                            NO.    89-028
          IN THE SUPREME COURT OF THE STATE OF MONTANA
                                  1990


MONTANA-DAKOTA UTILITIES CO.,
A Division of MDU Resources Group,
Inc., a Delaware corporation,
          Plaintiff and Appellant,


MONTANA DEPARTMENT OF PUBLIC SERVICE
REGULATION, MONTANA PUBLIC SERVICE
COMMISSION, AND MONTANA CONSUMER COUNSEL,
          Defendants and Respondents.



APPEAL FROM:   District Court of the Fifteenth Judicial District,
               In and for the County of Roosevelt,
               The Honorable M. James Sorte, Judge presiding.


COUNSEL OF RECORD:
          For Appellant:
               John Alke; Hughes, Kellner, Sullivan & Alke, Helena,
               Montana
               Lester H. Loble, 11; Montana-Dakota Utilities,
               Bismarck, North Dakota
          For Respondent:
               Mary Wright; Montana Consumer Counsel, Helena,
               Montana
               Denise Peterson; Public Service Commission, Helena,
               Montana


                                            Submitted:   April 10, 1990
                                              Decided:   J u l y 1 3 , 1990
Filed:
Justice R. C. McDonough delivered the Opinion of the Court.

     Montana Dakota Utilities Co. (MDU) appeals an order of the
Fifteenth Judicial District, Roosevelt County, which affirmed an
administrative rate order of the public Service Commission (PSC).
In that order, the PSC denied full recovery of costs incurred by
MDU, through a purchase of firm power from the Antelope Valley
Station I1 (AVS 11) power plant.     We affirm.
     The sole issue on appeal is:
     Was the District Court correct in affirming the PSC s decision
to reprice, for ratemaking purposes, the amount of the expense that
MDU could recover from its Montana ratepayers for power purchased
from AVS II?
     MDU is a regulated public utility providing natural gas and
electric service in Montana, South Dakota and Wyoming. To meet its
customersv demand     for   electric   service,   MDU   owns,    either
individually or in partnership with other utilities, a number of
generating stations located in or near its service territory.        It
is also a member of the Mid-Continent Area Power Pool (MAPP) from
which it can acquire power under certain limited circumstances.
MDUvsmembership in MAPP is contractual, and it is conditioned upon
MDU having its own generating capacity equal to customer demand
plus a reserve of fifteen percent.
     MDU   is   experiencing   a   steadily   increasing   demand   for
electricity.    To meet that demand, MDU has been acquiring modest
amounts of generating capacity as it becomes available.         In 1986,
pursuant to a contract made in 1981, it purchased forty-one
megawatts of firm power from AVS 11, a power plant which is owned
by Basin Electric.      Firm power is power which the seller is
obligated to provide for a fixed number of years. Correspondingly,
the buyer is obligated to make the purchase.   The contract between
MDU and Basin Electric provided the firm power purchases would be
made over a ten year period.    In addition to the AVS I1 purchase,
MDU acquired additional power through purchases of additional
generating resources.
       In order to recover costs associated with these acquisitions,
MDU filed an application with the PSC seeking authority to increase
its electric rates.     In the application, the company prepared a
cost of service which was based upon an historic test year, in this
case 1985.     The application also reflected the actual costs MDU
incurred in purchasing forty-one megawatts of firm power from AVS
11.
       Following MDU1s filing, the Montana Consumer Counsel (MCC)
intervened on behalf of Montana Ratepaying Consumers. At a public
hearing, the MCC presented testimony from its expert, Albert Clark.
Mr. Clark testified as to the effect of the AVS I1 purchase.     In
his testimony, he stated that MDU, through its purchase from AVS
11, effectively replaced cheap power which could be generated at
its existing plants with very expensive AVS I1 power.     He noted,
in this regard, that the average cost of energy produce at MDU1s       n

