AES, through its subsidiary AES Tanzania, has seen through the completion of the $340 million financing for its Songo Songo gas-to-electricity project (Songas), a much welcomed closure given the years of protraction the project has faced ? well before it was taken over by AES last year. It is also Tanzania's first independent power project (IPP), and East Africa's second.

AES is the lead sponsor in Songas, whose other partners are the Tanzania Development Finance Company Ltd (TDFL), a vehicle including CDC, FMO and the EIB, and the Tanzanian gas and power utilities Tanesco and TPDC. AES, advised by HSBC, bought out the original partner, Trans Canada Pipelines (TCP) last year.

The Songas project involves developing a gasfield 25 km off the south coast of Tanzania in the Indian Ocean at Songo Songo Island and transporting it via a marine pipeline and a 217km land pipeline to Dar es Salaam and Wazo Hill where it will fuel the existing 112MW Ubungo thermal turbine power plant, which is to be converted to gas-firing, before its privatization.

The deal comes heavily backed by multilateral credit financing from the International Development Agency (IDA), a World Bank financing arm, and the European Investment Bank (EIB). The former is providing a $183 million interest free credit directly to the Government of Tanzania. On similar terms, the EIB is also lending $55 million from its risk capital resources to the Government, which will then on-lend both loans to the project company, Songas Ltd.

Equity contributions equivalent to $72 million include $50 million from AES, $18 million from CDC and $4 million from EIB. The attractive feature of the equity is that the escrow account protects investments in default situations, while reducing the costs to the government going forward. The debt/equity split is 70:30.

The ownership of the existing facility at Ubungo and the corresponding outstanding debt obligations will be transferred to Songas.

IDA involvement in the project was chosen instead of a World Bank Partial Risk Guarantee (PRG) instrument, also originally under close scrutiny for possible use in the financing package.

One benefit of IDA involvement is the fact that IDA credits allow projects recourse to a World Bank Letter of Credit to cover the procurement of goods and services in the event of default, ensuring that contractors will still be paid. More generally, IDA's involvement, and World Bank participation more broadly, is seen by many as crucial in the region, easing risk profiles into more palatable shapes for private foreign investment.

Ultimately, IDA use over PRG came down to the project's historical design, which had been carved out on the assumption of IDA credit. And the financial structure in place is ultimately very beneficial to the government since it gets the credit on very concessionary terms.

Tanzania, one of the poorest countries in terms of GDP per capita, suffers a power sector notoriously inadequate for sustainable economic growth. Only about 7% of the country's population has access to electricity, a situation partly due to the inefficient operation and weak performance of (and acute under-investment in) the country's power company, Tanesco. Unable to meet its debt service requirements because of wavering tariffs and poor collection performance, the company's credibility and commercial potential has been a major issue throughout contractual negotiations on the Songas project, given Tanesco's position as power offtaker. A 20-year power purchase agreement in place with Tanesco. But to help effect the company's reform and proper functioning, the World Bank has imposed fairly stringent conditions on the Government of Tanzania for Tanseco's privatization.

The cost of the project itself is reflected directly in the electricity tariff, levelized at $0.08 ? which, according to CDC's Paul Kupert, is ?very competitive for the region.? The gas price is concessionary for the Ubungo plant for the first 100MW, and the market price thereafter. ?If we succeed in selling additional gas, the savings from the additional sales will be passed on almost entirely to Tanseco,? says AES Tanzania's project director Helen Wilson.

Songas is expected to provide cheaper power than thermal alternatives currently available in the country. It will, in theory, help Tanesco manage its asset more cost-effectively than its hydro-power resource and to meet unsupplied power requirements with more efficiency.

The project's initial phase, the development of the Songo Songo gas reserve, also represents a first stage in further development of gas and power sectors, creating substantial opportunities for additional cheap power in Tanzania and for export of gas to Kenya. With proposed interconnections to the Southern Africa Power Pool and to Kenya, Tanzania could be well positioned to become a net exporter of power in the region.

?In general terms,? says Wilson, ?the assumption is that more gas-fired generation is needed but as of now, no one has officially started planning for this. But by 2005 we could see some new developments.?

A key issue still facing future IPP development is the extent of commercial bank participation in financing. Risk perceptions are still prohibitively high and even deals like last year's much touted Kipevu II IPP in Kenya, despite its success, may do little to establish new financing benchmarks for future deals going forward. That deal flaunted an IFC B loan umbrella which provided sufficient comfort for commercial bank lending

The Songo deal, in contrast, called for purely multilateral debt. ?Commercial funding is clearly something we'd love to have but right now conditions are not optimal throughout Sub-Saharan Africa?, says Wilson. And the question being asked by sponsors and lenders alike is whether project finance is indeed a viable route for the entire region, at least for IPPs.

That remains to be seen. However, the major concerns for the region will be demonstrating that investments like Songas do in fact make sense and that it, and projects like it can, and will, make positive contributions to economic growth. From the current perspective, this is one deal that looks set to make a healthy impact.