Court Opinion

ID: 9793345
Source: CourtListenerOpinion
Date Created: 2023-08-31 02:46:17.15095+00
Date Added: 2024-06-11T08:04:34.435660
License: Public Domain

HUNTLEY, Justice.
The issue presented by this appeal was first addressed by this court in Washington Water Power v. Idaho Public Utilities Commission, 101 Idaho 567, 617 P.2d 1242 (1980) (hereinafter referred to as WWP I). As that opinion contains a complete statement of the facts relevant to this appeal, we will not recite them again here. The primary issue in WWP I was whether the Commission erred in concluding that Washington Water Power Company (WWP) had failed to carry its burden of proving the reasonableness of its costs for coal it purchased from its wholly-owned subsidiary, Washington Irrigation and Development Company (WIDCo). We held that the Public Utilities Commission (the Commission) had failed to set out sufficient support for the conclusions it reached regarding its treatment of the coal supply expenses from WIDCo. Accordingly, the Commission’s rate-setting order (No. 13856) was set aside. Id at 579, 617 P.2d at 1254. We are now faced with the same issue, raised in the context of the October 20,1981, rate-setting order (No. 16829) in which the Commission again held that WWP had failed to sustain its burden of proof that the price it paid for coal from its subsidiary was just and reasonable. We are presented with the additional issue of whether the Commission’s adoption of the “California approach” as a means of dealing with the WIDCo/WWP coal supply arrangement is arbitrary or unreasonable.
I.
In WWP I this court discussed at some length the problem of determining the “reasonableness" of operating costs incurred by a utility in transactions with an affiliated company. We noted that determination of the reasonableness of payments to an affiliate involved many complex issues which are best left for the Commission to deal with, and that the function of this court is limited to a review of that determination. This court quoted with approval from State v. Public Service Commission, 537 S.W.2d 655 (Mo.App.1976):
“ ‘If the commission has the power and duty to inquire into the reasonableness of the transactions in question, the commission, as the repository of the legislative rate-making power entrusted to it, has the right to determine a reasonable standard of judgment consistent with statutory and constitutional limitations. The limited authority of a court upon judicial review of the commission’s action does not encompass a substitution by the reviewing judicial authority of its judgment for that of the commission.’ Id at 664” 101 Idaho at 575, 617 P.2d at 1250.
This court cited several cases affirming a public utility commission’s authority to adopt its own standard for determining reasonableness of expenses in transactions between utilities and their affiliates so long as that standard is reasonable and does not deprive the utility of a fair rate of return. 101 Idaho at 574, 617 P.2d at 1249. See, eg., Pacific Northwest Bell Telephone Co. v. Sabin, 21 Or.App. 200, 534 P.2d 984, 996 (1975); Application of Montana-Dakota Utilities Co., 278 N.W.2d 189, 191 (S.D.1979).
In Boise Water Corp. v. Idaho Public Utilities Comm’n, 97 Idaho 832, 555 P.2d 163 (1976), this court held that the utility company had the burden of proving reasonableness of its operating expenses paid to an affiliate, and “[t]he Commission had discretion to rule that it was not persuaded by the Company’s evidence that these charges were reasonable.” Id. at 838, 555 P.2d at 169. In the instant case WWP *279had the burden of proving that the expenses which it incurred through purchasing coal from its wholly-owned subsidiary were just and reasonable. The Commission held that WWP did not carry its burden of proof. This court’s task is to determine whether the Commission’s ruling is supported by “adequate findings of fact based upon competent and substantial evidence.” Washington Water Power v. Idaho Public Utilities Comm’n, 101 Idaho at 575, 617 P.2d at 1250.
To meet its burden of proving the reasonableness of its coal expenses, WWP introduced evidence intended to show “arm’s-length bargaining” between WIDCo and WWP. The coal supply agreement was not solely between WWP and its subsidiary, WIDCo. The agreement was between WIDCo and Pacific Power and Light Company (PP&L) as joint owners of the coal reserves (sellers) and the eight owners of the Centralia power plant (purchasers). It was determined that the two “majority owners” of the Centralia plant, PP&L (47V2) and WWP (15%), would be excluded from having a vote on base price changes, and that the six “minority owners” (none of whose interest exceeded 8%) would have certain specific rights in the event an agreement on a reasonable coal price was not reached. If an agreement could not be reached, the minority owners could submit the matter to arbitration, and they were free to secure bids from some entity other than WIDCo to operate the mine.
