Montana-Dakota Utilities Co. v. Bollinger

No. 80-346
IN THE SUPREME COURT OF THE STATE OF MONTANA
1981

MONTANA-DAKOTA UTILITIES CO.,
Plaintiff and Appellant,

GORDON E. BOLLINGER, CLYDE JARVIS,
et al.,
Defendants and Respondents.

Appeal from: District Court of the Seventh Judicial District,
In and for the County of Dawson.
Hon. Nat Allen, Judge presiding.
Counsel of Record:
For Appellant:
Crowley, Haughey, Hanson, Toole & Dietrich,
Billings, Montana
George Dalthorp argued, Billings, Montana
Joseph R. Maichel argued, Bismark, North Dakota
For Respondents:
Eileen E. Shore argued, Helena, Montana
James Paine argued, Helena, Montana
John Allen, Helena, Montana

Submitted: June 8, 1981
Decided: AU6 5- 1 t
M
Filed: 5-
Mr. J u s t i c e Gene B. D a l y d e l i v e r e d t h e O p i n i o n o f t h e C o u r t .

Montana-Dakota U t i l i t i e s Company ( M D U ) a p p e a l s f r o m a

judgment entered i n t h e Dawson C o u n t y D i s t r i c t C o u r t , the

Honorable Nat A l l e n presiding, a f f i r m i n g an o r d e r of the
P u b l i c S e r v i c e Commission (PSC) w h i c h s e t a l l o w a b l e e l e c t r i c

and n a t u r a l g a s r a t e s .
I n March 1978 MDU f i l e d a n a p p l i c a t i o n w i t h t h e PSC

requesting, among o t h e r items, a n i n c r e a s e o f i t s e l e c t r i c
u t i l i t y rates. I n i t s r e q u e s t MDU a s k e d t h e PSC t o a c c e p t ,
a s p a r t o f t h e r a t e b a s e , money e x p e n d e d by t h e company i n
o b t a i n i n g c o a l from K n i f e R i v e r C o a l Company ( K n i f e R i v e r ) .
Knife River is MDU ' s wholly-owned s u b s i d i a r y and supplies
100 percent of the coal needed for MDU's coal-fired

generators under long-term contracts. Approximately 34

p e r c e n t o f K n i f e R i v e r ' s t o t a l s a l e s a r e made t o MDU w i t h

the remaining 66 percent of sales being made to other
u t i l i t i e s and m a n u f a c t u r i n g c o n c e r n s .
D u r i n g a h e a r i n g on t h e r a t e increase request, the

PSC h e a r d t e s t i m o n y on two d i f f e r e n t m e t h o d s f o r m o n i t o r i n g

t h e r e a s o n a b l e n e s s o f t h e p r i c e MDU p a y s f o r i t s c o a l . MDU

s u g g e s t e d t h e u s e o f a " m a r k e t p r i c e " method: a n e x a m i n a t i o n
of t h e p r i c e charged i n t h e m a r k e t p l a c e f o r s i m i l a r s a l e s i n
c o m p a r i s o n t o t h o s e p r i c e s b e i n g c h a r g e d by t h e s u b s i d i a r y

t o t h e p a r e n t ; i f a f a v o r a b l e c o m p a r i s o n is f o u n d , t h e p r i c e

i s deemed reasonable and no adjustment is n e c e s s a r y . A

" r a t e o f r e t u r n " method was o f f e r e d by t h e Montana Consumer
C o u n s e l which c a l l e d f o r a n e x a m i n a t i o n o f t h e r e t u r n b e i n g
e a r n e d by the s u b s i d i a r y on its sales to the parent; an
e x c e s s i v e r a t e of r e t u r n r e q u i r e s an a d j u s t m e n t .

I n a s s e r t i n g t h e a p p l i c a t i o n o f i t s m e t h o d , t h e Con-
sumer Counsel's expert witness, Dr. John W. Wilson, testi-
fied that: the return on the total net investment for Knife
River for 1977 was approximately 33 percent. (This rate of
return was based on Knife River's capitalization of
$15,899,519. ) Dr. ~ i l s o nwas of the opinion that the per-
centage was in excess of a reasonable rate of return and
recommended that MDU's coal expense be reduced by 2.6
million dollars. This adjustment would represent the
reduction of all Knife River profits to a level equal to the
profit (rate of return) MDU is allowed to earn on its equity
investment (12.124 percent). MDU resisted the Consumer
Counsel's recommendation, claiming that its coal purchases
from Knife River were reasonable and fair having been made
in a competitive environment.
In issuing its order the PSC deemed the claimed coal
expense excessive and chose to make use of the rate of
return method in monitoring its reasonableness. In applying
this method, the PSC used the following formula:
A. Knife River's capitalization is determined by the
Consumer Counsel's witness, Wilson, in the amount of
$15,899,519.
B. MDU's rate of return on equity is applied to the
capitalization to produce a revenue amount: 12.124 percent x
$15,899,519 = $1,927.658.
C. This amount is subtracted from the return
actually earned by Knife River: $4,475,885 - $1,927,658 =
$2,548,227.
D. MDU's direct and indirect purchases of coal from
Knife River are determined by Consumer Counsel's witnesses
to be 33.91 percent of Knife River's total sales.
 E. D i r e c t and i n d i r e c t s a l e s from K n i f e R i v e r t o MDU

a r e t h e n d e t e r m i n e d : $ 2 , 5 4 8 , 2 2 7 x 32.8272% = $ 8 3 6 , 5 1 2 .
F. Montana's p o r t i o n of t h e claimed e x c e s s i v e c o a l
c o s t s i s t h e n d e t e r m i n e d by m u l t i p l y i n g by t h e p r o p o r t i o n o f
Montana's kwh sales to total interconnected system kwh

sales: $836,512 x 33.91% - $ 2 8 3 , 6 6 1 . (Consumer C o u n s e l ' s
position that the reduction be based on all Knife River

p r o f i t s was - a d o p t e d . )
not
An a p p e a l o f t h e PSC o r d e r was t a k e n t o t h e D i s t r i c t
C o u r t by MDU. After review, t h e c o u r t h e l d t h a t t h e r e was
substantial evidence in the record to sustain the PSC's

d e c i s i o n t o use the r a t e of r e t u r n method a s w e l l a s t h e
a p p l i c a t i o n o f t h a t method.

