rates. In the application, the company prepared a cost of servicewhichwas based upon anhistoric testyear, in this

case 1985. The application also reflected the actual costs MDU incurred in purchasing forty-one megawatts of firm power fromAVS 11. Following MDU1sfiling, the Montana Consumer Counsel (MCC) intervened on behalf of Montana Ratepaying Consumers. At a public hearing, theMCC presented testimony from itsexpert, Albert Clark. Mr. Clark testified as to the effect of the AVS I1 purchase. In his testimony, he stated that MDU, through its purchase from AVS 11, effectively replaced cheap power which could be generated at its existing plants with very expensive AVS I1 power. He noted, in this regard, that the average cost of energy produce at MDU1s n existing plants ranged between $13.52 to $24.74 per megawatt hour (mwh)

# . The cost of AVS I1 power, meanwhile, equaled $48.84 per mwh.Mr. Clark further testified, thatmost of the energyproduced by AVS I1 could have been generated internally at MDU's existing plants. Relying upon this testimony, the PSC found that although AVS I1 was not purchased for the purpose of replacing existing facilities,that is in fact what happened because 77% of thenewly acquired energy could have been generated at existing facilities. He said the net effect of this acquisition was to replace 88,750 mwh of existing energy production with more expensive AVS I1 power. The purchase also allowed MDU to increase off system sales to other utilities by 45,172mwh. And finally, the AVS I1 acquisition replaced 64,638 mwh of Schedule E energy, which is purchased from MAPP. Schedule E is cheap energy which is generally purchased in order to replace more expensive energy produced by an individual power company. It is not a reliable source of power, however, because the seller can cancel the salewith a one day notice. In order to be eligible to purchase Schedule E, an individual power company must be capable of meeting its baseload requirements and have a fifteen percent surplus to meet peak demand. Clark stated that the AVS I1 acquisition actually replaced existing power sources with very expensive energy. He therefore maintained that itwas unfair to saddle the consumer with the full cost of AVS 11. He, therefore, sought to "remix1'the company's power supply figures in order to come up with a rate that was fairer to the consumer. Mr. Clark accomplished this taskby repricingtheAVS I1poweraccording to an alternative energy scenario. Inhis proposal,the electric rates were figured as if: (1) Base load energy generation at MDU1s existing facilities were increased to pre-AVS I1 levels. This course of action, he maintained, prevented the replacement of inexpensive power withvery expensive AVS I1power; (2) The increased off-system sales were not imputed to the consumers; (3) MAPP Schedule H energy was purchased in order to replace some of the energy produced by AVS 11. Schedule H energy is relatively inexpensive energy which could be used by MDU well into the future, because there is a substantial surplus; and (4) Remaining energy needs were satisfied through purchases of Schedule E energy from MAPP. Initially, the PSC rejected Clark's proposal and granted a rate increase, but at a level lower than MDU requested. The PSC based its action partly upon Clark's suggested use of Schedule E energy. As stated above, Schedule E is not a dependable energy
sourcebecause it can be cancelled on one day's notice. Therefore, in order to avail itself of thepower, a utility companymust have energy to forgo. The PSC, upon reviewing Clark's proposal, determined that he was treating Schedule E as a long-term source of energy. Due to its limitations, Schedule E cannot be used as a dependable source of power, and therefore it concluded that Clark's proposal was not feasible. Following this decision, both the MCC and MDU submitted motions for reconsideration. In its motion, the MCC argued that the PSCmisinterpretedClark's testimony. Itmaintained thatMDU1s own power supply figures indicated that MDU could utilize 139,288mwh of Schedule E energy. The MCC maintained that these figures indicated thatMDU had energy to forgo prior to theAVS I1purchase and therefore was able to avail itself of the cheaper energy. Obviously, if MDU had excess energy before theAVS I1 acquisition, it had to have extra energy following its purchase. The MCC thereforemaintained that itwasnot treating ScheduleE as a longterm energy source,but was instead, treating it exactly as it is supposed to be, namely a source of low cost energy which is purchased to displace higher cost energy. Upon reconsideration, the PSC agreed that it misinterpreted the information contained in Mr. Clark's testimony. It concurred thathisproposal treated ScheduleE energy correctlyand that this treatment made the AVS I1 adjustment acceptable. It therefore granted theMCC's motion and furtherreduced the level of the rate increase. MDU then appealed thematter to District Court. The District Court affirmed the PSC's order and specifically found that itacted properly in "repricing1'AVS I1 energy because MDU's own numbers established that it did not need to incur the expense to meet present or future demand. It further found that a portion of the expense incurred through the AVS I1 acquisition was unreasonable and therefore should not be passed on to the consumer. This appeal followed. Inutility rate cases thisCourthas traditionallyheld itself bound by a very strict standard of review. In previous cases we have stated:

