Court Opinion

ID: 9793346
Source: CourtListenerOpinion
Date Created: 2023-08-31 02:46:17.156178+00
Date Added: 2024-06-11T08:04:34.549152
License: Public Domain

BAKES, Justice,
concurring in part and concurring in the judgment:
I concur in that part of the majority opinion which rejects the so-called “California approach” adopted by the Public Utilities Commission in this case. However, I cannot concur with Part I of the Court’s opinion which states that, from a review of the record, we “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.” Ante at 1010. As the Court’s opinion points out, “it is the Commission’s position that the presence of arm’s-length bargaining in the WIDCo coal pricing agreements was irrelevant because there is insufficient evidence of a competitive market.” Ante at 1010. However, the presence of arms-length bargaining is never irrelevant, and the degree of competitiveness in the market from which the utility is purchasing any given product is only one evidentiary factor to be considered by the commission in determining whether the price paid is reasonable. For example, if one assumed that WWP held no ownership interest in the WIDCo coal mining operation, there still would be “insufficient evidence of a competitive market” according to the commission, and yet if WWP arrived at a coal purchase agreement by arms-length bargaining with such a non-affiliated company, that agreement would satisfy the presumption of reasonableness set out in Boise Water Corporation v. Idaho Public Utilities Comm’n, 97 Idaho 832, 555 P.2d 163 (1976), and WWP would be entitled to include the entire price of that coal in its rate, in the absence of the commission proving that it was unreasonable. If an electric utility has a need for additional generating capacity and elects to build a coal-fired thermal plant adjacent to a coal mine in which it owns no ownership interest, the utility may include in its rate structure the cost of procuring the coal from that mine without any further showing of reasonableness, even though there is no competition in the market in the sense used by the commission in that all other sources of coal are so far distant that the transportation costs would be prohibitive. The burden would be on the commission to prove that the price of coal paid by the utility was so high that it unreasonably increased the electric rates of the utility, and then that determination would seemingly have to be made prospectively before the utility invested the huge amounts that are necessary to construct such a facility. Thus, “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,” ante at 1010, is a basic misconception of the law as it relates to the allowance of operating expenses by a utility-
Our case law is clear that to make out a prima facie case for the reasonableness of operating expenses paid to a non-affiliate, a utility must merely show actual incurrence of the expenses. The burden then shifts to the commission to show by substantial competent evidence that the payments were due to inefficiency or bad faith. Boise Water Corp. v. Idaho Public Utilities Comm’n, supra. However, when the transaction is between affiliated entities, the utility’s burden is greater. This distinction between affiliated and non-affiliated transactions exists because:
“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 expenditures are legiti*283mate. Boise Water Corp. v. Idaho Public Utilities Comm’n, 97 Idaho at 838, 555 P.2d at 169.
The existence of a non-affiliated transaction requires the commission to prove the unreasonableness of the transaction, because in that circumstance it is reasonable to assume that by arms-length bargaining between two unrelated entities the price paid by the utility is a fair and reasonable one. It is the presumed presence of arms-length bargaining in a non-affiliated transaction which satisfies the utility’s burden of proof. However, with regard to transactions between affiliates, no such presumption occurs, and the utility must prove the reasonableness of the price paid.
The transaction in question here involving coal purchases by WWP from WIDCo in many respects more closely resembles a transaction between non-affiliates than between affiliated companies. The coal reserves are owned jointly by WIDCo and Pacific Power & Light Co. WIDCo is the operator of the mine. The coal purchase agreement negotiated between WIDCo, as seller, and the eight participating utilities which operate the Centraba coal-fired generating plant, as purchasers, does not permit the two majority owners of the generating plant, WWP and Pacific Power & Light, to participate in setting the price for the coal for the Centraba plant. The price is negotiated with WIDCo by the six utilities who have no ownership interest in the coal mining operation. Thus, while WWP shares in WIDCo’s profits (and the losses) of the WIDCo coal mining operation, it has no say in the negotiations for the price of that coal.