MDU now a p p e a l s t o t h i s C o u r t c l a i m i n g : (1) t h a t t h e

PSC i s o p e r a t i n g u n d e r a m i s t a k e o f l a w i n c o n c l u d i n g t h a t
u n d e r t h e c i r c u m s t a n c e s i t c o u l d a p p l y a r a t e o f r e t u r n on

n e t f i x e d a s s e t s method a s a means o f determining whether
t h e p r i c e p a i d f o r K n i f e R i v e r c o a l was r e a s o n a b l e ; (2) that

the PSC has regulated Knife River which is beyond their
s t a t u t o r y power; and ( 3 ) t h a t the order is a n u n c o n s t i t u -
t i o n a l d e p r i v a t i o n of p r o p e r t y w i t h o u t d u e p r o c e s s of law.
The issue presented to this Court for review is
framed a s f o l l o w s :

Did t h e PSC a b u s e its a u t h o r i t y in its utilization

and t h e n its p a r t i c u l a r a p p l i c a t i o n of the r a t e of return

method in ascertaining the reasonableness of MDU's coal
e x p e n s e f r o m a wholly-owned subsidiary corporation?
Appellant, Montana-Dakota Utilities, generally
c o n t e n d s t h a t t h e c e n t r a l i s s u e is whether t h e p r i c e o f c o a l
s o l d t o MDU by K n i f e R i v e r i s e x c e s s i v e ; if i t is n o t , t h e
full cost should be allowed as a ratepayer expense. In

making t h i s d e t e r m i n a t i o n an e x a m i n a t i o n s h o u l d have been
made o f t h e g o i n g p r i c e f o r c o a l i n t h e a p p l i c a b l e c o m p e t i -
t i v e marketplace. Nere, t h e r e is s u b s t a n t i a l e v i d e n c e t h a t

a c o m p e t i t i v e m a r k e t p l a c e e x i s t s and t h a t t h e p r i c e p a i d was
equal t o or less t h a n t h e going p r i c e . A s a consequence,

t h e c o s t s c l a i m e d by MDU s h o u l d n o t h a v e b e e n deemed e x c e s -

sive, and t h e r a t e o f r e t u r n method should n o t have been

applied.
A p p e l l a n t f u r t h e r c o n t e n d s t h a t e v e n i f t h e r e is n o t
a c o m p e t i t i v e m a r k e t p l a c e by which t o e v a l u a t e t h e r e a s o n -

a b l e n e s s o f t h e p r i c e c h a r g e d MDU, it does n o t f o l l o w t h a t

t h e p r i c e was e x c e s s i v e . I f t h e p r o f i t s r e c e i v e d by K n i f e

R i v e r on t h e s a l e o f c o a l t o MDU a r e c o n s i d e r e d i n r e l a t i o n
to the fair market value of the assets of the company
($118,000,000), its r a t e of r e t u r n is merely 1.6 p e r c e n t .

C e r t a i n l y such a margin of p r o f i t a b i l i t y is n o t e x c e s s i v e
and, thus, is r e a s o n a b l e e v e n i n a b s e n c e o f a competitive

marketplace .
Appellant argues further that use of the rate of
r e t u r n method is u n f a i r and i n a p p r o p r i a t e i n t h i s i n s t a n c e .
Knife River is engaged in a nonregulated competitive
industry. The m e t h o d , a s a p p l i e d , i s t h u s t a n t a m o u n t t o t h e
c o n f i s c a t i o n of K n i f e R i v e r ' s a s s e t s . I t has t h e e f f e c t of

u t i l i z i n g a d e p l e t a b l e a s s e t of K n i f e R i v e r t o a r t i f i c i a l l y

d e p r e s s e l e c t r i c u t i l i t y r a t e s b e l o w t h e p r o p e r and r e a s o n -
able l e v e l mandated by our current inflationary economy.
The o n l y p r o p e r means o f d e t e r m i n i n g t h e r e a s o n a b l e n e s s o f
the p r i c e paid by MDU in this instance is in applying a
" f a i r m a r k e t " method.
 Respondent c l a i m s t h a t b o t h methods p r e s e n t e d t o t h e

PSC h a v e b e e n r e c o g n i z e d a s a c c e p t a b l e m o n i t o r i n g d e v i c e s t o
t e s t t h e r e a s o n a b l e n e s s of c o a l s a l e s . A fundamental pre-

r e q u i s i t e o f t h e c o m p e t i t i v e p r i c e m e t h o d , however, is t h a t
a n i n d e p e n d e n t c o m p e t i t i v e m a r k e t be p r e s e n t i n which com-
p a r a b l e p r i c e s c a n be drawn. H e r e , t h e r e is no c o m p e t i t i v e

e n v i r o n m e n t a s i n d i c a t e d by t h e f o l l o w i n g f a c t o r s : ( 1 ) 100

p e r c e n t o f M D U ' s c o a l r e q u i r e m e n t is s u p p l i e d by K n i f e R i v e r

under long-term c o n t r a c t ; ( 2 ) b o i l e r d e s i g n s r e q u i r e c o a l of

a c e r t a i n g r a d e o r t y p e , and MDU f a i l e d t o show w h e t h e r a n y
other "competitor" could supply the needed quality; (3)

