German utility E.ON AG (EOAN.XE) Tuesday raised its 2012 earnings outlook after settling a long-running dispute with Russia's natural-gas giant OAO Gazprom (GAZP.RS) over the commercial conditions of long-term gas procurement contracts.

The settlement includes retroactive price adaptations that should help restore the competitiveness of E.ON's wholesale gas activities, which the company had repeatedly labeled as its most pressing operating risk after it accumulated operating losses of around 1 billion euros ($1.26 billion) in the last three months of 2010 through the end of 2011.

E.ON said that the settlement will enable it to recoup those losses and will boost group earnings before interest, taxes, depreciation and amortization, or Ebitda, in the first half 2012 by about EUR1 billion. E.ON also lifted its full-year earnings outlook, citing "one-off effects on taxes and net interest expenses as well as a generally lower tax rate."

The agreement comes as the European wholesale gas market has become oversupplied, on a combination of increased liquefied natural gas supply and lower demand after a mild winter and amid a broader economic downturn. At the same time, higher production of shale gas in the U.S. has helped pushed prices for Gazprom's long-term, oil-indexed contracts above spot market level.

European utilities including Italy's Eni SpA (E) and France's GDF Suez SA (GSZ.FR) had previously managed to secure better commercial terms from Gazprom.

E.ON, Germany's largest utility by market value, is Gazprom's single largest customer. Months-long negotiations between the two had been delicate, with billions of euros at stake for both. E.ON sources more than 25% of its gas from Russia, or about 20 billion cubic meters per year, so even small price reductions would result in massive revenue shortfall for Gazprom.

E.ON said that the settlement will "substantially reduce its exposure to the gas-to-oil spread", and that arbitration proceedings between the two over the issue of long-term gas contracts will be stopped.

The news sent E.ON's shares sharply higher, although most of the gains were later subsequently lost. At 1129 GMT, E.ON traded higher EUR0.08 or 0.4% at EUR17.30, underperforming a broadly higher market. In Moscow, Gazprom shares were up 1.1% at RUB158.09, slightly underperforming the wider market.

E.ON said it now expects 2012 Ebitda at between EUR10.4 billion-EUR11.0 billion, compared with its previous outlook of EUR9.6 billion-EUR10.2 billion; its underlying after tax profit is expected at between EUR4.1 billion-EUR4.5 billion, compared with the previous forecast of EUR2.3 billion-EUR2.7 billion.

E.ON said the new guidance also reflects lower earnings from its gas transmission unit Open Grid Europe, which it has agreed to sell. It also reflects revised earnings assumptions for its exploration-and-production unit, which now is expected to post a decline in operating earnings for 2012 due to a delayed in production at the gas field Skarv Idun, offshore Norway.

E.ON had previously said that the delay could result in additional costs in the low to medium three-digit-million euro range.

Write to Jan Hromadko at jan.hromadko@dowjones.com