MONTANA-DAKOTA UTILITIES v BOLLING

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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: Decided: Filed: 5- June 8, 1981 AU6 5- 1 t M 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 . 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 Montana-Dakota 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 , 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 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 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 , u t i l i t y rates. 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 100 is MDU ' s wholly-owned River percent generators of under the coal s u b s i d i a r y and needed long-term for contracts. MDU's . supplies coal-fired 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, testified that: the return on the total net investment for Knife River for 1977 was approximately 33 percent. return was based $15,899,519. ) on Knife River's (This rate of capitalization of 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 million dollars. coal expense be reduced by 2.6 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. Consumer Knife River's capitalization is determined by the 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. 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 E. 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 . 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 F. 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 sales: kwh sales that total interconnected x 33.91% - $ 2 8 3 , 6 6 1 . $836,512 position to the reduction be system kwh (Consumer C o u n s e l ' s 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. substantial After review, evidence d e c i s i o n t o use in the the r a t e of t h e c o u r t h e l d t h a t t h e r e was record to sustain the PSC's 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 ; the PSC has regulated s t a t u t o r y power; and Knife River is beyond which ( 3 ) t h a t the order (2) that their 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 and t h e n method in its p a r t i c u l a r ascertaining its a u t h o r i t y a p p l i c a t i o n of the e x p e n s e f r o m a wholly-owned Appellant, in its utilization the r a t e of reasonableness of MDU's return coal subsidiary corporation? 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 making should be allowed as a ratepayer expense. In 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 less t h a n t h e going p r i c e . equal t o or 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, t h e p r i c e was e x c e s s i v e . it does n o t f o l l o w t h a t 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 ($118,000,000), value of the assets of the company 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, marketplace 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 . 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 industry. is engaged in a nonregulated competitive 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 " f a i r m a r k e t " method. in this instance is in applying a 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- is t h a t 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, 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 p a r a b l e p r i c e s c a n be drawn. i n which com- 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 ( 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 under long-term c o n t r a c t ; 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" MDU's generating p l a n t s a r e located i n proximity t o Knife River's mines could giving supply it an a d v a n t a g e when t r a n s p o r t a t i o n the needed quality; insurmountable (3) competitive costs are figured into coal costs. Respondent r a t e of further argues application of the 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 . is t o that limit the coal The o n l y e f f e c t o f t h e PSC o r d e r e x p e n s e s MDU c a n p a s s a l o n g t o Montana c u s t o m e r s i n i t s r a t e b a s e . limit the p r i c e MDU p a y s Knife River's profits I t d o e s n o t i n a n y way Knife River, from sales its to nor does MDU or it limit 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 subsidiary by allowing the subsidiary to i n its 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 . f u n c t i o n of A 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 is t o see t h a t MDU's utility, criminatory. S e c t i o n 69-3-330, obligation, it follows that rates are just I n complying w i t h t h i s MCA. the and n o n d i s - 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 . one o f the i s c a u s e d by t r a n s - t h e e x p e n s e s s u b m i t t e d by MDU a c t i o n s w i t h a s u b s i d i a r y company, PSC must be all the more t h e s c r u t i n y a p p l i e d by intense. See 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 - G e n e r a l T e l e p h o n e Co. 1 7 N.Y.2d o f U p s t a t e New York v . 3 7 3 , 218 N.E.2d When Priest, 1, p . 80; Lundy ( 1 9 6 6 ) , 274. 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 MDU, 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 its subsidiary, c o a l from 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. which showed: is lower In this regard, MDU submitted evidence (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 than the price available source; ( 2 ) t h a t Knife River charges its other from any alternative c h a r g e s MDU t h e same p r i c e i t 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. of 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 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, testimony t h a t Knife River prices t h e PSC h e a r d 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 requires complying sales of with coal the of Robinson kind like Patman and Act quantity which 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 generating p l a n t s t o Knife River g i v e s Knife River a MDU's competitive advantage competitors when one that insurmountable is considers o f t e n exceed c o a l c o s t s . that This, by current transportation costs 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 PSC1s c o n c l u s i o n the 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 1975; Application of t h e F e d e r a l Coal L e a s i n g A c t o f 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. C i r . 1 9 5 7 ) , 252 F.2d 6 1 9 . F e d e r a l Power Commission ( D . C . 