MDU's generating p l a n t s a r e located i n proximity t o Knife
River's mines giving it an insurmountable competitive

a d v a n t a g e when t r a n s p o r t a t i o n costs are figured into coal

costs.
Respondent further argues that application of the

r a t e of r e t u r n method d o e s n o t c o n s t i t u t e a n i m p e r m i s s i b l e
r e g u l a t i o n of Kn i fe R i v e r . The o n l y e f f e c t o f t h e PSC o r d e r
is t o limit the coal e x p e n s e s MDU c a n p a s s a l o n g t o its

Montana c u s t o m e r s i n i t s r a t e b a s e . I t d o e s n o t i n a n y way

limit the p r i c e MDU p a y s Knife River, nor does it limit

Knife River's profits from sales to MDU or any other
customer.
Respondent t h e n concludes t h a t use of Knife R i v e r ' s

c a p i t a l i z a t i o n a s a b a s e a g a i n s t which p r o f i t s a r e m e a s u r e d
was n o t i m p r o p e r . The i n t e r e s t o f t h e PSC is t o s e e t h a t
MDU d o e s n o t r e a p a n u n f a i r p r o f i t on i t s i n v e s t m e n t i n its
subsidiary by allowing the subsidiary to overcharge the
p a r e n t f o r c o a l when t h e c o a l e x p e n s e w i l l b e p a s s e d on t o

the ratepayers. The c a p i t a l i z a t i o n f i g u r e represents MDU's
investment i n Knife River. I n a s c e r t a i n i n g t h e r a t e on t h a t
i n v e s t m e n t , t h e c a p i t a l i z a t i o n f i g u r e m u s t be u s e d .

A f u n c t i o n of the PSC, in fulfilling its duty to
s u p e r v i s e and r e g u l a t e t h e o p e r a t i o n s o f MDU a s a n e l e c t r i c

utility, is t o see t h a t MDU's rates are just and n o n d i s -
criminatory. S e c t i o n 69-3-330, MCA. I n complying w i t h t h i s

obligation, it follows that the PSC must scrutinize and
r e v i e w t h e o p e r a t i n g e x p e n s e s o f MDU t o p r e v e n t u n r e a s o n a b l e

o p e r a t i n g c o s t s from b e i n g p a s s e d on t o t h e c u s t o m e r . When

one o f t h e e x p e n s e s s u b m i t t e d by MDU i s c a u s e d by t r a n s -
a c t i o n s w i t h a s u b s i d i a r y company, t h e s c r u t i n y a p p l i e d by
the PSC must be all the more intense. See Priest,

P r i n c i p l e - - - - u b l i c U t i l i Q -R e g u l a t i o n , V o l .
s- o f- P
- - 1, p . 80;
G e n e r a l T e l e p h o n e Co. o f U p s t a t e New York v . Lundy ( 1 9 6 6 ) ,
1 7 N.Y.2d 3 7 3 , 218 N.E.2d 274.

MDU, i n an a t t e m p t t o e s t a b l i s h t h e r e a s o n a b l e n e s s o f
t h e c o a l e x p e n s e r e s u l t i n g from t h e p u r c h a s e o f c o a l from
its subsidiary, s u b m i t s t h a t t h e p r i c e s h o u l d be m o n i t o r e d

i n the context of a natural r e s o u r c e company o p e r a t i n g i n
t h e f r e e m a r k e t p l a c e , and n o t i n t h e c o n t e x t o f a r e g u l a t e d
public utility. In this regard, MDU submitted evidence

which showed: (1) t h a t t h e p r i c e c h a r g e d MDU b y K n i f e R i v e r

is lower than the price available from any alternative
source; ( 2 ) t h a t Knife River c h a r g e s MDU t h e same p r i c e i t

charges its other customers; and (3) that Knife River's
p r o f i t s a r e r e a s o n a b l e when m e a s u r e d a g a i n s t t h e f a i r m a r k e t
v a l u e of its a s s e t s ( f a i r m a r k e t v a l u e o f $118,000 w i t h a
r a t e of r e t u r n a t 1.6 p e r c e n t ) .
U s e of t h e f a i r marketplace a s a monitoring d e v i c e a s

s u b m i t t e d by MDU i s o b v i o u s l y d e p e n d e n t upon a c o m p e t i t i v e
environment. W i t h o u t s u c h a n e n v i r o n m e n t , no a d e q u a t e f r a m e

of r e f e r e n c e e x i s t s i n which t h e f a i r n e s s o f K n i f e R i v e r ' s
p r i c e c a n be d e t e r m i n e d . In t h i s instance, t h e PSC h e a r d

testimony t h a t Knife River prices t o MDU a r e t h e same a s
t h o s e charged t o o t h e r customers, n o t n e c e s s a r i l y because of
t h e i n h e r e n t f a i r n e s s of t h e p r i c e , b u t because K n i f e R i v e r
is merely complying with the Robinson Patman Act which
requires sales of coal of like kind and quantity to be

o f f e r e d a t t h e same p r i c e t o a l l c u s t o m e r s .

