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Rating Action:

MOODY'S ASSIGNS A3 RATING TO EESTI ENERGIA'S PROPOSED EUROBOND(ESTONIA)

11 Jul 2002
MOODY'S ASSIGNS A3 RATING TO EESTI ENERGIA'S PROPOSED EUROBOND(ESTONIA)

London, 11 July 2002 -- Moody's Investors Service has assigned an A3 senior unsecured rating to Eesti Energia's proposed Eur 200million Eurobond. Moody's has recently assigned a long term Baa1 senior unsecured and a short term P-2 issuer rating to Eesti Estonia. The Baa1 issuer rating is on a par with the State of Estonia's foreign currency rating (Estonia: domestic currency issuer rating A1; foreign currency issuer rating Baa1). The outlook on all ratings is stable.

The Eurobond rating assignment is in line with Moody's rating methodology which allows the sovereign foreign currency ceiling to be exceeded ("pierced") on an issuer's foreign currency debt instruments in certain circumstances. The rating reflects Moody's view on the low probability of the Estonian Government declaring a general moratorium on servicing foreign currency debt should it default on its own foreign currency debt, plus the probability of the company in question being exempted from such a moratorium. Greater weight has been given in this equation to the first of these factors than to the second.

This methodology, which was amended in June 2001, was precipitated by the experience of recent bond defaults in countries in which governments had not declared a generalised moratorium, in fact where private and even public sector issuers were allowed to make foreign debt payments without interference. Whilst the majority of firms that have been assigned higher ratings than the country ceiling have been banks and major exporters, Moody's has also adjusted ratings for some important companies with predominantly domestic earnings, such as the South African electric utility, Eskom and the Mexican telecommunications firm Telmex.

In the event that the sovereign foreign ceiling were to be raised, then Eesti Energia's Baa1 issuer rating could also be raised, but it is unlikely to be more than one notch given its size and the challenges it faces.

The ratings reflect the strategic importance and strength of Eesti Energia's position in Estonia as the dominant vertically integrated electric utility. The rating also factors implicit support from its 100% state owner and a supportive regulatory regime as well as satisfactory financial flexibility. At the same time the rating recognises the company's relatively small size, execution risks associated with a sizeable investment modernisation programme, the still evolving nature of regulation and potential politicisation of tariffs and its exposure to developments in the Estonian economy, Moody's added.

Eesti Energia benefits from a strong domestic position - with a 97% share of the country's electricity and 30% share of its heating needs - and relatively low business risk. It owns 51% of the principal oil shale supplier, Eesti Polevkivi (the State hold the remainder). This fuel is the primary source for electricity generation and is considered of strategic importance to Estonia, offering security of supply over the long term. Eesti Energia has ample net generating capacity of around 2000MW although in need of significant upgrading. Additionally, Eesti Energia is the low risk monopoly owner and operator of all of the country's transmission grid and most of its distribution networks. The rating assumes that no significant change to its vertically integrated structure or ownership takes place in the intermediate to medium term.

Eesti Energia is expected to continue to operate in a protected supply market which is currently only 10% open. Estonia has applied for a derogation to the EU Electricity Directive to defer further market opening (35%) until 2008. Earlier market opening would be expected to put some pressure on market share and margins. Eesti Energia is interconnected with Latvia and Russia and these countries provide Eesti Energia with some export opportunities, although the prospect of relatively cheap Lithuanian (interconnected through Latvia) and Russian imports is also expected to maintain pressure on pricing to Eesti Energia's eligible customers.

Eesti Energia is not guaranteed by the State of Estonia. Moody's however believes that the State recognises the strategic importance of Eesti Energia - which is the largest indigenous company - and the oil shale industry to the country's stability and economic development and hence factors some implicit support.

The regulatory regime is considered broadly favourable albeit relatively new and untested. In the years since restructuring the environment has moved progressively towards full cost recovery and tariff rebalancing between industrial and household consumers. The new Electricity Market Act, which is expected to ratified by the Government this year and be effective during 2003, gives greater powers to the Regulator and provides for a transparent tariff setting mechanism, reflecting the principle of costs plus a reasonable profit. Nonetheless, whilst the need for some future above-inflation increase in tariffs is recognised, Moody's believes that the timing and amounts of such hikes could be influenced by political considerations which could slow the company's earnings potential.

Underinvestment has led to a need for modernisation of Eesti Energia's ageing facilities. Eesti Energia plans to invest Eur 550 - Eur 600 million over the next three years, principally to repower two oil shale-fired blocks at its generation subsidiary, Narva Power - essential to ensure compliance with future environmental requirements - as well as to increase efficiency. Efficiency improvements will also be undertaken in the networks to reduce losses. Moody's factors the execution risks associated with a sizeable investment plan. However a significant budget overrun or failure to meet environmental targets, although not currently expected, could put some negative pressure on the company.

Around half of its investment needs are expected to be debt financed but even at the peak of its investment period (2002-5) Eesti Energia should maintain satisfactory financial flexibility, assuming no significant currency movements, given its predominantly domestic revenue base and expected Euro denominated borrowings. Estonia currently has a fixed currency against the Euro which the government expects to maintain until entry into the European Exchange Rate Mechanism. Expected moderate electricity demand growth in Estonia will also be influenced by GDP growth development.

Eesti Energia is a vertically integrated electric utility based in Tallinn, Estonia. As at FYE March 2002 it had turnover of around Eur 330 million.

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

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

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