# . . 

# . [TJhisCourt is always confronted in ratemaking cases with the question of how far the court can go in interferingwith, ordirecting the exercise of power, by an equal department of government. We have repeatedly held that there will be no interference with the orders of the Commissionunless: (1) they go beyond the power constitutionallygiven; or (2)beyond their statutory power; or (3) 

### they are based on a mistake of law. Cascade County ConsumersAssln v. Public Service Commfn

(1964), 144 Mont. 169, 192, 394 P.2d 856, 868;Mountain States Telephone and Telegraph v. Department of Public ServiceRegulation (1981), 191Mont. 331, 339, 624 P.2d 481, 485.

This strict standard of review is necessitated by the nature of controversies surroundingutility rate cases. These cases are generally very complicated and involve the review and interpretation of testimony given by experts in fields such as engineering and economics. The PSC, because of its expertise and familiarity with these typesof cases, isbest suited toreview the evidence presented by such testimony and make the decisions. In light of this fact, this Court has traditionally refused invitations to substitute its judgment for that of the PSC. In rate cases, the PSC is the judge of fact and this Court only determines questions of law. In deciding questions of law,

our review only requires us to determine "whether the PSC acted arbitrarilyandunreasonably without sufficient evidencetosupport its findings or exercised its authority unreasonably or set the rates so low that they are confiscatory and deprive theutility of its property withoutdueprocess of law. Montana-Dakota Utilitiesv. Department of Public ServiceRegulation (1988), 231 Mont. 118, 752 P.2d 155. This standard of review, which has been described in case law, has its origins in the Montana Administrative Procedure Act. Under this act, findings of fact are subject to a IfclearlyerroneousN standard of review, while conclusions of law are subject to an Ifabuse of discretionffstandard of review. Section 2-4-101, MCA, et seq. MDU maintains that the PSC acted unlawfully by limiting its determination of the need for AVS I1power to the 1985 test year and by "repricingwtheAVS I1power without any determination that the company acted imprudently or unreasonably. As for the first assignment of error,MDU maintains that theAVS I1purchase should be considered a long-term investment which should be included in the ratebase. Usually, itemswhich are considered tobe ratebase expenditures include new power plants, transmission lines, etc. If theutility can prove that such facilitiesare ftused and usefulff they are entitled to earn a rate of return on the associated investments. Both the lower court and the PSC, however, maintain that neither the test year question nor the associated rate base issue

are relevant to the case now before us. They maintain that the only issue presented by MDUts appeal is whether there is substantial evidence to supportthePSCfs decision todisallowsome of the costs associated with the AVS I1purchase as unreasonable. We agree that this is a correct statement of the issue. The legislature has endowed the PSC with full power of

### supervision, regulation,and control ofpublic utilities inmatters related to rates and service. See 69-3-101,et. seq. Under 5 69- 3-303, MCA, the legislature has mandated that before the PSC can approve any rate increase, it must hold a public administrative hearing. At this hearing, theMCC may become aparty and following submission of all of the evidence, the PSC must issue a decision and order. Section 69-3-303,MCA. The PSC, in its order,may "fix and order substituted

# . . . rates, tolls, charges or schedules as are just and reasonablen upon finding that previous or proposed rates are unreasonable. Section 69-3-330(1), MCA. This statutory scheme is based upon and is often followedby policies whichhavebeen enunciatedby commentatorsand thecourts. ProfessorA.J.G. Priest in Principles of Public Utility Regulation

(1969) states that: regulatory agency cannot lawfully ignore the necessary, fair and reasonable expenses of operation incurred in the rendition of service

# .. .but must 

# ..

. allowall such expenses constitutingchargeson income



# . . ." (Emphasisadded.) 

### Id at 50. Similarly, this Court has stated: A function of the PSC, in fulfilling its duty to supervise and regulate the operation of MDU, as an electric utility, isto seethatMDUtsrates are justand nondiscriminatory (cites omitted). In complying with this obligation,it follows that the PSCmust scrutinize and review the operating expenses of MDU to prevent unreasonable costs from being passed to the customer.

(Emphasisadded.)