existing plants ranged between $13.52 to $24.74 per megawatt hour
(mwh)  .   The cost of AVS I1 power, meanwhile, equaled $48.84 per
mwh.
     Mr. Clark further testified, that most of the energy produced
by AVS I1 could have been generated internally at MDU's existing
plants.   Relying upon this testimony, the PSC found that although
AVS I1 was not purchased for the purpose of replacing existing
facilities, that is in fact what happened because 77% of the newly
acquired energy could have been generated at existing facilities.
     He said the net effect of this acquisition was to replace
88,750 mwh of existing energy production with more expensive AVS
I1 power.   The purchase also allowed MDU to increase off system
sales to other utilities by 45,172 mwh.   And finally, the AVS I1
acquisition replaced 64,638 mwh of Schedule E energy, which is
purchased from MAPP.
     Schedule E is cheap energy which is generally purchased in
order to replace more expensive energy produced by an individual
power company.    It is not a reliable source of power, however,
because the seller can cancel the sale with a one day notice.    In
order to be eligible to purchase Schedule E, an individual power
company must be capable of meeting its baseload requirements and
have a fifteen percent surplus to meet peak demand.
     Clark stated that the AVS I1 acquisition actually replaced
existing power sources with very expensive energy.    He therefore
maintained that it was unfair to saddle the consumer with the full
cost of AVS 11.   He, therefore, sought to "remix1' the company's
power supply figures in order to come up with a rate that was
fairer to the consumer.
     Mr. Clark accomplished this task by repricing the AVS I1 power
according to an alternative energy scenario. In his proposal, the
electric rates were figured as if:
     (1) Base load energy generation at MDU1s existing
     facilities were increased to pre-AVS I1 levels. This
     course of action, he maintained, prevented the
     replacement of inexpensive power with very expensive AVS
     I1 power;
     (2) The increased off-system sales were not imputed to
     the consumers;
     (3) MAPP Schedule H energy was purchased in order to
     replace some of the energy produced by AVS 11. Schedule
     H energy is relatively inexpensive energy which could be
     used by MDU well into the future, because there is a
     substantial surplus; and
    (4) Remaining energy needs were satisfied        through
    purchases of Schedule E energy from MAPP.

     Initially, the PSC rejected Clark's proposal and granted a
rate increase, but at a level lower than MDU requested.   The PSC
based its action partly upon Clark's suggested use of Schedule E
energy.   As stated above, Schedule E is not a dependable energy
source because it can be cancelled on one day's notice. Therefore,
in order to avail itself of the power, a utility company must have
energy to forgo.     The PSC, upon reviewing Clark's proposal,
determined that he was treating Schedule E as a long-term source
of energy.   Due to its limitations, Schedule E cannot be used as
a dependable source of power, and therefore it concluded that
Clark's proposal was not feasible.
     Following this decision, both the MCC and MDU submitted
motions for reconsideration.   In its motion, the MCC argued that
the PSC misinterpreted Clark's testimony. It maintained that MDU1s
own power supply figures indicated that MDU could utilize 139,288
mwh of Schedule E energy.   The MCC maintained that these figures
indicated that MDU had energy to forgo prior to the AVS I1 purchase
and therefore was able to avail itself of the cheaper energy.
Obviously, if MDU had excess energy before the AVS I1 acquisition,
it had to have extra energy following its purchase.        The MCC
therefore maintained that it was not treating Schedule E as a long-
term energy source, but was instead, treating it exactly as it is
supposed to be, namely a source of low cost energy which is
purchased to displace higher cost energy.
     Upon reconsideration, the PSC agreed that it misinterpreted
the information contained in Mr. Clark's testimony.    It concurred
that his proposal treated Schedule E energy correctly and that this
treatment made the AVS I1 adjustment acceptable.       It therefore
granted the MCC's motion and further reduced the level of the rate
increase.
     MDU then appealed the matter to District Court.   The District
Court affirmed the PSC's order and specifically found that it acted
properly in "repricing1'AVS I1 energy because MDU's own numbers
established that it did not need to incur the expense to meet
present or future demand.   It further found that a portion of the
expense incurred through the AVS I1 acquisition was unreasonable
and therefore should not be passed on to the consumer. This appeal
followed.
     In utility rate cases this Court has traditionally held itself
bound by a very strict standard of review.   In previous cases we
have stated:
        . . .
            [TJhis Court is always confronted in ratemaking
     cases with the question of how far the court can go in
     interfering with, or directing the exercise of power, by
     an equal department of government. We have repeatedly
     held that there will be no interference with the orders
     of the Commission unless:
        (1) they go beyond the power constitutionally given; or
        (2) beyond their statutory power; or
        (3) they are based on a mistake of law.

     Cascade County Consumers Assln v. Public Service Commfn
     (1964), 144 Mont. 169, 192, 394 P.2d 856, 868; Mountain
     States Telephone and Telegraph v. Department of Public
     Service Regulation (1981), 191 Mont. 331, 339, 624 P.2d
     481, 485.

