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Announcement:

Moody's changes outlook on Eesti Energia's Baa1/P-2 ratings to negative

08 Jan 2013

EUR600 million of debt affected

London, 08 January 2013 -- Moody's Investors Service has today changed to negative from stable the outlook on the Baa1/Prime-2 issuer rating of Eesti Energia AS. Concurrently, Moody's has changed the outlook to negative on the Baa1 senior unsecured debt rating of Eesti Energia.

RATINGS RATIONALE

Today's rating action reflects the expected deterioration in Eesti Energia's credit profile due to wide-ranging market pressures on its electricity generation and supply activities coupled with the group's evolving business risk profile.

Whilst there is some upside to the full opening of the market on 1 January 2013, as it may lead to higher average power prices in Estonia in the near term, volatility and pressure on Eesti Energia's cash flows will intensify as the market becomes more competitive. In addition, further integration of the Estonian market with other Baltic states and the Nordic region may exert pressure on Eesti Energia's ability to maintain its profitability given its CO-2-intensive oil-shale-based generation assets. Starting from this year, Eesti Energia will need to buy a certain portion of CO2 emissions allowances, such portion increasing over time, which will impair the group's generation segment profitability further. More positively, Moody's notes that the extent of the pressure is mitigated by the group's hedging policy in the near term.

An increasing proportion of Eesti Energia's business comprises shale oil activities, which Moody's considers carry higher risk compared with the group's core utility services. Indeed, Eesti Energia's shale oil activities will increase materially this year following the start of production at the group's Enefit280 facility. Moody's notes that, due to technological problems, the project has encountered some delays to its scheduled start of production in September 2012, but understands that the facility will be fully operational later this year.

Eesti Energia's financial profile has been solid over recent years. However, the group has increased its capital expenditure programme materially, resulting in estimated negative free cash flow generation of more than EUR300 million in 2012. Whilst some of the investments were supported by an equity injection last year from the Government of Estonia amounting to EUR150 million, Eesti Energia's credit metrics will deteriorate over time from their historically strong levels given the group's over EUR900 million in committed investments for 2013-15.

Eesti Energia falls under Moody's rating methodology for Government-Related Issuers (GRIs) given its 100% ownership by the Government of Estonia (A1 stable). Eesti Energia's Baa1 rating incorporates uplift for potential government support to the group's standalone credit quality, expressed by Moody's as a baseline credit assessment (BCA), which the rating agency views as commensurate with a baa2 rating.

Eesti Energia's BCA is underpinned by the group's strong position in its domestic market as a vertically integrated utility and its historically moderate leverage. The rating is, however, constrained by the group's (1) growing shale oil activities; (2) small size and ageing CO2-emission-intensive generation portfolio; and (3) high level of capital expenditure, which Moody's would expect to weigh on the group's financial profile. Eesti Energia's current rating does not take into account any further significant investments that the group could make into the expansion of shale oil production.

WHAT COULD CHANGE THE RATING UP/DOWN

Given the current negative outlook on the ratings, Moody's does not expect upward rating pressure in the next 12-18 months. However, the rating agency could change the outlook back to stable if, following the full opening of the electricity market in Estonia, Eesti Energia demonstrates an ability to maintain (1) its strong market position; and (2) profitability in its more competitive markets; and (3) show improvement in free cash flow generation.

Eesti Energia's rating could come under downward pressure if the company's funds from operations (FFO)/interest coverage ratio were to fall below 5.0x and its FFO/net debt ratio were to decline, and remain, below 25% under an assumption of a continued strong cash flow generation of the electricity segment. In addition, negative pressure on Eesti Energia's rating could develop as a result of (1) a shift in the group's business risk profile, as evidenced by a material increase in cash flows stemming from shale oil activities; (2) material adverse changes in the regulatory framework in Estonia; (3) significant further expenditure on shale oil activities and financing of thereof; or (4) a deterioration in the credit quality of the Government of Estonia and/or a reduction in the support assumptions currently incorporated in Moody's assessment.

PRINCIPAL METHODOLOGY

The methodologies used in this rating were Unregulated Utilities and Power Companies published in August 2009, and Government-Related Issuers: Methodology Update published in July 2010. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

Headquartered in Tallinn, Estonia, Eesti Energia is the dominant vertically integrated utility in the country. The group generates 90% of Estonia's electricity and around 17% of its heating needs, owning and operating most of its distribution networks. Eesti Energia also owns 100% of Estonia's principal supplier of oil shale, the country's long-term primary fuel source for electricity generation. Eesti Energia is 100% owned by the Government of Estonia. Its consolidated revenues amounted to EUR832 million in the year ended December 2011.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

Information sources used to prepare the rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entity or its related third parties within the two years preceding the credit rating action. Please see the special report "Ancillary or other permissible services provided to entities rated by MIS's EU credit rating agencies" on the ratings disclosure page on our website www.moodys.com for further information.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history. The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Joanna Fic
Asst Vice President - Analyst
Infrastructure Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Andrew Blease
Senior Vice President
Infrastructure Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's changes outlook on Eesti Energia's Baa1/P-2 ratings to negative
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