Before WIDCo can increase the price of coal, it must give the six participating utilities six months’ notice. These utilities have an opportunity to demand the books and records of WIDCo to determine the reasonableness of WIDCo’s proposed price before negotiating. In the event that WIDCo and the six utilities are unable to agree on a price, the matter is to be submitted to arbitration. In the final event that the six utilities who participate in negotiating the price of the coal still are unsatisfied, they can terminate WIDCo’s right to mine the coal and obtain another operator for the coal mine.
The commission nevertheless ' concluded that, because it found a lack of a competitive market in coal in the Centraba area, it would apply the so-called California approach and arbitrarily reduce WWP’s coal purchase allowance to a figure which would yield to WIDCo the same return as WWP was authorized to receive. The commission was not satisfied that the coal supply agreement in this case sufficiently guaranteed the fairness of the price charged for the coal and, finding no competitive market for coal, rejected the traditional approach of evaluating the reasonableness of the charges for coal paid by WWP in favor of “the ‘California approach’ as a safeguard to ensure that the subsidiary receives the same rate of return as the parent utility.”1
However, the California approach does not ensure that the subsidiary will receive the same rate of return as the utility. It only ensures that it will never receive more, at least on the business it conducts with the utility. It does not guarantee that the affiliate’s rate of return will be the same as the utility’s. In this case, for example, WIDCo actually sustained losses in three years, 1971, 1972 and 1974, and its average rate of return for the ten years, 1971 to 1980, from operation of the mine was only 7.22%, substantially less than WWP’s authorized rate of return. In the test year, its rate of return was higher than WWP’s, so as a result WWP’s allowance for coal was reduced below what it actually paid in order “to ensure” that WIDCo’s rate of return did not exceed that of the utility’s. However, there is nothing in the cases adopting the California approach, or in the record in this case, to suggest that in years when WID-Co’s return was less than WWP’s authoriz*284ed rate of return WWP was allowed a greater allowance for its coal purchases than it actually paid for the coal, in order to ensure that WIDCo would receive the same rate of return as its parent, WWP. The “California approach,” at least as applied in this case, is a one-way street.
Accordingly, I concur in the majority’s rejection of the so-called “California approach” and the remand of the matter to the commission to determine a reasonable coal cost to WWP which will allow a reasonable rate of return for WIDCo with its different set of risks and needs. Based upon those findings, the commission can then determine whether or not the price which WWP pays to WIDCo will result in an unreasonable return to WIDCo. In this regard, WWP presented expert testimony that WIDCo’s rate of return was less than that of companies which were most nearly comparable. The witness did acknowledge the absence of an industry norm, a fact which the commission prominently relied on in its order. Nevertheless, he rendered an expert opinion that WIDCo’s actual rate of return in the test year was unreasonably low, considering the risks involved, and that the rate of return proposed by the commission was even more unreasonably low.
However, there was no evidence offered by the staff to support the commission’s finding that WIDCo’s rate of return in the coal mining operation should be the same as WWP’s rate of return. Not only did the staff fail to present evidence that the price WWP paid to WIDCo was unreasonable, they also presented no evidence that the rate of return finally allowed to WIDCo is a reasonable rate of return for WIDCo. The staff’s expert witness testified that she made no study on a fair rate of return for a coal mining operation because she did not think it was relevant. She further stated that she had made no study showing the comparative risks of a coal mining operation and a utility such as WWP, and when asked the basis for her opinion that there was no greater risk in a coal mining operation, she replied, “It’s intuitive.” She also testified that she made no study of the reasonableness of the price set by WIDCo for its coal and rejected the position of WWP that the coal supply agreement was evidence of a reasonable value set in an arms-Iength transaction.
The commission adopted the position of the staff witness, stating that, “It is not possible to compare the price of WIDCo with that of any other coal supply source,” and that “the minority owners or an arbitrator would find it no easier to determine a reasonable price than this commission has found it to be.”
However difficult those factual questions are to decide, that is the commission’s function, and it cannot use an arbitrary formulation such as the so-called “California approach” as a substitute for making the difficult factual determinations that it is charged by law to make.
