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: 

John Alke; 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, 1990 
Justice 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 the District Court correct in affirming the PSC s decision 

to reprice, for ratemaking purposes, the amount of the expense that 

MDU could recover from its Montana ratepayers for power purchased 

from AVS II? 

MDU is a regulated public utility providing natural gas and 

electric service in Montana, South Dakota and Wyoming. To meet 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 in MAPP is contractual, and it is conditioned upon 

MDU having its own generating capacity equal to customer demand 

plus a reserve of fifteen percent. 

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-one 
megawatts of firm power from AVS 11, a power plant which is owned 

by Basin Electric. Firm power is power which the seller is 

obligated to provide for a fixed number of years. Correspondingly, 

the buyer is obligated to make the purchase. The contract between 

MDU and Basin Electric provided the firm power purchases would be 

made over a ten year period. In addition to the AVS I1 purchase, 

MDU acquired additional power through purchases of additional 

generating resources. 

In order to recover costs associated with these acquisitions, 

MDU filed an application with the PSC seeking authority to increase 

its electric rates. In the application, the company prepared a 

cost of service which was based upon an historic test year, in this 

case 1985. The application also reflected the actual costs MDU 

incurred in purchasing forty-one megawatts of firm power from AVS 

11. 

Following MDU1s filing, the Montana Consumer Counsel (MCC) 

intervened on behalf of Montana Ratepaying Consumers. At a public 

hearing, the MCC presented testimony from its expert, 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, that most of the energy produced 

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 the newly 

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 45,172 mwh. 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 sale with 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 it was 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 task by repricing the AVS I1 power 
according to an alternative energy scenario. In his 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 with very expensive AVS 

I1 power; 

(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 

source because it can be cancelled on one day's notice. Therefore, 

in order to avail itself of the power, a utility company must 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 PSC misinterpreted Clark's testimony. It maintained that MDU1s 

own power supply figures indicated that MDU could utilize 139,288 
mwh of Schedule E energy. The MCC maintained that these figures 

indicated that MDU had energy to forgo prior to the AVS I1 purchase 

and therefore was able to avail itself of the cheaper energy. 

Obviously, if MDU had excess energy before the AVS I1 acquisition, 

it had to have extra energy following its purchase. The MCC 

therefore maintained that it was not treating Schedule E 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 

that his proposal treated Schedule E energy correctly and that this 

treatment made the AVS I1 adjustment acceptable. It therefore 

granted the MCC's motion and further reduced the level of the rate 

increase. 

MDU then appealed the matter to District Court. The District 

Court affirmed the PSC' s order and specifically found that it acted 

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. 

In utility rate cases this Court has traditionally held itself 

bound by a very strict standard of review. In previous cases we 

have stated: 
. . . [TJhis Court is always confronted in ratemaking 

cases with the question of how far the court can go in 

interfering with, or directing 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 Commission unless: 

(1) they go beyond the power constitutionally given; or 

(2) beyond their statutory power; or 

(3) they are based on a mistake of law. 

Cascade County Consumers Assln v. Public Service Commfn 

(1964), 144 Mont. 169, 192, 394 P.2d 856, 868; Mountain 

States Telephone and Telegraph v. Department of Public 

Service Regulation (1981), 191 Mont. 331, 339, 624 P.2d 

481, 485. 

This strict standard of review is necessitated by the nature 

of controversies surrounding utility 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 types of cases, is best suited to review 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 

arbitrarily and unreasonably without sufficient evidence to support 

its findings or exercised its authority unreasonably or set the 

rates so low that they are confiscatory and deprive the utility of 

its property without due process of law. Montana-Dakota Utilities 
v. Department of Public Service Regulation (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 

Ifclearly erroneousN standard of review, while conclusions of law 

are subject to an Ifabuse of discretionff standard 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 I1 power to the 1985 test year 

and by "repricingw the AVS I1 power without any determination that 

the company acted imprudently or unreasonably. As for the first 

assignment of error, MDU maintains that the AVS I1 purchase should 

be considered a long-term investment which should be included in 

the rate base. Usually, items which are considered to be rate base 

expenditures include new power plants, transmission lines, etc. 

If the utility can prove that such facilities are 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 support the PSCfs decision to disallow some 

of the costs associated with the AVS I1 purchase 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 of public utilities in matters 

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, the MCC may become a party 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 followed by 

policies which have been enunciated by commentators and the courts. 

Professor A.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 . . . allow all such expenses constituting charges on income . . ." (Emphasis added.) 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, is to see that MDUts rates are just and 

nondiscriminatory (cites omitted). In complying with 

this obligation, it follows that the PSC must scrutinize 

and review the operating expenses of MDU to prevent 

unreasonable costs from being passed to the customer. 

