With only three weeks to go until its official launch, treasury ministers signalled that a dry run at the beginning of June for the new Polish Power Exchange in Warsaw had got off to a promising start. And according to reports, there were no technical glitches when 4,867MWh of electricity was traded in bids placed by six companies at an average daily price of Z83.99 ($19.18) per MWh ? this is around 27% cheaper than the average price of Z115 that electricity distributors paid to generators in the first quarter of the year.

?Feelings about the new power exchange are no different in Poland than they were for other exchanges elsewhere,? says Tom Maj, associate director in the global structure finance department at WestLB in Warsaw. ?Some people think it will be a disaster but my view is that it will produce a liberal environment but there will also be direct bilateral contracts for sale.?

The success of the new bourse, in which the Polish treasury has a 30% stake together with Poland's Elektrim, Spain's Endesa, the Warsaw Stock Exchange and the Polish Power Grid, has implications not only for Polish consumers but also for the trade of electricity across eastern Europe. Potentially it could become the electricity trading hub for Poland, the Czech Republic, Slovakia and Lithuania. Following in the path of similar ventures in the UK and Scandinavia, the PPE is part of Poland's accession into the EU.

And this same desire to meet EU criteria for entry has also had other implications for Poland, most importantly that the government is having to address the structure, age and productivity of all its power distribution and generation companies. Consequently during the past 10 years in Poland, the power sector has undergone considerable restructuring.

In 1997, the government introduced an energy law promoting competition and liberalization. This was followed in 1998 and 1999 by secondary legislation governing the privatisation of the sector and the establishment of an independent regulator.

But 10 years of restructuring and the gradual booming of the country's economy, which has seen Poland's rating rise to a steady BBB, is only just beginning to show results. Poland may be more advanced in liberalising its power sector than many of its neighbours but it is still far from achieving an ideal.

Since the 1998 signing of Nowa Sarzyna, Poland's first greenfield independent power plant to be financed on a non-recourse finance basis, there have been no further true non-recourse deals signed until now.

In the next two months, Dresdner Bank is expected to bring the Chorzow deal to the market. The project is sponsored by Elcho which is 88% owned by the US power company, PSEG. The debt-to-equity ratio on the project is 80:20. Dresdner is arranging $268 million in debt for the deal. This is split into two tranches ? a $193 million tranche and a $75 million zloty equivalent local currency tranche. Both tranches carry an 18.5-year tenor, which includes the three-year construction period. Pricing details have not been released yet but the deal is already attracting considerable attention in the market place.

Chorzow, like its predecessor the Nowa Sarzyna plant, however, is unlikely to provide a template for future power transactions. Both projects are essentially greenfield projects and both have long-term power purchase agreements (PPA). Chorzow is in fact one of the last deals to have such a PPA with the state power company. Future deals will be operating in Poland's liberalised market ? however that pans out.

Says Mark Henderson, assistant director and team leader in the power sector team in the project finance group at Dresdner Bank in London: ?This is probably one of the last fully contracted power deals in Poland. Now we are heading towards a merchant power model.?

Further more the next round of power projects are unlikely to involve greenfield projects because Poland has enough existing capacity but most of its is extremely old. What foreign companies have been acquiring and buying stakes in existing companies and it is here that most of the action will be in the next few years.

Michael Davies, partner at the law firm Allen & Overy in Warsaw says that while some companies are still talking about greenfield projects, ?now all the action is going to be in the privatisation process?. He adds: ?There are still a lot of upgrades which may require non-recourse or limited recourse financing.?

Meanwhile, Marubeni, NRG and GE Capital are in talks with the government over the sale of a 35% stake in Poland's 1,725MW Rybnik power plant.

Structuring deals on balance sheet remains an attractive option for some companies. Citibank, WestLB and Crédit Lyonnais were recently mandated to arrange a $250 million US dollar project finance tranche for the Turow phase III project in Poland. However, differences of opinion caused the three banks to pull out of the deal and PKO stepped into finance the tranche on a corporate finance basis. Turow's financing, which mainly involves export credits, could trigger some interest later this year if its sponsors proceed with a bond issue, marking a first for the sector.

Local banks PKO, Handlowy BRE and PEKAOSA had already provided $250 million in financing for a zloty tranche. Some see this increasing involvement from local banks as promising, although others claim that they lack the funding and knowledge base to back big deals. But with many of the international banks acquiring or boosting stakes in the Polish banking sector, local banks will benefit.