We indicated in WWP I that it was for the commission, in the first instance, after the parties produced evidence in support of their views, to decide what standard should be used to determine reasonableness in this case. However, as we also noted, it is for the courts on review to determine, based upon the record made, whether the approach adopted by the commission is arbitrary or unreasonable. If it is arbitrary or unreasonable, as the Court rules today that it was, it must be rejected by this Court. Washington Water Power Co. v. Idaho Public Utilities Comm’n, supra.
The California approach, as applied by the commission in this case, which automatically limits WWP to a deduction for coal charges of an amount which would yield a return to WIDCo no greater than the return the parent utility is entitled to earn, without any evidence to support that rate of return, was an arbitrary act by the commission. There is no disagreement among the members of the Court on that issue.
The transaction in question is one between a subsidiary and parent, and should be, of course, subject to strict scrutiny by the commission. It does not follow, however, that because it is subject to strict scrutiny the subsidiary should automatically be limited to no greater return than its *285parent. The predetermined rate of return allowed to a utility is one which the commission has determined is a reasonable rate of return for a public utility, with its set of risks. As a result, its profits are essentially guaranteed at a level to produce that rate of return. The same rate of return might very well be unreasonable for a coal producing company, where the risks are greater, and there is no guarantee. Thus, in mechanically applying the California rule and in assuming the utility’s rate of return for WIDCo’s coal mining operations, with no evidence to support that assumption, the commission failed in its responsibility to determine a fair allowance for WWP’s coal purchases. While one factor to be considered by the commission is whether the contract price would result in an unreasonable rate of return to WIDCo, the commission cannot arbitrarily assign a rate of return to the subsidiary that has previously been determined as reasonable only for the parent utility which has entirely different costs and risks.
The California approach has been recently rejected by other courts for similar reasons. In Montana-Dakota Utilities Co. v. Bollinger, 632 P.2d 1086 (Mont.1981), the Montana Supreme Court noted:
“It does not automatically follow, however, that the coal company should be held to the same rate as its parent public utility. Nor does it follow that the parent is only allowed to receive the same rate of return on the investment in its coal subsidiary as it receives on its utility property, with respect to sales between the subsidiary and the parent. If any limitation on coal profits or ratepayer coal expense is in order, it should be based on a reasonable rate of return as established by a comparable marketplace, not upon a predetermined rate as established for a regulated utility.” 632 P.2d at 1090.
The court in Bollinger rejected the California approach as unreasonable, saying:
“We note, however, that the majority of those cases using this [the California] approach involve the Bell Telephone System and its manufacturing subsidiaries. These subsidiaries sell virtually all their manufactured products to the parent, Bell Telephone — a fact which is materially different from the present situation where the bulk of Knife River coal (a depletable natural resource) is sold to customers other than its parent .... Such an approach should not be deemed applicable in this instance.” 632 P.2d at 1091.
Some of the factors mentioned by the court from which it drew its conclusions were the fact that the coal company also sold its product to entities other than Montana-Dakota Utilities (which presumably included negotiations resulting from arms-length bargaining, thus producing a resulting price more reliable than one negotiated solely between parent and subsidiary); the fact that the coal business is a much different business than a utility concern; that coal is a depreciable resource, etc.
The same considerations apply here. WIDCo is a coal company, not a utility, and the fact that it is a subsidiary of WWP should subject transactions between the two to strict scrutiny, but should not bind WIDCo to a rate of return equal to that of WWP. The primary, but not the sole factor that should be considered in determining the reasonableness of a commodity price purchased by a utility is the presence of arms-length bargaining. Others include a comparison of the prices paid by others for coal to the prices paid by the utility, and a comparison of the rate of return on the coal mining operation with other comparable mining operations.
The South Dakota Supreme Court has also recently rejected the California approach, saying:
“While the rate of return on wholly-owned coal companies is subject to close scrutiny under SDCL 49-34A-19.2, it does not follow that the coal companies should be held to the same rate of return as a public utility. First, they are not subject to the authority of the Commission. Secondly, the rate of return to coal companies, because of the depletion factor, cannot be considered on the same *286basis as a utility which buys its raw materials on the competitive market and sells its electricity to the consumer based upon a rate fixed by the various costs of doing business.” Application of Montana-Dakota Util. Co., 278 N.W.2d 189, 193 (S.D.1979).