Montana-Dakota utilities Co. v. Bollinger (1981)

## , 632 

### P.2d 1086,

Both the PSC and theMCC argue that the actions taken in this, 1 .I

case, i.e. disallowing a portion of the costs associated with AVS 11, fully comply with the statutorymandate of 9 69-3-330(1), MCA, and the reasoning of legal commentators and the Montana Supreme Court. We agree that the PSC has both the constitutional and statutoryauthority toreviewratesand todisallowrateswhich are proven unreasonable. Moreover, in accomplishing this task, the PSCneed notdeterminethatthe company's actionsareunreasonable. Their task is only to review rates and determine whether they are reasonable to the consumer. We must, therefore, now review the evidencepresented to the PSC in order to determine whether it was justified in denying MDU1sproposed rate increase. We have previously set out much of the evidence relied upon by the PSC in our statement of facts. However, for the sake of clarity,we will repeat much of this evidence and apply it to the standard of review which must be utilized in this case in order to determine whether there is substantial evidence to support the PSCtsorder. In its findings of fact and conclusions of law, the PSC summarized and analyzed the testimony given at the public hearing and the records submitted by MDU. This information led the Commission to conclude that MDU was, in point of fact, replacing inexpensive electricity which could be generated internally or acquired from MAPP with very expensive AVS I1 power. When the total operationandmaintenance expenses ofAVS I1power were taken into account, it became apparent that it cost up to 261 percent

more to operate than MDUtsexisting plants. In the opinion ofMCC1sexpert,Mr. Clark, the ratepayers should not be saddledwith such power supply costs. His opinion, itwas found,was bolstered by MDU1sown records which indicated that subsequent to the AVS I1 purchase, MDU had backed down production at its existing plants, decreased its use of purchased power from MAPP and increased its unregulated off system sales to other utilities. In order to come up with a compromise that was fair to both the consumer and MDU, the PSC adopted Mr. Clark's proposal that MDU s energy resources be "remixed.

## " This proposal assumed that MDU could acquire Schedule E and Schedule 

### H energy from MAPP and that it could utilize them as a cost reducingmechanism. Evidence

was presented of abundant power and energy. In fact it was shown that there is a surplus in MAPP until at least 1995. Moreover, MDU's own records suggested that it could utilize 139,288 mwh of Schedule E energy. This fact indicates that the company had this much power from its own units to forego, because in order to qualify for ScheduleEpurchases,a company must have excess energy tomeetpeak customerdemand. Mr. Clark'sproposal,which actually reflects less Schedule E energy than MDU's own records indicates it could acquire, is a feasible alternative to the dilemma. Inmaking its final decision it is obvious that the PSC chose to accept Mr. Clark's suggested alternative. It based its conclusion upon evidence found within the record, which was presented by both sidesto the controversy. Obviously inaccepting this testimony,the PSC chose to reject expert testimonypresentedby MDU. However, such a decision was clearly within its discretion. As we stated in Dept. of Public Service Regulation v. Montana Irrigators (1984), 209 Mont. 375, 381, 680 P.2d 963, 966: Rate structuring involveshighly specializedtheories of economics. Theweighing and balancing of expert opinion pro and con is properly vested in the administrative agency in its field of expertise. In view of the facts presented and their application to the standard of review presented by utility rate cases, we hold that the PSC1s denial of a portion of the costs associated with theAVS I1purchase was not beyond its constitutional or statutorypower. Nor was the decision based upon a mistake of law. We also cannot say the decision of the PSCwas arbitrary in this case. The order of the District Court upholding the PSCSsorder is therefore affirmed.

Justices / sifting for

## ust tic^John C. Sheehy



# 6a/*.c"fl! District Judge C.B. McNeil sitting for Justice Wm. E. Hunt, Sr.Justice Fred J. Weber dissents as follows: Ido not dissent from the legal principles cited and applied in themajority opinion. There is no conflictbetween theparties

as to those legal principles. My problem is with the required purchase by MDU of 41 megawatts of power in each year. In 1981 MDU entered into an agreement with Basin Electric which obligated MDU to purchase 41 megawatts of power from a particular generating plant in which Basin Electric had an interest, and which also obligated Basin Electric to furnish that 41megawatts for each of ten years. It is important to note that the Basin Electric power plant did not become operational until June of 1986. Under its determination, the PSC deniedMDU the recovery of $1,474,932 in costs it incurred in agreeing topurchase the 41megawatts of power for one year. All parties agree that the PSC has the power to disallow unreasonable expenses. My contention is that the PSC improperly used that power in the present case. The PSC relied upon the expert testifying in behalf of the Montana Consumer Council (MCC)

# . It is critical to keep in mind that the MCC expert conceded that MDU needed its generating

resources including the 41megawatts ofpower each year contracted for with Basin Electric. The expert conceded that the power was reasonablyneeded for the forecasted consumerdemands of MDU. The expert conceded that the power was reasonably needed for the forecasted consumer demands ofMDU. Wemay therefore conclude thatboth the MCC and the PSC agreed that it was both reasonable and necessary for the MDU to enter into the 1981 agreement for the obligated purchase of 41 megawatts each year starting at the completionof constructionof the power plant in 1986. Thataspect

was not considered in the PSC determination nor in the majority opinion. TheMCC expertattacked only theamount which MDU was required to pay in one year for the 41 megawatts of power. The expert emphasized that MDU reduced some of its owned production of power which resulted in an increased cost to the consumer because the contracted price for the 41 megawatts exceeded the cost of production in certain of the MDU units. In addition, the expert testified that in 1985 MDU couldhavepurchased cheaper power from a power pool at a rate substantially less than the price paid for the 