While it is correct that evidence of arm’s-length bargaining will help establish the reasonableness of the price paid for coal, that evidence alone will not establish reasonableness, where, as in this case, the supply agreement partakes of an affiliated transaction. In such a transaction there arises the potential for two separate threats to a reasonable price: collusion and inhibited competition. In Boise Water, supra, 97 Idaho at 838, 555 P.2d at 169, we stated:
“The reason for the distinction between affiliate and non-affiliate expenditures appears to be that the probability of unwarranted expenditures corresponds to the probability of collusion. In dealing with non-affiliates the pressures of a competitive market and the fact of arm’s-length bargaining for goods and services allows us to assume, in absence of a showing to the contrary, that such operating expenses are legitimate.” (Some emphasis added.)
In addition to arm’s-length bargaining, we noted the role of a competitive market in influencing the reasonableness of prices paid. It is the Commission’s position that the presence of arm’s-length bargaining in the WIDCo coal pricing agreements was irrelevant because there was insufficient evidence of a competitive market. The Commission in its findings draws attention to several factors which it found created a non-competitive market: (1) the price of coal sold by WIDCo was set in a long-term contract under which the owners of the Centralia plant agreed to purchase all of their coal requirements from the WIDCooperated mine through the year 2006; (2) the contract provides for automatic increases as WIDCo’s expenses increase, and WID-Co can at any time give six month’s notice of an intent to increase the price for any other reasons; (3) the nearest alternative coal supplier is Westmoreland Resources, Inc., a coal mining company located in Southeastern Montana, and the price of Westmoreland coal, delivered to Centralia, would be $33.40 per ton as compared with WIDCo’s price of $14.86 per ton; and, (4) the Centralia plant is located at the very “mouth” of WIDCo’s coal mine. In addition, the record shows that the Centralia plant was specifically designed to burn coal from WIDCo’s and PP&L’s coal reserves. To burn other coal, WWP witness Richard McCarthy testified, might require modification of Centralia’s boilers.
We have reviewed the record and cannot say that the Commission has acted arbitrarily or abused its discretion in holding that WWP’s proof of arm’s-length negotiations was not controlling on the issue of reasonableness of price.
*280II.
We now consider whether the Commission’s adoption of the “California approach” for dealing with the WWP/WIDCo coal supply relationship was arbitrary or unreasonable. We hold that it was. The “California approach,” and its counterpart the “traditional approach,” were discussed by this court in WWP I, 101 Idaho at 573-74, 576, 617 P.2d at 1248-49, 1251.
In brief, the California approach allows a utility to include in its rate base only those expenses it incurs in dealing with a subsidiary which would give the subsidiary a rate of return equal to the parent utility’s, and no higher. In other words, where the subsidiary is a related part of the parent utility’s operation, it is presumed under this approach to be entitled to no higher return on its capital than the fair rate of return of the parent utility. In WWP I we noted that the “theory underlying this approach is that where a utility enjoys an integrated position and market dominance, it ‘should not be permitted to break up the utility enterprise by the use of affiliated corporations and thereby obtain an increased rate of return for its activities.’ ” 101 Idaho at 573, 617 P.2d at 1248.
At the foundation of this approach is the concept of “integration.” It is thought that to the extent that a subsidiary and its parent utility are “vertically integrated,” that is, closely connected in the unified utility function, and interdependent, the subsidiary ought to be limited to the authorized rate of return for the utility itself.1 In that sense, the California approach is not so much a means to measure reasonableness of affiliate pricing as it is a presumption that any price which allows the affiliate a higher rate of return than the utility is per se “unreasonable.” WWP I, supra, 101 Idaho at 573, 617 P.2d at 1248.
WWP contends such an approach is inflexible and thus unreasonable and unfair. We cannot conclude that it is at all times inappropriate, however, to treat a wholly-owned subsidiary as simply a part of the utility. Where an electrical utility has created a separate corporate identity for its wholly-owned coal supply operation, and where that subsidiary continues as an integrated part of the unified production and distribution function of the utility, it would not be unreasonable or arbitrary for the Commission to combine the subsidiary’s rate base, income and expenses with those of the utility for rate-making purposes. At the root of the determination to treat the subsidiary the same as the utility is the recognition that (1) in some cases the separation is in name only, and (2) the unique position of the subsidiary coal supplier, having as it does an assured market for its coal, limited risk and a non-competitive environment, makes price comparisons with other coal companies of limited value in determining “reasonableness,” and that in the absence of some showing of outside factors which would make the subsidiary operate at a greater risk than the utility, the Commission might be justified in assuming the utility’s fair rate of return is fair for the subsidiary also.
