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Rating Action:

MOODY'S ASSIGNS A3 ISSUER RATINGS TO DONG AND DONG NATURGAS (DENMARK); NEGATIVE OUTLOOK

07 Sep 2004
MOODY'S ASSIGNS A3 ISSUER RATINGS TO DONG AND DONG NATURGAS (DENMARK); NEGATIVE OUTLOOK

London, 07 September 2004 -- Moody's has today assigned senior unsecured long-term issuer ratings of A3 to Dansk Olie og Naturgas A/S (DONG A/S) and to its subsidiary DONG Naturgas A/S. The outlook on both ratings is negative.

DONG's A3 rating reflects the company's strong position in the Danish gas industry as well as Moody's view that the company is well placed to achieve its strategy to become a predominantly integrated gas and electricity player within Denmark, with a balanced portfolio of businesses and a financial profile commensurate with the rating. The rating also reflects Moody's expectation that the Danish State will maintain majority ownership. The negative outlook, nonetheless, reflects the execution risks inherent in achieving this strategy.

Moody's rating factors DONG's position, through its wholly owned subsidiary DONG Naturgas A/S, as the leading gas supplier in Denmark. DONG benefits from its ownership of the offshore gas pipelines as well as take-or-pay agreements with the partners in the Danish Underground Consortium (DUC) which will provide DONG with significant gas supplies until 2012, with volumes steeply declining thereafter. Whilst it is Moody's expectation that DONG will maintain its leading position given these strengths, the rating agency, nonetheless, expects DONG's market share and margins to come under pressure given the impact of full liberalisation in 2004, although the company's continuing sales efforts into neighbouring markets should help mitigate this impact.

Moody's notes that DONG currently enjoys a strong financial and liquidity position which provides it with financial flexibility. However, the rating recognises the company's clear strategy to become an integrated gas and electricity player in Denmark through the acquisition of major domestic electricity assets, and hence factors a substantial increase in debt in order to implement this strategy. The company currently owns an 18% stake in Elsam, the largest generator and a direct 13% stake in NESA, the largest distributor and supplier (Elsam recently acquired an 86,6% stake in NESA). DONG has recently reached agreement to buy an additional stake of 22% in Elsam from the "Hobro" consortium although existing shareholders may exercise preemption rights. DONG has also stated that this agreement is a natural step towards a merger between DONG and Elsam. Were this not to take place, then Moody's would expect DONG to consider other options to enhance its position in the domestic electricity sector.

In Moody's view, DONG's somewhat weaker financial profile following such acquisitions would be more than compensated by a strengthening of the company's business profile, given that expansion into domestic electricity, would add a lower risk business to DONG's current business profile. This currently remains weighted towards Exploration & Production (E&P), which the rating agency views as significantly higher risk. Furthermore, Moody's believes that success in this strategy would allow DONG to balance its strong gas position against the largely thermal-based Danish electricity market. DONG intends to increase investments in oil and gas exploration in order to develop a larger equity gas position designed to help serve as a vertical hedge to the development of DONG's gas trading business in the future. This vertical hedge strategy mitigates some of the risks inherent with E&P activities, were they to be run as a separate business.

The rating factors the current State ownership, and whilst DONG's initial public offer (IPO) is expected within a couple of years, Moody's expects that the government will retain a majority stake of the company at least in the near term. However, any spin-off in the company's infrastructure assets or a reduction in State ownership below 51% during this transitional period could have negative rating implications.

At the same time Moody's recognises that there are a number of challenges facing DONG which are reflected in the current negative outlook. In particular, these include the transitional and execution risks of transforming itself from an gas and oil company into a primarily integrated electricity and gas player -- with both upstream and downstream assets -- without overpaying for either electricity or gas assets, and whilst extracting the appropriate benefits. Although DONG stands a good chance of accomplishing its power strategy, success is not assured, and the timing, price and final shape of the full execution of its strategy is uncertain. Even if achieved, DONG would still be a relatively small player in the European market, albeit large in Denmark.

Moody's A3 rating therefore assumes that (i) DONG will make steady progress towards achieving its integrated power strategy, (ii) the company will continue to pursue its E&P policy prudently. (Undue prominence to this activity, investments in high priced oil reserves or failure to achieve exploration success would be viewed negatively.) (iii) DONG will not significantly increase leverage to support its E&P business or materially increase dividends from current levels (should debt not be allocated towards the lower risk electric utility business), (iv) the State will not reduce ownership below 51% or divest of infrastructure assets during this transitional period (v) the company maintains a sound financial profile on implementation of its strategy (Moodys assumes a minimum of 25% Retained Cash Flow/Net Adjusted Debt) achieved within a balanced portfolio of businesses. Any deviation from these assumptions could lead to downward pressure on the rating. Conversely, successful execution of the company's strategy within the parameters outlined, or significant progress in this direction, should allow Moody's to change the rating outlook to stable.

Moody's assigns the same senior unsecured issuer rating (A3 with a negative outlook) to DONG Naturgas AS. This reflects the significant importance of this company as the gas purchase, trading and supply subsidiary of DONG AS as well as its close integration within the DONG group. DONG Naturgas, whilst small, has a strong financial profile with relatively modest third part debt. It contributed around 40% of Group Free Funds from Operations in 2003 which would generally be sufficient to meet its own operating and capital expenditure needs, although DONG AS has a policy of upstreaming 100% of subsidiary profits by way of dividends. At the same time, the parent centralises all cash management as well as general debt raising for the group. DONG Naturgas' cash flows can be subject to year on year volatility given the company's exposure to oil and USD price movements and timing differences between indexation in its sales and purchase contracts. Nonetheless these risks are mitigated by the company's strong cash flow and direct and indirect access to the parent's substantial back up facilities.

Headquartered in Copenhagen, Denmark, DONG is a 100% state-owned oil and gas company. As of FYE 2003 group turnover was DKK14 billion (EUR1.9billion). DONG Naturgas is its 100% owned subsidiary, active in gas purchasing and supply activities; its turnover as at FYE 2003 was DKK10billion (EUR 1.3billion).

London
Stuart Lawton
Managing Director
European Corporates
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Helen Francis
Vice President - Senior Analyst
European Corporates
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

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