     This strict standard of review is necessitated by the nature
of controversies surrounding utility rate cases.            These cases are
generally       very   complicated    and     involve     the   review   and
interpretation of testimony given by experts in fields such as
engineering and economics.      The PSC, because of its expertise and
familiarity with these types of cases, is best suited to review the
evidence presented by such testimony and make the decisions.              In
light    of     this   fact, this    Court    has    traditionally   refused
invitations to substitute its judgment for that of the PSC.
     In rate cases, the PSC is the judge of fact and this Court
only determines questions of law.           In deciding questions of law,
our review only requires us to determine "whether the PSC acted
arbitrarily and unreasonably without sufficient evidence to support
its findings or exercised its authority unreasonably or set the
rates so low that they are confiscatory and deprive the utility of
its property without due process of law.            Montana-Dakota Utilities
v. Department of Public Service Regulation (1988), 231 Mont. 118,
752 P.2d 155.    This standard of review, which has been described
in case law, has its origins in the Montana Administrative
Procedure Act.   Under this act, findings of fact are subject to a
Ifclearly erroneousN standard of review, while conclusions of law
are subject to an Ifabuse of discretionff standard of review.
Section 2-4-101, MCA, et seq.
       MDU maintains that the PSC acted unlawfully by limiting its
determination of the need for AVS I1 power to the 1985 test year
and by "repricingw the AVS I1 power without any determination that
the company acted imprudently or unreasonably.     As for the first
assignment of error, MDU maintains that the AVS I1 purchase should
be considered a long-term investment which should be included in
the rate base. Usually, items which are considered to be rate base
expenditures include new power plants, transmission lines, etc.
If the utility can prove that such facilities are ftused
                                                       and usefulff
they are entitled to earn a rate of return on the associated
investments.
       Both the lower court and the PSC, however, maintain that
neither the test year question nor the associated rate base issue
are relevant to the case now before us.       They maintain that the
only    issue presented   by   MDUts appeal   is whether   there   is
substantial evidence to support the PSCfsdecision to disallow some
of the costs associated with the AVS I1 purchase as unreasonable.
We agree that this is a correct statement of the issue.
       The legislature has endowed the PSC with full power of
supervision, regulation, and control of public utilities in matters
related to rates and service. See 69-3-101, et. seq. Under 5 69-
3-303, MCA, the legislature has mandated that before the PSC can
approve any rate increase, it must hold a public administrative
hearing. At this hearing, the MCC may become a party and following
submission of all of the evidence, the PSC must issue a decision
and order. Section 69-3-303, MCA. The PSC, in its order, may "fix
and order substituted   . . . rates, tolls, charges or schedules as
are just and reasonablen upon finding that previous or proposed
rates are unreasonable.   Section 69-3-330(1), MCA.
     This statutory scheme is based upon and is often followed by
policies which have been enunciated by commentators and the courts.
Professor A.J.G. Priest in Principles of Public Utility Regulation
(1969) states that:
         regulatory agency cannot lawfully ignore the
     necessary, fair and reasonable expenses of operation
     incurred in the rendition of service  ...   but must  ..
     . allow all such expenses constituting charges on income
     . . ."   (Emphasis added.) Id at 50.

     Similarly, this Court has stated:
     A function of the PSC, in fulfilling its duty to
     supervise and regulate the operation of MDU, as an
     electric utility, is to see that MDUtsrates are just and
     nondiscriminatory (cites omitted).    In complying with
     this obligation, it follows that the PSC must scrutinize
     and review the operating expenses of MDU to prevent
     unreasonable costs from being passed to the customer.
     (Emphasis added.)

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


     Both the PSC and the MCC argue that the actions taken in this
                                                                 1
                                                                      ,
      . I