Another case that discussed the difference between the two approaches and rejected the California approach is Central Louisiana Electric Co. v. Louisiana Public Service Comm’n, 373 So.2d 123 (La.1979). In that case the court also noted that all of the cases adopting the California approach involved telephone equipment companies with near monopolies, and thus were clearly distinguishable from the situation where a commission is considering prices charged by a coal producing company. The court rejected the California approach, saying:
“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.” 373 So.2d at 129.
The evidence presented at the commission level in the present case indicates the existence of arms-length bargaining. The price of coal charged to WWP was set in a long term contract negotiated between WIDCo and the six minority owners of the Centralia Power Plant.2 Neither WWP nor Pacific Power & Light, the other majority owner of the Centralia plant, are allowed to participate in changes in the base coal price. The contract is a long term one, establishing a base price, and providing for automatic increases as certain expenses increase. However, WIDCo was required to give six months’ notice if it intended to ask for an increase for any other reason. WIDCo is required under the agreement to give the minority owners of the Centralia plant access to its books and records for audit, for purposes of determining the validity of WIDCo’s demand for a price increase. The owners may require WIDCo to furnish data supporting the proposed increase. The owners may also hire outside consultants. After negotiation with the minority owners, if an agreement cannot be reached, the minority owners may either demand arbitration or may discharge WIDCo and contract with another company to operate the mine. Because WWP owns only a 15% interest in the Centralia plant, and is not the operating company for that plant, it is in effect only buying 15% of the output of the mine from its subsidiary WIDCo. The balance is purchased by the other utilities who not only set their own price by negotiation, but in that same process set the price which WWP must pay.
The importance of arms-length bargaining in determining a reasonable price for coal should not be underestimated, and in no case should evidence of arms-length bargaining be summarily rejected as immaterial as the commission did in this case after it determined to adopt the California approach. Such summary rejection can only lead to an arbitrary judgment, a result which is forbidden by law.
Evidence of comparative market prices should also always be considered. The difficulty of comparing coal prices because of the various factors involved should not be a deterrent to allowing and considering evidence of comparative market prices. As the Montana court said in Bollinger:
*287“While it is true that the PSC found that absolute comparability between coal prices impossible to determine, it appears to this Court that the prices paid by a number of other companies to Knife River for two-thirds of its coal production is evidence of a competitive market for comparison to the Knife River price paid by MDU. In addition, there was evidence of prices charged by other companies in the competitive area.” 632 P.2d at 1092.
The other non-affiliated companies were, in effect, purchasing coal from WIDCo under the same contract. Prices paid by those non-affiliated companies, negotiated directly by them with WIDCo, constituted evidence of the price those buyers were willing to pay for coal and was competent evidence of competitive market prices.
The commission’s summary rejection of the evidence offered by WWP to prove its case is illustrative of the arbitrariness of the California approach. Any approach that allows the commission to reject summarily evidence presented on the reasonableness of a price paid for a commodity, and allows the commission to arbitrarily set a rate of return without inquiry into the reasonableness of that rate of return for the particular company under consideration, is arbitrary and unreasonable and by our opinion today has been rejected. Montana-Dakota Utilities Co. v. Bollinger, supra; Application of Montana-Dakota Utilities, supra; Central Louisiana Electric Co. v. Louisiana Public Service Comm’n, supra.
I join in the Court’s judgment reversing the order of the Public Utilities Commission.
SHEPARD, J., concurs.

. Having adopted the “California approach,” the commission concluded on rehearing that “additional evidence on the issue of whether or not arms length bargaining occurred would be immaterial.”

. The owners of the Centralia plant and their percentage interests in the plant are:
Pacific Power & Light Co. 47.5%
Washington Water Power Company 15.0%
Puget Sound Power & Light Company 7.0% Portland General Electric Company 2.5%
PUD No. 1 of Gray’s Harbor County 4.0%
PUD No. 1 of Snohomish County 8.0%
The City of Seattle 8.0%
The City of Tacoma 8.0%
Only the six minority owners are allowed to vote on, or negotiate price changes under the WIDCo contract.