E v i d e n c e was also presented that the p r o x i m i t y of
MDU's generating p l a n t s t o Knife River g i v e s Knife River a

competitive advantage that is insurmountable by current

competitors when one considers that transportation costs
o f t e n exceed c o a l c o s t s . This, taken with the f a c t t h a t
K n i f e R i v e r s u p p l i e s 100 p e r c e n t o f M D U 1 s c o a l r e q u i r e m e n t s

under long-term contracts, leads to the PSC1s c o n c l u s i o n
t h a t a n t i - c o m p e t i t i v e f a c t o r s w e r e p r e s e n t and t h a t e v i d e n c e

o f a c o m p e t i t i v e environment needed t o a p p l y a m a r k e t p r i c e
method was i n c o n c l u s i v e . A s a consequence, t h e PSC r e f u s e d
t o examine m a rk e t p r i c e o r m a r k e t v a l u e a s t h e s o l e f a c t o r s

t o be c o n s i d e r e d i n d e t e r m i n i n g t h e r e a s o n a b l e n e s s o f M D U ' s

c o a l expense.
The m a r k e t p r i c e method n o t b e i n g a v a i l a b l e f o r u s e
i n t h i s i n s t a n c e , t h e PSC c h o s e t o u t i l i z e a r a t e o f r e t u r n
method. T h i s method of monitoring the reasonableness of
c o a l p r i c e s p a i d by a p a r e n t t o i t s s u b s i d i a r y i s n o t new t o
the field of utility law. See Competition i n t h e Coal
I n d u s t r y , R e p o r t o f t h e U n i t e d S t a t e s Department of J u s t i c e ,
Pursuant t o S e c t i o n 8 of t h e F e d e r a l Coal L e a s i n g A c t o f
1975; Application of Montana-Dakota Utility Co. for
Authority t o Establish Increased Rates for E l e c t r i c Service

(S.D. 1 9 7 9 ) , 278 N.W.2d 189; M i s s i s s i p p i R i v e r F u e l Corp. v.

F e d e r a l Power Commission ( D . C . C i r . 1 9 5 7 ) , 252 F.2d 6 1 9 .

I n a p p l y i n g t h i s method t h e PSC c h o s e t o u s e a c o s t
a p p r o a c h t o a n a l y z e K n i f e R i v e r ' s p r o f i t s and computed a 33
p e r c e n t r a t e of r e t u r n d u r i n g t h e 1977 t e s t y e a r ( r e l a t i o n
of p r o f i t s t o o r i g i n a l investment l e s s d e p r e c i a t i o n ) . The
PSC t h e n c o n c l u d e d t h a t t h i s r a t e o f r e t u r n was t o o h i g h and

r e s t r i c t e d MDU's c o a l expense s t a t i n g t h a t a reasonable r a t e
o f r e t u r n f o r K n i f e R i v e r ' s s a l e s t o MDU s h o u l d be e q u a l t o

the r a t e of return allowed MDU on its overall operation
(12.124 p e r c e n t ) . W n o t e , however, t h a t t h e PSC, i n making
e
t h i s c o n c l u s i o n , f a i l e d t o i n d i c a t e on what b a s i s i t deemed

a 33 p e r c e n t r a t e o f return unreasonable or why a 1 2 . 1 2 4

p e r c e n t r a t e is r e a s o n a b l e under t h e c i r c u m s t a n c e s .

The Consumer C o u n s e l ' s e x p e r t w i t n e s s t e s t i f i e d t h a t
o t h e r c o a l companies earned r e t u r n s t h a t were s i g n i f i c a n t l y
lower t h a n Kn i fe Ri v e r I s . The o n l y a c t u a l c o m p a r i s o n made,

however, i n d i c a t e d t h a t a n i n d e p e n d e n t c o a l company had a
31.89 percent r a t e of r e t u r n i n 1 9 7 7 , a s compared t o K n i f e
River's 33.43 percent. On a five-year average (1973 t o

1977), the rate of return for the independent was 17.8
p e r c e n t and f o r K n i f e R i v e r 20.69 p e r c e n t . The p e r c e n t a g e o f
Knife River is c e r t a i n l y h i g h e r , b u t t h i s Court q u e s t i o n s

whether such a small sampling is s u p p o r t i v e of a finding
t h a t 33.43 p e r c e n t is e x c e s s i v e o r t h a t 12.143 o f e q u i t y is
a reasonable r a t e of r e t u r n .
I n imposing a l i m i t of 12.143 p e r c e n t r a t e of r e t u r n
on K n i f e R i v e r ' s c o a l s a l e s t o MDU, t h e PSC a p p a r e n t l y was
acting on the rationale that a ratepayer should not be
forced t o contribute t o the p r o f i t of t h e u t i l i t y company

twice. Here, t h e ratepayer pays a f a i r ra.te of return to

t h e u t i l i t y on i t s c o s t o f capital (12.124 p e r c e n t ) . The
consumer i s t h e n a s k e d b y MDU t o p a y f o r i t s c o a l e x p e n s e
w h i c h c o n t a i n s a 33 p e r c e n t p r o f i t l e v e l t o b e e a r n e d by MDU

a s t h e p a r e n t company ( i n v e s t o r ) o f Knife River. The e n d
result i s t h a t MDU is allowed a profit from its u t i l i t y
operations, a s a l l o w e d by the r e g u l a t o r y body, then also

e a r n s a n " e x c e s s " p r o f i t on i t s i n v e s t m e n t f r o m t h e s u b s i d -
i a r y , a l l a t t h e expense of t h e r a t e p a y e r .
MDU's e a r n i n g s on i t s i n v e s t m e n t i n Knife River is

n o t p e r se i m p r o p e r . I t is only t h e earning of e x c e s s i v e ,

and thereby unreasonable, profits at the expense of the
r a t e p a y e r which t h e PSC seeks t o p r e v e n t . With t h i s p r i n -

c i p l e i n mind, t h e PSC was w i l l i n g t o a l l o w MDU t o e a r n a
r e t u r n on b o t h i t s u t i l i t y o p e r a t i o n s and i t s s u b s i d i a r y ' s
operation, so long a s the ratepayer's contribution to the

earnings of the subsidiary were limited to a reasonable
l e v e l of 12.124 p e r c e n t .