case, i.e. disallowing a portion of the costs associated with AVS
11, fully comply with the statutory mandate of 9 69-3-330(1), MCA,
and the reasoning of legal commentators and the Montana Supreme
Court.      We agree that the PSC has both the constitutional and
statutory authority to review rates and to disallow rates which are
proven unreasonable.     Moreover, in accomplishing this task, the
PSC need not determine that the company's actions are unreasonable.
Their task is only to review rates and determine whether they are
reasonable to the consumer.     We must, therefore, now review the
evidence presented to the PSC in order to determine whether it was
justified in denying MDU1s proposed rate increase.
     We have previously set out much of the evidence relied upon
by the PSC in our statement of facts.    However, for the sake of
clarity, we will repeat much of this evidence and apply it to the
standard of review which must be utilized in this case in order to
determine whether there is substantial evidence to support the
PSCts order.
     In its findings of fact and conclusions of law, the PSC
summarized and analyzed the testimony given at the public hearing
and the records submitted by MDU.       This information led the
Commission to conclude that MDU was, in point of fact, replacing
inexpensive electricity which could be generated internally or
acquired from MAPP with very expensive AVS I1 power.      When the
total operation and maintenance expenses of AVS I1 power were taken
into account, it became apparent that it cost up to 261 percent
more to operate than MDUts existing plants.     In the opinion of
MCC1s expert, Mr. Clark, the ratepayers should not be saddled with
such power supply costs.
     His opinion, it was found, was bolstered by MDU1s own records
which indicated that subsequent to the AVS I1 purchase, MDU had
backed down production at its existing plants, decreased its use
of purchased power from MAPP and increased its unregulated off
system sales to other utilities.
     In order to come up with a compromise that was fair to both
the consumer and MDU, the PSC adopted Mr. Clark's proposal that
MDU s energy resources be "remixed."   This proposal assumed that
MDU could acquire Schedule E and Schedule H energy from MAPP and
that it could utilize them as a cost reducing mechanism.    Evidence
was presented of abundant power and energy.   In fact it was shown
that there is a surplus in MAPP until at least 1995.       Moreover,
MDU's own records suggested that it could utilize 139,288 mwh of
Schedule E energy.   This fact indicates that the company had this
much power from its own units to forego, because in order to
qualify for Schedule E purchases, a company must have excess energy
to meet peak customer demand. Mr. Clark's proposal, which actually
reflects less Schedule E energy than MDU's own records indicates
it could acquire, is a feasible alternative to the dilemma.
     In making its final decision it is obvious that the PSC chose
to accept Mr.   Clark's suggested alternative.      It based    its
conclusion upon evidence found within the record, which was
presented by both sides to the controversy. Obviously in accepting
this testimony, the PSC chose to reject expert testimony presented
by   MDU.     However, such a decision was    clearly within     its
discretion. As we stated in Dept. of Public Service Regulation v.
Montana Irrigators (1984), 209 Mont. 375, 381, 680 P.2d 963, 966:
      Rate structuring involves highly specialized theories of
      economics. The weighing and balancing of expert opinion
      pro and con is properly vested in the administrative
      agency in its field of expertise.
      In view of the facts presented and their application to the
standard of review presented by utility rate cases, we hold that
the PSC1sdenial of a portion of the costs associated with the AVS
I1 purchase was not beyond its constitutional or statutory power.
Nor was the decision based upon a mistake of law.   We also cannot
say the decision of the PSC was arbitrary in this case.   The order
of the District Court upholding the PSCSs order is therefore
affirmed.




            Justices
                                 /



sifting for   ust tic^ John   C. Sheehy

6a/*.c"fl!
District Judge C.B. McNeil
sitting for Justice Wm. E. Hunt, Sr.
Justice Fred J. Weber dissents as follows:
     I do not dissent from the legal principles cited and applied
in the majority opinion. There is no conflict between the parties
as to those legal principles.
     My problem is with the required purchase by MDU of 41
megawatts of power in each year.       In 1981 MDU entered into an
agreement with Basin Electric which obligated MDU to purchase 41
megawatts of power from a particular generating plant in which
Basin Electric had an interest, and which also obligated Basin
Electric to furnish that 41 megawatts for each of ten years.     It
is important to note that the Basin Electric power plant did not
become operational until June of 1986.     Under its determination,
the PSC denied MDU the recovery of $1,474,932 in costs it incurred
in agreeing to purchase the 41 megawatts of power for one year.
     All parties agree that the PSC has the power to disallow
unreasonable expenses.   My contention is that the PSC improperly
used that power in the present case.
     The PSC relied upon the expert testifying in behalf of the
Montana Consumer Council (MCC)  .   It is critical to keep in mind
that the MCC expert conceded that MDU needed its generating
resources including the 41 megawatts of power each year contracted
for with Basin Electric.   The expert conceded that the power was
reasonably needed for the forecasted consumer demands of MDU.   The
expert conceded that the power was reasonably needed for the
forecasted consumer demands of MDU. We may therefore conclude that
both the MCC and the P S C agreed that it was both reasonable and
necessary for the MDU to enter into the 1981 agreement for the
obligated purchase of 41 megawatts each year starting at the
completion of construction of the power plant in 1986. That aspect
was not considered in the PSC determination nor in the majority
opinion.
     The MCC expert attacked only the amount which MDU was required
to pay in one year for the 41 megawatts of power.        The expert
emphasized that MDU reduced some of its owned production of power
which resulted in an increased cost to the consumer because the
contracted price for the 41 megawatts exceeded the cost of
production in certain of the MDU units.    In addition, the expert
testified that in 1985 MDU could have purchased cheaper power from
a power pool at a rate substantially less than the price paid for
the asi in ~lectric41 megawatts.   The substance of this testimony
was that MDU could have generated power and purchased power at
prices cheaper than paid to Basin Electric.      As a result, the
expert testified that it was proper to disallow $1,474,932 as an
unreasonable expense--even though that amount was required by
contract to be paid by MDU.   That is a 11catch-22n
                                                  position of the
worst sort so far as MDU is concerned. The result of this approach
is that the P S C in substance commends MDU for obligating itself to
purchase the 41 megawatts of power each year for 10 years--because
that is a reasonable protection so far as consumer requirements are
concerned.   The ttcatch-22tt
                            result is that the PSC then says--
however, as we review this case in hindsight, we find that in
actual fact you didn't need that power as you anticipated because
you could have purchased the power from other sources at a cheaper
rate, and we therefore will disallow your required payment as an
unreasonable expense.
     The 1'catch-22B1
                    situation is further emphasized by the very
nature of the "Pool power.''   MDU is a member of Mid-Continent Area