The Commission compares WIDCo with several other utility-owned coal operations which are integrated in the utilities’ extraction-production-distribution process. In its rate-setting order the Commission states:
“We note that our treatment of WID-Co is consistent with that accorded the coal operations of other utilities in a variety of regulatory contexts, PP&L owns its share of these coal fields directly, rather than through a subsidiary; regulatory bodies having jurisdiction over PP & L recognize this investment as a part of that utility’s investment in the Centraba plant. In like manner, Idaho Power Company owns coal reserves (adjacent to the Jim Bridger coal-fired stream plant in Wyoming) through a subsidiary, Idaho Energy Resources Company (IERCo). This Commission, since 1976, has been treating IERCo as an integral part of *281Idaho Power Company’s investment in the steam plant. Idaho Power Company has accepted this procedure. Finally, Utah Power & Light Company (UP&L) owns coal mines directly which provide fuel for that company’s coal-fired steam plants. These mines are included as utility plant by the regulatory bodies having jurisdiction over UP&L. Other than the existence of separate corporate identities for WIDCo and IERCo, the basic purpose of all these coal operations is identically the same, namely, to provide fuel to the steam plants of the parent utility. It is clear, therefore, that use of the ‘California approach’ with respect to WWP’s subsidiary, WIDCo, is not a departure from typical rate-making treatment accorded such coal operations by regulatory bodies.”
The question we now must consider is whether the WIDCo operation is characterized by such significant vertical integration as to justify its being held to a rate of return no greater than that of WWP. While it is true, as the Commission points out in its rate-setting order, that WIDCo is in many respects similar to other wholly-owned coal operations which are treated as part of their parent utilities, there are several notable differences.
In the WIDCo/WWP pricing relationship there is involvement of several other “non-affiliated” utility companies. WIDCo does not supply coal exclusively to its parent utility, but rather supplies to a plant owned by eight independent entities, each of which has its own interest in keeping coal supply expenses as low as possible. In this sense, WIDCo is similar, although in a lesser degree, to the subsidiary gas supplier in Central Louisiana Electric Co. v. Louisiana Public Service Comm’n, 373 So.2d 123 (La.1979). At issue in that case was the reasonableness of prices charged to the regulated electric utility by its subsidiary for natural gas. The court stated:
“However, in a case such as the instant proceeding in which the subsidiary’s operations are not closely integrated in those of the parent, but include substantial dealings with non-affiliated customers, and in which the subsidiary encounters business risks markedly different from its parent’s the fair rate of return of the subsidiary and not that of the parent should be the touchstone for determining if the subsidiary’s profits are unreasonable and for making any indicated adjustments. Of course, in a case involving a wholly owned subsidiary, the Commission’s inquiry is not concluded by the fact that comparable prices are charged by the affiliate to other utilities, or by comparable rates charged by independent suppliers. The Commission’s proper concern is not the level of price at which the inter-affiliate transaction is accomplished in comparison with prices in non-affiliate transactions, but instead whether there is a level of earnings by the wholly owned subsidiary at a rate higher than the subsidiary’s fair rate of return. (Emphasis added.) 373 So.2d at 129.
The court then remanded the case to the public service commission for it to inquire into the fair rate of return of the subsidiary. Accord, Montana-Dakota Utilities Co. v. Bollinger, 632 P.2d 1086 (Mont.1981).
It is clear, therefore, that in situations where there are sufficient factors shown to suggest a different level of risk borne by the subsidiary — where there are outside dealings, for example, it may be unreasonable to hold the subsidiary to the same rate of return found to be fair for the utility. While there are no doubt instances of such a degree of integration and utility dominance of a subsidiary so as to justify treating it as part of the utility, the present case does not fit that category. Accordingly, we reverse as to the Commission’s adoption of the California approach in this case and remand for a determination of a fair rate of return for WIDCo, as a basis for the Commission to determine the extent to which WWP’s coal supply expenses may be included in its operating costs.2
*282Affirmed in part, reversed in part and remanded. Parties bear their own costs.
SCOGGIN, J., Pro Tern, concurs.
DONALDSON, C.J., concurs in the result.

. For references dealing with the concept of “vertical integration” see Note, Treatment of Affiliated Transactions in Utility Rate Making: Western Electric Company and the Bell System, 56 Boston U.L.Rev. 558, 576-577 (1976).

. The commission should take into consideration the fact that WIDCo actually sustained losses in three years: 1971, 1972 and 1974, and its average rate of return for the ten-year peri*282od 1971 to 1980, from operation of the mine was only 7.22%, substantially less than the rate of return authorized to WWP. The commission might also take note of the significance, if any, of the “depletable resource” factor in calculating the coal company’s fair rate of return. See, Application of Montana-Dakota Util.Co., 278 N.W.2d 189 (S.D.1979).