(Emphasis added.) 

Montana-Dakota utilities Co. v. Bollinger (1981) , 632 P. 2d 1086, 

Both the PSC and the MCC 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 statutory mandate 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 

statutory authority to review rates and to disallow rates which are 

proven unreasonable. Moreover, in accomplishing this task, the 

PSC need not determine that the company's actions are unreasonable. 

Their task is only to review rates and determine whether they are 

reasonable to the consumer. We must, therefore, now review the 

evidence presented to the PSC in order to determine whether it was 

justified in denying MDU1s proposed 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 

PSCts order. 

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 operation and maintenance expenses of AVS I1 power were taken 

into account, it became apparent that it cost up to 261 percent 

more to operate than MDUts existing plants. In the opinion of 
MCC1s expert, Mr. Clark, the ratepayers should not be saddled with 

such power supply costs. 

His opinion, it was found, was bolstered by MDU1s own 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 reducing mechanism. 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 Schedule E purchases, a company must have excess energy 

to meet peak customer demand. Mr. Clark's proposal, which actually 

reflects less Schedule E energy than MDU's own records indicates 

it could acquire, is a feasible alternative to the dilemma. 

In making 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 sides to the controversy. Obviously in accepting 

this testimony, the PSC chose to reject expert testimony presented 
by 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 involves highly specialized theories of 

economics. The weighing 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 the AVS 

I1 purchase was not beyond its constitutional or statutory power. 

Nor was the decision based upon a mistake of law. We also cannot 

say the decision of the PSC was arbitrary in this case. The order 

of the District Court upholding the PSCSs order is therefore 

affirmed. 

Justices / 

sifting for ust tic^ John C. Sheehy 

6 a/*.c"fl! District Judge C.B. McNeil 

sitting for Justice Wm. E. Hunt, Sr. 
Justice Fred J. Weber dissents as follows: 

I do not dissent from the legal principles cited and applied 

in the majority opinion. There is no conflict between the parties 

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 41 megawatts 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 denied MDU the recovery of $1,474,932 in costs it incurred 

in agreeing to purchase the 41 megawatts 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 41 megawatts of power each year contracted 

for with Basin Electric. The expert conceded that the power was 

reasonably needed for the forecasted consumer demands of MDU. The 

expert conceded that the power was reasonably needed for the 

forecasted consumer demands of MDU. We may therefore conclude that 
both 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 

completion of construction of the power plant in 1986. That aspect 

was not considered in the PSC determination nor in the majority 

opinion. 

The MCC expert attacked only the amount 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 could have purchased cheaper power from 

a power pool at a rate substantially less than the price paid for 

the asi in ~lectric 41 megawatts. 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 as MDU is concerned. The result of this approach 

is that the PSC in substance commends MDU for obligating itself to 

purchase the 41 megawatts of power each year for 10 years--because 

that is a reasonable protection so far as consumer requirements are 

concerned. The ttcatch-22tt result is that the PSC then says-- 

however, as we review this case in hindsight, we find that in 
actual fact you didn't need that power as you anticipated because 

you could have purchased the power from other sources at 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 "Pool power.'' MDU is a member of Mid-Continent Area 

Power Pool from which it can acquire power. Its membership in that 

Power Pool is conditioned upon a contractual arrangement which 

requires that MDU have its own generating capacity equal to its 

customers1 demands plus 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 to purchase power from the Power Pool; the 

PSC will use the cheap power purchased from the Power Pool as a 

means of eliminating the right of MDU to include the Basin 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 the majority opinion, the PSC may fix rates 

which are ''just and reasonable.I1 As stated by Professor A.J.G. 

Priest in the majority opinion, a regulatory agency cannot lawfully 

ignore necessary, fair and reasonable expenses of operation. In 
addition, 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 from being passed to the consumer. Both the majority 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 

1981 ten year contract with Basin Electric. Such a procedure would 

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 

one year as being an unreasonable expense because power could have 

been obtained from other sources at a lesser cost. That hindsight 

was applied five years after the contract had 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 contract purchase 

price as being an unreasonable expense. This allows an after-thefact determination on the part of the PSC which is not either fair 
or 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 41 megawatts 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 41 megawatts 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 investment by MDU in the 

construction of its own power generating facility. The payment 

under the contract should be treated in a manner comparable to the 

investment in plant, not by the devise used in the present case. 

I conclude 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 and Justice John C. Harrison concur in 

the foregoing dissent. ,/ . ,<; ,J/4, /d