Upon reviewing the matter, this Court agrees in

p r i n c i p a l with t h i s approach, b u t w e q u e s t i o n whether the
imposed limit of 12.124 percent is "reasonable," a s sup-

p o r t e d b y t h e e v i d e n c e , and n o t m e r e l y a r b i t r a r i l y s e t .
The i n t e r e s t o f t h e PSC i s t o see t h a t MDU d o e s n o t

r e a p a n u n f a i r p r o f i t on i t s i n v e s t m e n t i n i t s s u b s i d i a r y b y
allowing the subsidiary t o overcharge t h e parent for coal
when the coal is p a i d for i n t o t a l by ratepayers. As a
c o n s e q u e n c e , t h e r a t e o f r e t u r n on s a l e s by K n i f e R i v e r , a s
a wholly-owned coal company, to its parent is s u b j e c t t o
close scrutiny. I t does not automatically follow, however,
t h a t t h e c o a l company s h o u l d be h e l d t o t h e same r a t e a s i t s
parent public u t i l i t y . Nor d o e s i t f o l l o w t h a t t h e p a r e n t
i s o n l y a l l o w e d t o r e c e i v e t h e same r a t e o f r e t u r n on t h e
investment in its coal subsidiary as it receives on its

utility property, with respect to s a l e s between the sub-

s i d i a r y and t h e p a r e n t . I f any l i m i t a t i o n on c o a l p r o f i t s
o r r a t e p a y e r c o a l e x p e n s e i s i n o r d e r , i t s h o u l d be b a s e d on
a reasonable r a t e of r e t u r n a s e s t a b l i s h e d by a c o m p a r a b l e

marketplace, n o t upon a p r e d e t e r m i n e d rate as established
for a regulated u t i l i t y .
P e r h a p s t h e PSC, i n s e t t i n g t h e r a t e o f r e t u r n l e v e l ,

was relying upon the theory prevalent in the "California
approach" t o t h e i s s u e a t hand. Under t h i s approach, the
s u b s i d i a r y is t r e a t e d n o t a s an i n d e p e n d e n t e n t i t y b u t a s

p a r t of t h e u t i l i t y f o r rate-making purposes. The t h e o r y
underlying t h i s p o s i t i o n was d i s c u s s e d i n W a s h i n g t o n Water

Power v . I d a h o P u b l i c U t i l . ( 1 9 8 0 ) , 1 0 1 I d a h o 5 6 7 , 617 P.2d

". . . where a u t i l i t y e n j o y s a n i n t e g r a t e d
p o s i t i o n and m a r k e t d o m i n a n c e , i t ' s h o u l d n o t
be p e r m i t t e d t o b r e a k up t h e u t i l i t y e n t e r -
p r i s e by t h e u s e o f a f f i l i a t e d c o r p o r a t i o n s
and t h e r e b y o b t a i n a n i n c r e a s e d r a t e o f r e -
turn for its a c t i v i t e s . ' [Citation omitted.]
Thus u n d e r t h i s a p p r o a c h t h e q u e s t i o n o f
w h e t h e r t h e p r i c e s a r e r e a s o n a b l e i s immate-
r i a l ; a l l integrated p a r t s of the u t i l i t y a r e
a l l o w e d t h e same r a t e o f r e t u r n . . ."
W note,
e however, t h a t t h e m a j o r i t y of those cases
using t h i s approach i n v o l v e t h e B e l l T e l e p h o n e S y s t e m and
its manufacturing subsidiaries. These subsidiaries sell
virtually all their manufactured products to the parent,
B e l l Telephone--a f a c t which is m a t e r i a l l y d i f f e r e n t from
t h e p r e s e n t s i t u a t i o n where t h e b u l k o f K n i f e R i v e r c o a l ( a
d e p l e t a b l e n a t u r a l r e s o u r c e ) is s o l d t o c u s t o m e r s o t h e r t h a n
its parent. See C i t y of Los A n g e l e s v . Public Utilities

Comm. (1972), 102 Ca1.Rptr. 313, 497 P.2d 785; Re New

England Telephone & T e l e g r a p h Co. (Me. 1 9 7 6 ) , 1 3 P.U.R.4th

65; Illinois Bell Telephone Co. v. Illinois Commerce
Commission (1973), 55 1 1 1 . 2 d 461, 303 N.E.2d 364; Note,

T r e a t m e n t o f A f f i l i a t e d T r a n s a c t i o n s i n U t i l i t y R a t e Makinq:

W e s t e r n E l e c t r i c Company a n d t h e B e l l S y s t e m , 56 B o s t o n U.

Law Rev. 558, 568-571 (1976). Such a n a p p r o a c h s h o u l d n o t
b e deemed a p p l i c a b l e i n t h i s i n s t a n c e .

