The difficulty spike: how would you address this situation?

As far as the difficulty spike goes, it sounds like adding guest characters is one solution you're exploring.

Honestly though, if Edgar is too weak now, he'll be too weak later as well. Cover is a pretty lackluster ability, unless the player is set up as a damage sponge (high natural HP, high defense). To set Edgar up this way, you'd need to subtract points from his other stats, like his Magic Attack. The ONLY game I've ever seen that has made "Cover" worth it is Xenosaga Episode III, where Ziggy could double his own HP for the duration of the battle, then force enemies to lock onto him. This made glass cannons like Momo viable.

Other possibilities:
* Drop Sabin's "Fire Dance" to level 12. Most players will already be at Lvl.12 when this fight starts, and if they're not, the exp they learn from the battle will probably put them over the edge.
* If Gau learns Rages just by encountering enemies (I'm reading between the lines here), make one of the enemy's rages a healing ability.
* If Shadow ends up in your party, have Banon give him 2 of the scroll that causes "image" status.
* If I remember correctly, one of the enemies casts Ice. Change that to an enemy skill that is less powerful, or drop that enemy's Magic Attack. In my 3 scenarios hack, I had to drop Rizopas's MA since he is encountered at the beginning of the scenario and not at the end. In Divergent Paths, I had to majorly change TunnelArmr, since Runic is not there.
* Put in an event where talking to Banon mid-battle will heal your HP/MP.

Two of Sabin's moves inflict revenge style damage.  One heals him to full, while one does his missing HP in damage to all enemies.  Mantra also heals the party for Sabin's current HP/targets, so Edgar's cover pairs well when Sabin is in the party.  I was also hoping players would use the Cure Ring to boost Edgar's HP; it becomes available in Jidoor and gives Regen and MaxHP+25%.  ...Maybe I should restrict that relic to him (or at least a smaller party set) to encourage its use on him.  Edgar gets another upgrade in the World of Ruin after beating Vargas (former Brachiosaur), a relic that replaces Cover with X-Jump.
I have to see how it plays out, though; I'm still testing the mechanics in this phase.

Gau does not learn rages from fights; he has an opportunity to grab some during the scenario split but you can't get back to the Veldt until you have an airship.  Greasemonk casts Cure and he starts with it, though, so it's not a problem.  As is, he's the strongest character in the fight, in part because he can use the specials twice (claw weapons work like Genji Gloves).

I've been meaning to bump up Sabin's learning of Blitz 4 for the Phantom Train event, so that sounds like a good idea too.  Making Banon heal the party is shear brilliance, though; it's a pity I don't have the event room to pull that off.

I had gotten Mog to do a pose after Banon's quote, but for some reason the game would soft-lock if Mog was in a party and there were team members not selected.  When I removed all the 'ready' poses from the start of the fight, this soft-lock vanished, so I'm guessing I hadn't set his actor up correct or a pointer was going to the wrong spot.  I did use some free event space to give him dialogue during the fight, though it's just "Kupo-po!".

This is the second byte in the event code. Subtract 80 from the second byte of the action queue, so if it is [0A 84], change it to [0A 04]. A value of 80 on the second byte indicates that the whole event cannot move on until that character's action is complete. However, if Mog is not on-screen, the action CAN'T complete.

And for this, you are my hero!  Now the event is indistinguishable from its original version within the same event space, save that Kefka smiles instead of laughing (had to cut the Action 0E and the repeat to make room).

I'll admit the event editing is very frightening for me; I've been trying to avoid it until I can get out another demo, so that if I break the game I still have something to show for all the effort.  If possible I want to release Version 2 before I do any more futzing with the event script.