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 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 p e r c e n t r a t e of 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 (12.124 p e r c e n t ) . allowed MDU on its overall operation 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 however, 31.89 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 percent r a t e of River's 1977), The o n l y a c t u a l c o m p a r i s o n made, I s . 33.43 the r e t u r n i n 1 9 7 7 , a s compared t o K n i f e percent. rate of a On return a five-year for the average independent (1973 t o 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 whether is c e r t a i n l y h i g h e r , such a small sampling b u t t h i s Court q u e s t i o n s 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 acting on the c o a l s a l e s t o MDU, rationale that a t h e PSC a p p a r e n t l y was ratepayer should not be forced t o contribute t o the p r o f i t of twice. Here, t h e ratepayer pays a f a i r ra.te of t h e u t i l i t y on i t s c o s t o f consumer t h e u t i l i t y company capital return to (12.124 p e r c e n t ) . The 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 result i s t h a t MDU operations, is allowed a s a l l o w e d by the Knife River. a profit from The e n d its u t i l i t y 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 . e a r n i n g s on i t s i n v e s t m e n t MDU's thereby unreasonable, profits at the expense r a t e p a y e r which t h e PSC seeks t o p r e v e n t . c i p l e i n mind, is I t is only t h e earning of e x c e s s i v e , n o t p e r se i m p r o p e r . and i n Knife River of the With t h i s p r i n - 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, earnings so long a s the of the ratepayer's subsidiary were contribution limited to a to the reasonable l e v e l of 12.124 p e r c e n t . Upon reviewing the matter, p r i n c i p a l with t h i s approach, imposed limit of 12.124 this Court agrees b u t w e q u e s t i o n whether percent is "reasonable," in the 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 when the coal is p a i d for i n t o t a l by for ratepayers. coal 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 close scrutiny. coal company, to its parent is s u b j e c t t o 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 investment utility in its coal property, with subsidiary respect s i d i a r y and t h e p a r e n t . as to r e t u r n on t h e receives it s a l e s between on the its sub- 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 marketplace, 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 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 approach" t o t h e i s s u e a t hand. Under in the "California 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 underlying purposes. t h i s p o s i t i o n was d i s c u s s e d Power v . I d a h o P u b l i c U t i l . The t h e o r y i n W a s h i n g t o n Water ( 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 immater 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 using its however, t h i s approach manufacturing virtually all those cases 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 subsidiaries. their B e l l Telephone--a t h a t t h e m a j o r i t y of manufactured f a c t which These subsidiaries products to sell the parent, 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. Comm. See C i t y of (1972), 102 England Telephone 65; Illinois Commission Ca1.Rptr. & Bell (1973), Los A n g e l e s v . 313, T e l e g r a p h Co. Telephone 55 1 1 1 . 2 d 497 Public Utilities P.2d 785; Re New (Me. 1 9 7 6 ) , 1 3 P.U.R.4th Co. v. 461, Illinois 303 N.E.2d Commerce 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 , Law Rev. 558, 568-571 (1976). 56 B o s t o n U. 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 result. " of do n o t p r o d u c e an u n j u s t or arbitrary 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 . Chamberlain, et al. (S.D. 1 9 7 8 ) , 265 N.W.2d Cities 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. t a i n S t a t e s Telephone & T e l e g r a p h Co. Service Regulation (1981), St.Rep. 165, 170. - Mont. , Dept. of Public 624 P . 2 d 4 8 1 , 38 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, Knife River's v. Moun- r a t e of t h e PSC s u m m a r i l y l a b e l e d 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 to it 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 show t h a t t h e r a t e o f is s u b s t a n t i a l evidence to 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 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 c o a l company, t h e MDU r a t e o f there 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 Knife River, that the natural resource company, its business with p a r t i e s doing a m a j o r i t y of 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. be not that determine the PSC the does rate of have return the on company a s compared t o a u t i l i t y . l a r g e p a r t of Knife R i v e r ' s a natural at a cost cover 585,000,000 $93,000,000. to readily resource coal The e v i d e n c e shows t h a t a 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 . acquired expertise I t may t o Knife A s an e x a m p l e , River of leases less t h a n $400,000 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 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, a l l o w e d on t h e B e u l a h m i n e . no p r o f i t a t a l l would b 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 should again consider if a rehearing, t h e r e is a n i n d e p e n d e n t , the PSC 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 imposs 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 twot 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, determination, if it can o b t a i n s u f f i c i e n t facts for its 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 : i f r a t e of r e t u r n is used, (1) 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 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 4 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 the loans. & T was charging Mountain Bell 9.86 percent for 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 differently from energy utilities? & T 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 unreasonable, 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 shareholders 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 consistent 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 million. 585 million tons with a market value of $93 It is told to disregard the original cost of the Beulah Mine, now depreciated. cannot do. These are things that the PSC 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.

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