I n d e t e r m i n i n g r e a s o n a b l e n e s s , t h e PSC s h o u l d n o t b e
restricted t o any s i n g l e formula "so long as t h e method

f o l l o w e d and t h e o r d e r e n t e r e d when a p p l i e d t o t h e f a c t s and
viewed a s a whole do n o t p r o d u c e an u n j u s t or arbitrary
result. " N o r t h w e s t e r n P u b l i c S e r v i c e Commission v . Cities

of Chamberlain, et al. (S.D. 1 9 7 8 ) , 265 N.W.2d 867, 872.
H e r e , t h e PSC c h o s e t o a p p l y a r a t e o f r e t u r n method i n a n
e f f o r t t o d e t e r m i n e t h e r e a s o n a b l e n e s s o f t h e p r i c e p a i d by

MDU f o r Knife River c o a l . Our i n q u i r y is t o d e t e r m i n e i f

t h i s method p r o d u c e s a n u n j u s t o r a r b i t r a r y r e s u l t .
I n c o n s i d e r i n g t h e method t h i s C o u r t c a n n o t s u b s t i -
tute i t s judgment for t h a t of t h e PSC, b u t t h e C o u r t may

d e t e r m i n e w h e t h e r t h e PSC a c t e d a r b i t r a r i l y and u n r e a s o n a b l y
without s u f f i c i e n t evidence t o support its findings. Moun-

t a i n S t a t e s Telephone & T e l e g r a p h Co. v. Dept. of Public
Service Regulation (1981), - Mont. , 624 P . 2 d 4 8 1 , 38
St.Rep. 165, 170. After analyzing Knife River's p r o f i t s i n
comparison t o c a p i t a l investment, t h e PSC s u m m a r i l y l a b e l e d
Knife River's r a t e of r e t u r n on s a l e s t o MDU a s u n r e a s o n -
a b l e , when i n f a c t no s u b s t a n t i a l e v i d e n c e was p r e s e n t e d t o
support such a conclusion. The PSC m u s t h a v e sufficient
evidence before it to determine if a particular rate of

r e t u r n is f a i r and j u s t f o r K n i f e R i v e r a s compared t o o t h e r
coal companies. Unless there is s u b s t a n t i a l evidence to
show t h a t t h e r a t e o f r e t u r n o f MDU i s a l s o a p p l i c a b l e t o
t h e c o a l company, t h e r e i s no b a s i s f o r a n a p p l i c a t i o n o f
t h e MDU r a t e o f r e t u r r n t o K n i f e R i v e r a s was d o n e by t h e
PSC.

It is apparent that the natural resource company,
Knife River, doing a m a j o r i t y of its business with p a r t i e s
o t h e r t h a n MDU, may b e e n t i t l e d t o a s i g n i f i c a n t l y d i f f e r e n t
r a t e o f r e t u r n t h a n would be t r u e i f i t w e r e a u t i l i t y o r i f

i t were s e l l i n g a l l o f i t s c o a l p r o d u c t i o n t o MDU. I t may

be that the PSC does not have the expertise to readily
determine the rate of return on a natural resource coal
company a s compared t o a u t i l i t y . The e v i d e n c e shows t h a t a
l a r g e p a r t of Knife R i v e r ' s c o a l r e s e r v e s were a c q u i r e d a
number o f y e a r s a g o a t a low c o s t . A s an e x a m p l e , leases

acquired at a cost t o Knife River of less t h a n $400,000
cover 585,000,000 t o n s o f c o a l which h a s a m a r k e t v a l u e o f
$93,000,000. I n a s i m i l a r manner, t h e e v i d e n c e shows t h a t
t h e B e u l a h mine owned by K n i f e R i v e r w i l l be f u l l y d e p r e -
c i a t e d i n 1981, s o t h a t i f u n d e p r e c i a t e d c o s t t o Knife River

is used for a r a t e of return, no p r o f i t a t a l l would b e
a l l o w e d on t h e B e u l a h m i n e . I f t h e PSC u l t i m a t e l y c o n c l u d e s

t h a t it s t i l l d e s i r e s t o u s e t h e r a t e of r e t u r n method, it
must t a k e i n t o c o n s i d e r a t i o n s u c h f a c t s a s t h e s e s o t h a t i t s
a c t i o n w i l l n o t be a r b i t r a r y .
I n view of the necessity for a rehearing, the PSC
should again consider if t h e r e is a n i n d e p e n d e n t , competi-

t i v e m a r k e t which e s t a b l i s h e s a g o i n g m a r k e t p r i c e f o r c o a l ,
from w h i c h t h e PSC c a n d e t e r m i n e i f t h e p r i c e MDU p a y s K n i f e

R i v e r f o r c o a l is r e a s o n a b l e . W h i l e i t i s t r u e t h a t t h e PSC

f o u n d t h a t a b s o l u t e c o m p a r a b i l i t y b e t w e e n c o a l p r i c e s impos-

s i b l e t o d e t e r m i n e , it a p p e a r s t o t h i s C o u r t t h a t t h e p r i c e s
p a i d by a number o f o t h e r c o m p a n i e s t o K n i f e R i v e r f o r two-
t h i r d s of its c o a l p r o d u c t i o n is e v i d e n c e o f a c o m p e t i t i v e

m a r k e t f o r c o m p a r i s o n t o t h e K n i f e R i v e r p r i c e p a i d by MDU.
In addition, t h e r e was e v i d e n c e o f p r i c e s c h a r g e d by o t h e r

companies i n t h e c o m p e t i t i v e a r e a . If t h e PSC f i n d s t h a t
t h e p r e s e n t evidence is i n s u f f i c i e n t , it appears a p p r o p r i a t e
that the PSC require the parties to submit additional
e v i d e n c e from which t h e PSC c a n d e t e r m i n e i f MDU i s p a y i n g
K n i f e R i v e r a p r i c e which i s no h i g h e r t h a n t h e c o m p e t i t i v e

marketplace requires.