Power Pool from which it can acquire power. Its membership in that
Power Pool is conditioned upon a contractual arrangement which
requires that MDU have its own generating capacity equal to its
customers1 demands plus a reserve of 15%.     By signing the contract
with Basin Electric, MDU has helped to establish its capacity to
purchase the pool power by establishing a reserve above projected
customer demands of     15%.     The   penalty   result of   the   PSC
determination is that while MDU must have 15% more than is needed
for its consumer demands to purchase power from the Power Pool; the
PSC will use the cheap power purchased from the Power Pool as a
means of eliminating the right of MDU to include the Basin Electric
contract price.   In addition, pool power is not guaranteed power
as is the power which must be furnished by Basin Electric.     It is
easy to look back and state that pool power was available, but
difficult, if not impossible, to look ahead and count upon its
availability.   Truly a "catch-22."
     As well stated in the majority opinion, the PSC may fix rates
which are ''just and reasonable.I1     As stated by Professor A.J.G.
Priest in the majority opinion, a regulatory agency cannot lawfully
ignore necessary, fair and reasonable expenses of operation.       In
addition, as stated by this Court in Montana Dakota Util. Co. v.
Bollinger   (Mont. 1981),        632 P.2d    1086, 38 St.Rep.      1221, in
complying with its duty to supervise and regulate, the PSC must
scrutinize and review operating expenses to prevent unreasonable
costs from being passed to the consumer. Both the majority opinion
and the dissent agree that the foregoing standards control.              My
contention is that the result reached by the PSC is neither just,
fair, nor reasonable.
     The technique used by the MCC, and accepted by the PSC, has
resulted    in   an     artful   bypass     of   a   fair   and   reasonable
determination.        In order to obtain such a fair and reasonable
determination, I believe it essential that the PSC determine
whether or not it was fair and reasonable that MDU enter into its
1981 ten year contract with Basin Electric. Such a procedure would
require that the PSC make a decision as to whether or not the
contract was fair and reasonable before disallowing any of the
payments required under the contract.            That was not done here.
Instead the technique used was to attack the payment required in
one year as being an unreasonable expense because power could have
been obtained from other sources at a lesser cost.           That hindsight
was applied five years after the contract had been signed. If that
same technique were followed during each of the remaining nine
contract years of the MDU-Basin Electric contract, it becomes
possible that the PSC could disallow the entire contract purchase
price as being an unreasonable expense. This allows an after-the-
fact determination on the part of the PSC which is not either fair
or reasonable.              If the power supply during the ten year contract
term is such that the 41 megawatts of power are needed for
customers of MDU because power is in short supply, then MDU will
be commended, and its purchase price of the 41 megawatts of power
will be allowed as a reasonable expense.                                   On the other hand, if
power continues to be in surplus during the contract term as was
true in 1985, then this would allow the PSC to disregard the
required purchase price of the 41 megawatts of power in each year
in which there was a surplus of power.                               Such procedure disregards
the nature of the MDU-Basin Electric contract.                                          That contract
requires the furnishing of power and the purchase of power in a
manner which is actually comparable to an investment by MDU in the
construction of its own power generating facility.                                          The payment
under the contract should be treated in a manner comparable to the
investment in plant, not by the devise used in the present case.
        I conclude that the PSC has failed to fix rates that are just
and     reasonable because                    it     ignored        the     necessary,          fair      and
reasonable expenses of operation of MDU.                                    I would remand for a
redetermination of the rates here involved.




        J u s t i c e D i a n e G.      B a r z a n d J u s t i c e J o h n C. H a r r i s o n c o n c u r i n

the f o r e g o i n g d i s s e n t .
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