In Foreign Parts: Declan Walsh in Bujagali, Uganda

Two cows, a sheep and a goat die to appease the river spirits

In the old days, Western multinationals trying to push through sensitive projects in the developing world had to do battle only with governments and environmental protesters. These days they also need the blessing of the spirits.

This week 40 spiritual diviners gathered above the spectacular Bujagali Falls, five miles from the source of the Nile in Uganda. The old men, dressed in bark cloth and cowrie shells, set a fire on the riverbank. Then they dragged two live animals – a goat and a cockerel – on to the coals and, in three groups of five, took it in turns to dance on the dying creatures while leading prayers.

Their purpose? To appease the ancient spirits of the falls in preparation for the day when they will be swamped by a $550m (about £400m) hydroelectric dam, which AES Corp, a huge US power company and one of Fortune magazine's 100 fastest-growing firms, plans to start building next month.

Conscious of the negative image that has dogged many large dam developments in the Third World, AES has gone to considerable lengths to win over sceptics of the Bujagali project. It has spent millions of dollars on compensating riverine residents, renovating run-down schools and sprucing up health centres. It has also paid for chicken-killing ceremonies.

"We have to appreciate the way people live. This is a way of life for a minority and we believe in facilitating them," said John Baptist Kaggwa, the AES cultural mitigation manager.

One sheep, two cows, four goats and many chickens were sacrificed by the spiritual diviners – healers, rainmakers and witch doctors – he said. Later, they sprinkled animal blood on sacred trees and said further prayers before sitting down to an evening feast of meat washed down with gallons of home-brew banana beer.

If the 250-megawatt Bujagali Power Project gets a green light from the World Bank next month, it will be east Africa's largest private investment yet. The project has its critics, mainly among environmentalists and in the tourism business, but AES has also been praised for its culturally sensitive approach. Now, however, the company is discovering that that world of river spirits can be just as hazardous as the rocky rapids of the Nile. A heated and sometimes violent row has erupted between two groups, both of which claim to represent the spirits of Bujagali Falls.

On one side are members of the Ntembe clan, who conducted last weekend's ceremony and who say they are the traditional "caretakers" of the spirits. On the other is their bitter rival, Nabamba Budhagali, a local witch doctor who wears shoulder-length dreadlocks and a tobacco yellow beard and who claims to be the 39th official "medium" of the falls. Most Ugandans are Christian, but a minority in rural areas still believes in traditional religion, and others mix the two beliefs.

The Living Budhagali (his full title) claims to have the power to cure impotence, bless the newborn and cure – or curse – cripples. Six weeks ago, AES paid him 12 million shillings (£5,000) to hold the first appeasement ceremony. But it failed, he said, and the fault lies with the Americans.

"We invited the wazungu [whites] to come and speak but they refused. They said it was evil," he said. "And that was why the spirits refused the construction to go ahead." Aisa, one of his four wives, offered another reason. "The money they gave was not enough to finish the whole function." The Budhagali said 30 million shillings (£12,000) would be acceptable.

AES officials are exasperated. The company started to woo the spiritual figure in 1998 when it sent a letter to "humbly request an introduction meeting between the Living Bujagali and Shandwick UK Public Relations Consultants", a company hired to buff its image locally.

Since then it has hired university professors to study local cultural practices, negotiated a deal for the appeasement of the spirits, and even signed a memorandum of understanding with the Budhagali. But still no appeasement. Mr Kaggwa said: "He gave us the requirements for the ceremony and we provided them. As far as we are concerned the spirits have been appeased."

But the spirits are not alone in resisting the project. The proposed dam will drown five sets of rapids along a four-mile stretch that is just six miles from where Lake Victoria empties into the Nile. Rafting companies say the government is allowing a beautiful – and highly lucrative – resource to be destroyed. Cam McLeay, a New Zealander who owns the Adrift rafting company, said: "This is probably the best stretch of rafting water in the world, more exciting than the Grand Canyon of the Colorado river. This will ruin one of Uganda's prime attractions overnight."

Other critics, such as a lobbying group in California called the International Rivers Network, argue that the compensation plan for 714 affected villagers is inadequate, and that the Ugandan government, which has entered into a 30-year contract with AES, has undersold itself. But the company also has its supporters, including some conservationists. They say its approach is a textbook model for other big projects, and point to the benefits of increased power in a country where 3 per cent of the population has electricity and where factories lose up to a third of production due to blackouts.

Now AES is awaiting final approval from the World Bank. If it gets it, construction work could start by the end of this year, according to the country director, Christian Wright. First, though, they want to overturn the supernatural hex.

Although a spiritual leader, the Living Budhagali has turned to earthly means to settle his dispute with the Ntembe clan. Last month his lawyers wrote a letter warning them to "back off". A few weeks later, a newly constructed Ntembe shrine was knocked over in the night. "I'm the one who demolished it," he admitted with a smile. "Those ones are confusing the situation. They want to get some compensation."

AES has referred the dispute to His Royal Highness the Kyabazinga, the traditional ruler of the Busoga kingdom. He in turn has passed the task of mediation to the Minister of Culture, Florence Akalya. She said: "As a woman and a retired teacher I know how I will approach this man. "We will sit with the elders of the masazas [councils] of Busoga. Then we will try to sort this out."