A s a matter of j u s t i c e , it appears t o t h i s Court t h a t
i t m i g h t b e b e t t e r f o r t h e PSC t o u s e a m a r k e t p l a c e c o s t o f

c o a l approach, if it can o b t a i n s u f f i c i e n t facts for its
determination, r a t h e r t h a n u s i n g t h e r a t e o f r e t u r n method
w i t h a l l o f i t s d i f f i c u l t t h e o r i e s and c o m p u t a t i o n s . While

t h e PSC d o e s have t h e r i g h t t o c h o s e t h e method f o l l o w e d ,

t h i s Court did not find a f a c t u a l reason for the summary
r e j e c t i o n of t h e marketplace c o s t of c o a l approach.
We, therefore, vacate the judgment of the District
C o u r t and remand t h e c a s e t o t h e PSC w i t h i n s t r u c t i o n s t o
h o l d an a d d i t i o n a l h e a r i n g t o d e t e r m i n e t h e f o l l o w i n g : (1)

i f r a t e of r e t u r n is used, a f a c t u a l b a s i s for t h e r a t e of
r e t u r n a l l o w e d K n i f e R i v e r c o n s i d e r i n g i t s a s s e t s and r a t e
of r e t u r n on a m a r k e t p l a c e b a s i s c o m p a r a b l e t o o t h e r c o a l
companies; o r ( 2 ) i n t h e e v e n t market c o s t of c o a l is used,
sufficient facts to support the PSC d e t e r m i n a t i o n o f the
f a i r market p r i c e f o r c o a l .

Justice 4

W e concur:

Chief J u s t i c e

~ o n o r ' a b l eLeonard H. ~ange;,
D i s t r i c t Judge, s i t t i n g i n p l a c e
of M r . J u s t i c e D a n i e l J. Shea
Mr. Justice John C. Sheehy, dissenting:

I have tried in vain to reason with my colleagues not
to take what I view as a backward step in the developing law
of utility regulation in Montana.
The result is a majority opinion that is unwarranted,
useless and contradictory. Unwarranted, because it is an
intrusion on the right of the Public Service Commission to
determine the methodology it uses for a reasonable rate of
return on equity. Useless, because it sets the PSC to an
impossible task, determining a market where no market exists.
Contradictory, because it conflicts with itself, and because
it contradicts Mountain States Telephone and Telegraph
Company v. The Department of Public Service Regulation, et
al., Decided February 5, 1981, 38 St.Rep. 165.
Let us take the contradictions first. By statute the
PSC "is not bound to accept or use any particular value in
determining rates; provided, that if any value is used, such
value may not exceed the original cost of the property . . ."
Section 69-3-109, MCA. Moreover, the Commission is invested
"with full power of supervision, regulation, and control" of
public utilities. Section 69-3-102, MCA. The PSC decided
under its broad power to follow the "California" approach
and treat MDU's subsidiary as a part of the utility for
ratemaking purposes. The majority opinion pays pious lip
service to the right of PSC to determine its own methodology
in valuing the coal purchased from Knife River, but then
contradicts itself. It is contradictory to require the PSC
to determine: "1. If rate of return is used, a factual
basis for the rate of return allowed Knife River considering
its assets and rate of return on a market place basis comparable
to other coal companies; or, 2. In the event market cost of coal
is used sufficient facts to support the PSC determination of
the fair market price for coal." Those requirements are
completely out of sync with the unitary method:
". . . Thus under this [California] approach the
question of whether - prices are reasonable is
the
immaterial; all integrated parts of the utility
-
are allowed the same rate of return . . ."
Washington Water Power v. Idaho Public Util. (1980),
101 Idaho 567, 617 P.2d 1242, 1248. (Emphasis
added. )
The majority opinion also contradicts a position we
took with respect to American Telephone and Telegraph Company
and Mountain Bell. In Mountain States Telephone and Telegraph
Company v. Department of Public Service Regulation, Decided
February 5, 1981, 38 St.Rep. 165, we refused to allow Mountain
Bell to employ a "double leverage" in its rate base, arising
out of funds in Mountain Bell's capital structure borrowed
from its parent AT & T.
This case is the inverse of the Mountain Bell situation.
In Mountain Bell, supra, the utility was claiming that it
should receive a rate of return 11.25 percent on its borrowed
funds when AT & T was charging Mountain Bell 9.86 percent for
the loans. We objected, saying "Mountain Bell's common
stockholders are 'leveraged' because Mountain Bell is paying
less interest on its borrowed funds than the return it makes
on the use of its borrowed funds." 38 St-Rep. at 167.
Here, the investment in Knife River from the retained earnings
of the MDU shareholders (or borrowed funds, whichever) is
"leveraged" because the shareholders will make more money
from their Knife River investment than the reasonable rate
of return on equity found by PSC. That will be the net
effect of the majority decision in this case.
The majority opinion is further contradictory in that
it distinguishes AT & T and its subsidiary companies, saying
the application of the unitary method as to AT & T is proper
merely because AT & T is large enough to purchase nearly all
of the manufactured products of its subsidiaries. What
economic or regulatory reason logically exists to treat AT & T
differently from energy utilities? The fact that a wholly-
owned subsidiary may sell to others than its parent is not a
sufficient reason to require the rate-payers of the parent
to pay excessive costs. The implications of the majority
opinion here will surely haunt us when future rate cases
involve utilities which purchase fuel or power from the
giant consortiums or joint enterprises of which the utilities
are now becoming a part.
I also said that the majority opinion is unwarranted. I
make that contention because the field of public utility
regulation belongs exclusively to the PSC under our statutes
and the methodology employed by it to determine a reasonable
rate of return is exclusively its province. his would be a
proper case for us to state as a rule that the PSC is not
restricted to any single formula in determining the rate of
return as long as the method followed does not result in an
unjust and arbitrary result. Application of Mont.-Dak. Util.
Co., Etc. for Authority to Establish Increased Rates for
Electric Service (S.D. 1979), 278 N.W.2d 189, 191. For a
business with a guaranteed market, a guaranteed
monopoly, and a guaranteed profit, a 12.124 percent rate of
return on equity is not to be snubbed as arbitrary or un-
reasonable, even in these days.
I have also said that the majority opinion is useless,
because it requires the PSC to make determinations that it
has already made, and that are materially inconsistent with
the unitary rate of return. The PSC carefully noted that it
was not in any event attempting to regulate Knife River or to
regulate its profitability or to regulate its rate of return.
MDU very carefully did not appeal from those findings of the
commission.
The commission found that Knife River's profitability
of 33.43 percent on net fixed assets, when compared to PSC's
allowance of 12.124 percent rate of return on equity, was an
"extreme" difference. It found that the only method of
protecting the ---payers from the excessive prices paid
for coal was to limit the amount (but only for the rate base)
that MDU would pay to Knife River for coal. After making
its computations, which amounted only to the elimination of
$283,661 of MDU's income,PSC made the following findings:
"MDU has suggested that the transfer price of
coal between MDU and Knife River be examined,
and if it appears to be competitive, no adjustments
be made. The Commission sees several disadvantages
with this approach. First, the rate payer would be
required to pay the going rate for coal regardless
of the rate of return being earned by MDU share-
holders as discussed above. Second, and most
importantly, absolute comparability between coal
prices is virtually impossible to determine due
to a multitude of variables in mining operations,
chemical composition of coal, transportation and
other factors (for example, the composition of
some coal may dictate the need for a more expensive
boiler than other coals; which would be a cost
for the utility but may not be reflected in the
price per ton for coal)(A. S. Kane Rebuttal, page 28,
line 14-31). Finally the bargaining between
MDU and Knife River is not at arms length. Anytime
an [sic] unitary entity bargains with itself, the
results tend to be different than the results between
bargaining between unrelated entities. (J. W. Wilson,
Rebuttal, page 20, lines 5-25).
"MDU suggested that if the Commission intends to
regulate Knife River's rate of return that the
fair market value of its reserves be used in
determining that rate of return. Firstly, the
Commission is not regulating Knife River's
rate of return. Rate of return has merely
been used as a method of determining excessive
coal prices. Secondly, and as has been stated
above, the Commission does not feel that MDU's
rate payers should be subjected to coal prices
that would not exist if MDU and Knife River were
a single corporation. Therefore, in computing the
amount MDU will pay Knife River for coal, the
 Commission has used the amount of Knife River's
capitalization which closely matched the original
cost depreciated valuation of its assets; the
same method used in valuing utility property subject
to regulation. This method of reporting is con-
sistent with the financial reporting of all corporations,
including natural resource companies." PSC Order No.
4467, Par. 411, at 25-27.
The majority opinion is further useless, because if it
is followed, we will have to set aside the results in the
next appeal. For example, the majority opinion requires PSC
to determine "if a particular rate of return is fair and
just for Knife River as compared to other coal companies."
The PSC is told to consider coal leases acquired at a cost
to Knife River of less than $400,000 which contain coal
reserves of 585 million tons with a market value of $93
million. It is told to disregard the original cost of the
Beulah Mine, now depreciated. These are things that the PSC
cannot do. It has no business or authority to determine a
fair rate of return for Knife River Coal Co. The commission
in its opinion carefully avoided in any manner regulating
Knife River Coal Co. The $93 million figure for coal reserves
is the fair market value of those reserves. By statute,
the commission cannot consider such a figure, for it may not
use any value in excess of the original cost of the property.
Section 69-3-109, MCA. It would be nice for MDU if it could
recover a profit on unmined coal reserves that are still in
the ground, but that has no place in the rate-making process.
The District Court properly took note of the fact that the
United States Supreme Court rejected the contention that
the assets of a natural resource company should be valued at
market value because it is gradually depleting its assets in
the course of its business operations. In Federal Power
Com'n. v. Hope Natural Gas Co. (1944), 320 U.S. 591, 606,
64 S.Ct. 281, 290, 88 L.Ed.2d 333, 347, the Supreme Court

said:
 "By such a procedure the utilities are made whole
and the integrity of its investment maintained.
No more is required."
Finally, the opinion is useless because it ought to be
apparent to al1,that a 33 percent return of profit in a
single year is a good indication that no competition in the
coal market exists.
The majority opinion, therefore, is amphi-gory. It is
a rigamarole of apparent meaning, but is basically meaningless.
In this proceeding, the commission granted an increase
in operating revenues for the gas utility of MDU in the sum
of $5,392,283 and a decrease in its electrical utility of
$88,447. The deduction which the PSC made for excessive
coal charges was $286,000 which represents approximately 5.3
percent of the increase. It is not the money but the principle
over which the parties here are waging war. The utility has
secured the rejection by this Court of the unitary or California
approach to subsidiaries as arbitrary and unreasonable. This
will prove to be a sorry day for rate-payers.
I would uphold the findings of the PSC and affirm the
decision of the District Court.