Poland may be ahead of many of its neighbouring countries in the liberalization of the power sector but full liberalization is still some way off and is causing concern.

Poland now has an energy regulator and a timetable for liberalization, which will be kick started by the launch of the new power exchange, but total liberalization will mean a move towards merchant plants where power is sold into a pool. This is already raising other issues.

In the UK, one of more advanced power trading markets, banks have only recently started to finance merchant deals. And even in some of these UK deals banks have not always fully understood the risks involved in financing merchant plants and that these risks are not reflected in the pricing of the debt. The question is whether banks will be able to take on that same risk in Poland. The recent Polish project finance deals have been done off the back of a long-term power-purchase agreement (PPA) and it does raise the question that if Poland moves away from the PPA, what impact will that have.

?Banks will have to get comfortable with the new environment where power is sold into a reasonably liberal market,? says Davies.

But others are less bullish about the pace of change in Poland. ?There are always lots of prospects but things are generally pretty slow,? says one London-based banker. ?Despite the recent legislation there has been no significant progress. And because the government is breaking up the electricity sector and new roles are being assigned there is a degree of uncertainty over major issues such as who the new offtaker will be.? This level of volatility is holding back some banks.

Added to this, there are also issues of third party access. EU directives aim to encourage free markets for power trading. Under the Polish Energy Law there is a form of third party access whereby a number of companies can access the grid but most are domestic companies. There is only a very limited amount of cross-border trade. Without reform these restrictions will affect not only the country's entry into the EU but its involvement in future projects.

One of the plans being mooted is a Russian power line which would carry power through Poland to Russia. Igor Muszynski, partner at White & Case in Warsaw, says that the benefits of exporting power ?will not be obtained over night?. But he adds: ?In order to export electricity or gas, new electricity grids and gas pipes which will provide from more transmission capacity must be developed. An investment of this size will require project financing before it is implemented.?

Poland's power problems are mimicked in its neighbouring countries.

Hungary's own power privatisation process has been clouded by uncertainties. For example, Electricité de France in May announced that it would be bidding for a stake in MVM. However, EdF first bid as part of a consortium in 1995 but at the time the state privatisation agency aborted the tender following a number of sales of gas and distrubution companies.

Now the sale of a minority stake in MVM, which is being restructured in preparation for Hungary's own market liberalization, is unlikely to take place for another two years. And even that date could be threatened by impending court cases.

These cases relate to the 1995-97 privatizations during which the then right wing opposition parties said that new power sector owners should not invest in Hungarian generators. And under the terms of their new sales contracts, the new owners of plants such as Bakony, Tisza and Budapest Power were obliged to build new power stations. But by 1998, when Commerzbank was well underway arranging financing for AES's Borsod project (Tisza-owned), MVM backed away from signing its power purchase agreement, along with that of Bakony.

Bakony Power has since launched an arbitration case against MVM over its alleged failure to adhere to the contract and AES is believed to be considering a similar action.

Just one step ahead of Borsod was the Csepel deal which signed at the end of 1998. The power financing became one of the deals of the year ? highlighting the sponsor PowerGen's innovative funding structure as well as the sponsor's ability to bring its arranging banks, Crédit Lyonnais and Credit Suisse First Boston, around to its way of thinking.

Hindered by the 1998, Russian crisis, sponsors are slowly pushing ahead with projects in other parts of central and eastern Europe. Enron, for example, has brought in the European Bank of Reconstruction and Development (EBRD) to finance its 240MW Jeretovec plan in Croatia. The initial financing structure involved plans for a euro denominated project bond but Enron has since dismissed that in favour of a traditional structure. The EBRD will arrange the Eu200 million deal using its A-B loan structure.

The further east and the greater the need for the EBRD.

But in countries such as Poland, Hungary and the Czech Republic the involvement of the EBRD in project finance deals is not as great. These countries face the difficult task of attracting international banks in and keeping international power sponsors committed to projects that, in some cases, they have already been involve with for several years. But if government's in countries such as Poland do not clarify the next stages in the liberalization process they could be in danger of losing interest.

Worse still the government could find that the only way banks will do business in Poland is at a premium.

Says Henderson: ?Sponsors need to clearly define what the timetable for these projects is. I wouldn't like to finance anything especially merchant plants without some level of certainty. It took eight years to structure merchant deals in the UK and if sponsors carry out financing before they have a clear structure in Poland, banks will start charging a premium. That won't attract the best rates from the banks and it won't help the end consumer.?