Steag and the State Investment Trust have closed financing on the $305 million Mindanao power project. Mindanao is Steag's first investment in Asia, the only project financing in the Philippines to close this year. It is, however, the last of its kind - the forthcoming privatisation of the country's power sector will make lender-friendly power purchase agreements (PPAs) difficult to strike.

Mindanao's other key feature is its choice of fuel - coal. Steag, a German power developer, is owned by RAG, one of the largest global coal producers. It views Asia, with an undeveloped power sector, and vast reserves of coal, as a key opportunity. For a specialist coal generator, the fact that coal can undercut gas-fired generation over time is a useful advantage.

The downside is that coal's reputation as major source of pollutants and greenhouse gases has reached as far the political and economic discourse of emerging markets. Recent improvements in technology have taken longer to penetrate local consciousness. Thus, the Roman Catholic Diocese on the island decided to oppose the plant, while saying that a gas-fired station would have been broadly acceptable.

The 210MW plant, located at Villanueva, Misamis Oriental, on the second largest island in the Philippines, has had a number of opponents, including the diocese and Friends of the Earth. The latter launched campaigns in Japan and Germany, home of two prospective funders. Ultimately the Japan Bank for International Cooperation (JBIC) and the Kreditanstalat fur Wideraufbau (KfW) decided to back the project with a mixture of covered and direct loans.

The financing breaks down into $60.6 million from JBIC, $40.4 from NEXI, $100 million from Gerling (the German insurer) and a $15 million equivalent VAT facility denominated in Pesos. Sponsor equity of $89 million made up the difference. Lending under these facilities were the KfW, as well as commercial banks Dresdner Kleinwort Wasserstein and HVB Group.

The two banks are long-time supporters of RAG and Steag, but their ability to take the role of agent in a transaction funded by JBIC is a real coup - such business has traditionally been the preserve of Japanese banks. This breakthrough can be ascribed to a combination of the fact that the two banks have strong Asian project businesses, but more likely the fact that while Kawasaki Heavy Industries is the lead contractor, much of the expertise with coal generation lies with Steag.

Steag's persistence with the project is impressive, given the current atmosphere for foreign investment in the Philippines. Lenders called to support the PIATCO airport and Maynilad water deals will have less-than-fond memories of doing business in the country. The country's largest power investor, Mirant, is currently in bankruptcy.

Moreover, the country is continuing with the deregulation of the power industry, which means a potential end to the boom years of the independent power producer. There has been consistent pressure on the government to renegotiate power purchase agreements, and, following the passage of Philippines Electricity Power Industry Reform Act, the president ordered the examination of 35 IPP PPAs by the special committee. Mindanao was one of 35 PPAs to be reviewed and came out of the review process without any significant alterations.

However, during the process of reform, the PPA was transferred from the National Power Corporation (NPC), to the Public Sector Assets and Liabilities Management Corporation (PSALM). The PPA was evidently seen as one of the liabilities with which the NPC could not be presented to potential investors. The change in offtaker required a shift in the project's timetable, and also led the lenders to demand that both entities were liable under the contract.

Perhaps the greatest challenge, however, is the political situation in Mindanao. The island is not connected to the Luzon grid, but guerillas fighting in the south would like to see it separated to a far greater degree. The struggle, taking on Islamist tones, has brought the Philippines into the War on Terror.

Bankers are rarely keen to lend into global terrorist hotspots, and since 9-11 insurance coverage, let alone terrorism coverage, has become extremely expensive. Dresdner says that the hurdle was overcome with "creative solutions", while another source close to the deal describes the final arrangement as "hideously complex. Clawback provisions are only part of it."

One key mitigant will be the fact that the plant is in the north of the island, while the separatists operate in the south. Another is the fact that demand on the island for electricity is increasing rapidly. At the start of the year, the government, worrying about an economically-driven slump in demand, introduced price cuts to large industrial producers to stimulate activity. Since then the economic situation has improved, and the demographic fundamentals remain strong.

Developers in parts of Asia dominated by gas have started to note the advantages available to coal capacity - mining operations have now attained the necessary level of competitiveness, and gas is now often better exported. The technology has also got cleaner - this plant uses flue gas desulphurisation equipment, and burns low sulphur coal. This puts it just inside World Bank and JBIC guidelines, although that has not satisfied all its critics.

State Power Development Corporation

Status: Closed 28 November 2003

Size: $305 million

Location: Mindanao, Philippines

Description: 210MW coal-fired plant

Sponsors: Steag, State Investment Fund

Debt: $216 million

Arrangers: KfW, Dresdner, HVB

Provider: JBIC/NEXI

Lawyers to the sponsors: Linklaters

Lawyers to the lenders: Shearman & sterling

Consultants: PB Power