Oil Bonds

Subject – Economy

Concept –

Oil bonds are issued by the government to compensate oil marketing companies (OMCs), fertilizer companies and the Food Corporation of India (FCI) for losses borne by them in the process of regulating prices in the domestic market. It was introduced in 2005 to defer the payment of money to the oil marketing companies
They are akin to government securities. These usually have a long maturity period extending over 15-20 years. Interest payments will be due at fixed intervals during the tenure of the bond.
These debts are not accounted in the fiscal deficit number of the issuing year. Unlike cash subsidies, there is no direct cash flow. Moreover, oil bonds do not qualify as statutory liquidity ratio (SLR) securities, making them less liquid when compared to other government securities.
Oil bonds can be traded for liquid cash by sale in the secondary market to insurance companies, banks, and other financial institutions.

Background:

The then government in 2005 took to issuing oil bonds as a substitute for subsidies between 2005 and 2010. High crude prices and the blowback from the recession of 2008 increased fiduciary pressure on the government.
By raising capital through bonds, these payments could be made in a deferred manner without causing a major escalation in prices, thus insulating customers.
Between 2005 and 2009, the government issued bonds worth Rs 4 lakh crore. This was done to partially compensate OMCs for recoveries amounting to Rs 2.9 lakh crore.
Under-recoveries are the difference between the cost of purchasing crude oil in the international market and the price at which petroleum products are sold in the domestic market. In the aftermath of the recession, OMCs were facing large under-recoveries. This presented the government with the dilemma of ensuring financial stability of OMCS, many of which are government-owned, while taking into account political repercussions of allowing fuel prices to rise.
Oil bonds were chosen as the vehicle to dampen the pressure on OMCs while keeping prices in check.