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* Spanish utilities lead European index in past 12 months
* Gains follow regulatory shake-up and Spanish recovery
* Further gains seen depending on Ukraine developments
By Tracy Rucinski
MADRID, Aug 8 (Reuters) - Spanish utilities' lack of exposure to Russian gas could give their shares a second wind given rising trade tensions over Moscow's interference in Ukraine, even after a 12-month rally which has left them looking fully-valued against European peers.
Despite heavy falls this week, Spanish utility stocks have still done twice as well as European utilities over the past year, taking prices to a 4-year high relative to European peers.
The rally has been fuelled by greater clarity over domestic regulation and by historically low Spanish bond yields, which make the high dividends paid by local utilities more attractive.
Whether it continues depends largely on developments between Ukraine and Russia, which is the main supplier of gas to northern Europe. Spain, meanwhile, gets most of its gas from Algeria.
After the West imposed sanctions on Russia for its support of separatists in eastern Ukraine, Russia has hit back with a ban on many Western food products, and some analysts fear a trade dispute could spread to the energy sector.
"If Ukraine tensions heighten, investors may see Spanish utilities as a safer bet than other European ones," said Alvaro Navarro, analyst at Madrid-based brokerage Intermoney Valores.
Just two years ago, Spanish utilities were among the worst performers on the STOXX Europe 600 Utilities index.
But since then, Spain has bounced back from the brink of an international bailout and the government has taken definitive steps to tackle a multi-billion-euro deficit that was hanging over the industry after years of selling power at regulated rates that did not cover renewable subsidies and other costs.
While the reforms, which include higher taxes and subsidy cuts, have dented Spanish utilities' profits and threatened their financial strength, the firms have sold assets to raise funds, expanded abroad and put their finances back on track.
"There's finally visibility on regulation, dividends and cash flow, and the low bond yields are also helping the utilities to refinance debt," said Navarro.
Within Spain, utility stocks have also significantly outpaced the Spanish benchmark indexes, though that has shown signs of changing in August as investors eye other sectors they had shunned during the country's long financial crisis.
Shares in Endesa were trading around 26.62 euros on Friday, above analysts' average target of 26.50 euros, while Iberdrola's were in line with a 5.34 euro average target. Gas Natural shares were around 21.52 euros, also near a 22.73 euro target price.
"For conservative investors, I'd say Spanish utilities are in their price," said one trader who asked not to be named according to company policy.
"But if investors remain bullish and decide to ignore risks such as continued weak energy demand and exposure to currency factors in Latin America, they may still go up. And Ukraine will be key," he said.
Spanish energy demand, which plummeted during a long recession, has yet to reach pre-crisis levels, though a return to sustained economic growth suggests this could happen in time.
And while the utilities have diversified into Latin America to offset hardships at home, a weakening of local currencies against the euro in countries such as Brazil and Colombia hurt first-half profits.
Most analysts have "hold" recommendations on Endesa and Gas Natural, but are divided on Iberdrola, which is investing heavily in regulated power grids and renewable energy abroad.
"In a market where geopolitics can cause continuous turmoil, we favour clear and stable investment cases. Iberdrola now falls into that category, with one of the clearest and most visible strategies within European utilities," said Deutsche Bank, which has a "buy" rating.
Goldman Sachs is more downbeat, rating the stock a "sell".
"We believe Iberdrola's strong share price correlation to Spanish bond yields ignores continuing weak fundamentals in Spanish electricity demand and prices," it said in a research note.
There may be more opportunities in gas grid operator Enagas , with one of the highest dividend yields among its peers at 5.5 percent, compared with 10-year Spanish government bond yields of about 2.6 percent.
Its shares are still trading slightly below an average 25.00 euro price target. Most analysts rate the stock a "buy".
Spanish utilities versus Spanish benchmark: link.reuters.com/kac62w.
Spanish utilities versus Spanish borrowing costs: link.reuters.com/cud62w
Spanish utilities earnings revisions: link.reuters.com/sac62w (Additional reporting by Geert de Clercq and Vikram Subhedar; Editing by Mark Potter)