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Rating Action:

MOODY'S DOWNGRADES DONG AND DONG NATURGAS TO Baa1; STABLE OUTLOOK

25 May 2005
MOODY'S DOWNGRADES DONG AND DONG NATURGAS TO Baa1; STABLE OUTLOOK

London, 25 May 2005 -- Moody's Investors Service has today downgraded to Baa1 from A3 the senior unsecured long-term ratings of DONG A/S ("DONG") and its subsidiary DONG Naturgas A/S. The rating outlook is stable.

This rating action concludes the review for possible downgrade that was initiated on 11 February 2005 following DONG's announcement that it had entered into various agreements to buy an increased stake in Elsam (up to 65%) and gain control of the electricity activities of København Energi as well as the latter's 34% stake in Energi E2 ("E2"). These agreements were designed to give DONG ultimate control of both E2 and Nesa.

Today's downgrade reflects the following factors:

1) Moody's view that, although there is a good chance of a favourable resolution, these transactions result in a degree of execution risk. DONG and Swedish energy group Vattenfall AB (A3 issuer rating, stable) have signed a letter of intent to reach an agreement to assign power assets to Vattenfall equal to Vattenfall's current 35% share in Elsam. Although the success of such an agreement may be helpful in meeting any competition authority concerns, all the necessary approvals -- including any competition authority rulings -- are not expected to be secured until the end of 2005.

2) A higher level of debt than factored into the original A3 rating which is likely to result from the recent transactions. The total value of the electricity deals is expected to total around DKK26 billion, although DONG expects to use a minimum of around DKK10 billion in equity to fund the transactions. In addition, DONG recently agreed to purchase a stake in the Ormen Lange gas field for US$1.2 billion (eq DKK 7billion).

3) Risks relating to the successful integration of the acquired companies and the extraction of appropriate synergies. However, Moody's notes that bringing together a significant part of the Danish electricity industry should allow for significant cost efficiencies.

4) Moody's expectation that DONG's financial profile will be weaker until around 2007, when cash flows should be boosted by gas coming on stream from Ormen Lange as well as an improvement in generating profits and the effect of potential synergies resulting from the acquisitions. However, any delay in Ormen Lange coming on stream, adverse developments in commodity prices or realisation of synergies could slow this financial recovery.

5) The fact that DONG will increase its exposure and be "long" in the higher-risk gas supply segment -- particularly in the 2007-10 period before its long term gas procurement with DUC begins to run off. As a mitigating factor, the company has some time to negotiate further gas sales contracts in advance of this gas coming on stream and to use some of the gas in its acquired generation portfolio; it will also benefit if prices remain high. Longer term, the "equity gas" provided by Ormen Lange will diversify DONG's procurement risk.

Assuming successful completion of the transactions noted above, DONG will be the market leader in Danish electricity power generation market and control a good proportion of distribution and supply. Overall it will be slightly "long" in generation and will hence be more exposed to developments in commodity prices (such as electricity, coal and gas). However, its exposure to regulated gas and electricity networks and quasi-monopoly activities such as district heating will, in Moody's view, mitigate this risk somewhat and provide a reasonable degree of vertical integration in its portfolio.

At the same time, Moody's recognises that, assuming successful completion of these transactions, DONG will have achieved its ambition of becoming the dominant player in the Danish electricity and gas market within a short period of time. It will have a much more diversified portfolio than its existing profile, which is orientated towards gas and oil. The company has the support of its shareholder, the Danish Ministry of Finance, in building this leading position in the country. Moody's expects that the proposed IPO of DONG will be delayed until 2006 or 2007 to accommodate the approval process. Nonetheless Moody's expects a majority of DONG to remain with public ownership. Moody's factors a degree of State support into the current rating.

The stable outlook on the Baa1 rating takes account of the integration and execution risks facing the company as well as a degree of financial stretch over the next two to three years. However, successful execution of the company's strategy should result in a rapidly improving financial profile from 2007 onwards. Evidence that DONG is well on track to achieving its objectives could over time lead to positive pressure developing on the rating. Moody's would expect any positive rating movement also to be dependent on the company being in a position to demonstrate that it is close to achieving and maintaining RCF/debt of 18-25% and FFO/debt of 25% upwards.

DONG Naturgas, as its gas purchasing and supply arm, is an integral part of the DONG group, generating around 40% of current Funds from Operations and with very limited third party debt. The parent upstreams most of its cash by way of dividend and closely controls the company. Its rating is likely to remain closely influenced by developments at the parent company level. However a significant leveraging up or increase in business risk could be negative.

Negative pressure could develop on the ratings if there were significant delays in executing the strategy, a large increase in debt over those levels assumed or a significant downturn in the electricity and gas business environment. However, such developments are not currently expected.

Headquartered in Copenhagen, Denmark, DONG is a 100% state-owned energy company. As of FYE 2004, group turnover was DKK14.3billion (EUR1.9billion). DONG Naturgas is its 100% owned subsidiary, active in gas purchasing and supply activities, with a turnover of DKK10billion (EUR 1.3billion) as at FYE 2004.

Elsam is the largest generator in Denmark, with total revenues of DKK9.3billion (EUR1.2billion) as at FYE 2004. E2 is the second largest generator with total revenues as at FYE 2004 of DKK6.4billion (EUR0.9billion). Københavns Energi is a leading distributor and supplier of electricity. Nesa is another Danish distribution company owned 87% by Elsam and 13% directly by DONG.

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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