The Shinko Kobe Power project could signal the dawn of a new era in Japanese power financings. With a total cost of roughly ¥200 billion ($1.5 billion), it is the largest IPP to hit the markets since deregulation of the country's power industry got underway in 1995. This involved the Japanese government revising the Electric Utility Industry Law to open a portion of the retail power market to free competition. But progress has been slow and ? despite further revisions in 2000 designed to accelerate liberalisation ? only a handful of IPPs have come to fruition.

Of those that have emerged, the majority have been small capacity plants funded through corporate means. Only two power projects preceding Kobe opted to raise non-recourse debt. 1998 witnessed the first, with a joint venture between Steel Works and Tomen Corp successfully raising ¥11.8 billion for a gas-fired power plant in Osaka. Debt was split between a Development Bank of Japan tranche and a commercial facility arranged by UFJ, also financial adviser. In 1999, the same financing structure was used to raise ¥22.4 billion debt for a 149MW coal fired baseload power station in Nagoya sponsored by the same parents.

Continuity can be seen running through to Kobe with UFJ and DBJ again playing significant roles. However, with debt of ¥162.6 billion ($1.4 billion equivalent), this transaction clearly steps Japanese IPP financing up a gear. Proceeds fund construction of two 700MW units of a coal-fired plant in Kobe City. Sponsor Kobe Steel (Kobelco) secured two PPAs from regional incumbent Kansai Electric Power Co. (KEPCO) in 1996 and 1997. Commencing in April 2002 and April 2004 respectively, KEPCO will buy all power output from the units for a period of 15 years. With offtake agreements in place, domestic steel manufacturing giant Kobelco has established a special wholly-owned subsidiary Shinko Kobe Power Inc as the borrowing vehicle and project company. Debt is non-recourse to Kobelco.

DBJ pledged half the debt (¥81.3 billion) and financial adviser UFJ was joined by Dai-Ichi Kangyo Bank, IBJ and Sumitomo Bank in lead arranging the commercial portion. (IBJ and Dai-Ichi Kangyo have subsequently become members of the newly formed Mizuho Financial Group). Each of these four retained ¥9.3 billion, with the remainder sold down in syndication. Participating institutions are Yasuda Trust, Nippon Life Insurance, Norinchukin Bank, Mitsubishi Trust, Toyo Trust, Shinsei Bank, Aozora Bank, Bank of Tokyo Mitsubishi, Asahi Mutual Life Insurance, Sumitomo Life Insurance, Meiji Life Insurance and Yasuda Mutual Life Insurance.

The margin is believed to be 195bp over Libor, with repayment in 26 unequal semi-annual instalments following a three-year grace period. This facility enjoys credit enhancement from the Industrial Structure Improvement Fund, which was set up under the Private Participation Promotional Law in 1986. According to this, lenders will receive comprehensive coverage of up to ¥10 billion in the event of project default.

Commercial sell down was 160% oversubscribed, illustrating the allure this deal held for the Japanese lending market. Keeping it a solely domestic affair worked to mitigate political and currency risks but this was apparently not the driving motivation. ?There was no specific intention to borrow exclusively from Japanese lenders,? says a deal participant. ?It simply happened that way as a result of Japanese banks' strong appetite for long term finance, their familiarity with the sponsor and the project's need for long term yen financing.?

Kenji Takeshima in the project and structured finance department at UFJ, agrees. ?Syndication has included only Japanese banks because the sponsor prefers relationship banks. But this is not necessary. I believe that there is room for foreign banks in such syndications.?

The Shiko Kobe project boasts a number of factors that work to mitigate risk for lenders. ?Offtake risk is extremely low,? points out Yoshio Kato, assistant manager in the finance department at Kobe Steel. ?KEPCO, which has an AA- rating from Standard & Poor's, is taking all power output by paying both capacity and fuel payments to Shinko Kobe Power.? With the first unit on schedule for completion by April 2002, construction risk did not pose a major obstacle for the deal. Furthermore, the major sub-contractors are Mitsubishi Heavy Industries, Hitachi and Ishikawajima Harima Heavy Industries which all have considerable experience supplying power plant equipment.

Kobelco's operating record as a steel manufacturer in Japan and the strategic nature of the proposed plants were crucial to the deal's robust nature. There is no existing power plant in the Kobe City area, despite strong demand. Electricity is presently supplied from neighbouring cities though transmission lines. The serious inadequacy of this situation was demonstrated following the Hanshi-Awaji earthquake of 1995 that hit Kobe City and resulted in huge transmission losses and power shortages. Both Kansai and Kobe City residents have subsequently been very keen to get a local power station up and running. Kobelco was a particularly popular choice. It is well know as a steel manufacturer in Kobe City and played a role in reconstruction following the earthquake.

Successful closure of this deal potentially paves the way for future project financings of IPPs in Japan. The project sets a benchmark for the power industry in terms of size and amount of non-guaranteed debt that commercial lenders are willing to take on. ?It has long been said that Japan lacks the legal and contractual infrastructure for project finance. I believe that the Kobe IPP financing demonstrates that many of these issues have practically been resolved,? says Yuichi Nishigori of IBJ's project finance department in Tokyo. ?I believe that the next round of opportunities for energy project financiers in Japan will be in conjunction with the introduction of a more deregulated power market. The government will announce policy measures to take this forward in the spring of 2002.?

The extent to which liberalisation of the retail power market speeds up will dictate the pace with which new IPPs hit the market. But there are certainly opportunities for domestic (and possibly foreign) developers and Kobe has firmly established project finance as a method with which to exploit them.