### asi in ~lectric 41megawatts. The substance of this testimony was that MDU could have generated power and purchased power at prices cheaper than paid to Basin Electric. As a result, the expert testified that it was proper to disallow $1,474,932 as an unreasonable expense--even though that amount was required by contract to be paid by MDU. That is a 11catch-22n position of the worst sort so far asMDU is concerned. The result of thisapproach is that the PSC in substance commends MDU for obligating itself to purchase the 41megawatts of power eachyear for 10years--because that isa reasonable protection so farasconsumer requirementsare concerned. The ttcatch-22tt result is that the PSC then says-- however, as we review this case in hindsight, we find that inactual fact you didn't need that power as you anticipated because you couldhavepurchased thepower from other sourcesat a cheaper rate, and we therefore will disallow your required payment as an unreasonable expense. The 1'catch-22B1 situation is further emphasized by the very nature of the "Poolpower.'' MDU isa member of Mid-ContinentArea Power Pool fromwhich it can acquirepower. Itsmembership in that Power Pool is conditioned upon a contractual arrangement which requires that MDU have its own generating capacity equal to its customers1demandsplus a reserve of 15%. By signing the contract with Basin Electric, MDU has helped to establish its capacity to purchase the pool power by establishing a reserve above projected customer demands of 15%. The penalty result of the PSC determination is that while MDU must have 15% more than is needed for its consumer demands topurchasepower fromthe Power Pool;the PSC will use the cheap power purchased from the Power Pool as a
means of eliminating theright of MDU to includetheBasin Electric contract price. In addition, pool power is not guaranteed power

as is the power which must be furnished by Basin Electric. It is easy to look back and state that pool power was available, but difficult, if not impossible, to look ahead and count upon its availability. Truly a "catch-22." As well stated in themajority opinion, the PSCmay fix rates which are ''just and reasonable.I1 As stated by Professor A.J.G. Priest inthemajority opinion, a regulatory agencycannot lawfully ignore necessary, fair and reasonable expenses of operation. Inaddition, as stated by this Court in Montana Dakota Util. Co. v. Bollinger (Mont. 1981), 632 P.2d 1086, 38 St.Rep. 1221, in complying with its duty to supervise and regulate, the PSC must scrutinize and review operating expenses to prevent unreasonable costs frombeing passed tothe consumer. Both themajority opinion and the dissent agree that the foregoing standards control. My contention is that the result reached by the PSC is neither just, fair, nor reasonable. The technique used by the MCC, and accepted by the PSC, has resulted in an artful bypass of a fair and reasonable determination. In order to obtain such a fair and reasonable determination, I believe it essential that the PSC determine whether or not it was fair and reasonable that MDU enter into its 1981ten year contract with Basin Electric. Sucha procedurewould require that the PSC make a decision as to whether or not the contract was fair and reasonable before disallowing any of the payments required under the contract. That was not done here. Instead the technique used was to attack the payment required in

oneyear asbeing anunreasonable expense because power could have been obtained from other sources at a lesser cost. That hindsight

was applied fiveyearsafter the contracthad been signed. If that same technique were followed during each of the remaining nine contract years of the MDU-Basin Electric contract, it becomes possible that the PSC could disallow the entire contractpurchase price as being an unreasonable expense. This allows an after-thefact determination on thepart of the PSCwhich is not either fairor reasonable. If the power supply during the ten year contract term is such that the 41 megawatts of power are needed for customers of MDU because power is in short supply, then MDU will be commended, and its purchase price of the 41megawatts of power will be allowed as a reasonable expense. On the other hand, if power continues to be in surplus during the contract term as was true in 1985, then this would allow the PSC to disregard the required purchase price of the 41megawatts of power in each year in which there was a surplus of power. Such procedure disregards the nature of the MDU-Basin Electric contract. That contract requires the furnishing of power and the purchase of power in a
manner which is actually comparable to an investmentby MDU 

### in the construction of its own power generating facility. The payment under the contract should be treated in a manner comparableto the investment in plant, not by the devise used in the present case. Iconclude that the PSC has failed to fix rates that are just and reasonable because it ignored the necessary, fair and reasonable expenses of operation of MDU. I would remand for a redetermination of the rates here involved.

Justice Diane G. Barz andJustice John C. Harrison concur in the foregoing dissent. ,/ 

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### ,J/4, /d