What is oil bond?

• 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. On November, 2010, the Minister of State for Petroleum and Natural informed Rajya Sabha that the debt burden was to be shared by public sector oil companies, the government, banks, and other stakeholders.

Remedy:

• Petroleum and diesel prices were heavily subsidized to keep the consumers insulated from the global oil price rise during 2005 to 2012 but at the cost of the increased subsidized cost which the future generations have to pay.
• The first step towards deregulation was taken in 2010 with the announcement that oil bonds will be discontinued, and OMCs will be paid in cash.
• In June 2010, petrol prices were deregulated, mirroring the market price of crude. Diesel went the same way in October 2014. In June 2017, the government adopted the system of dynamic fuel pricing whereby the retail price of petrol and diesel fluctuate on a daily basis.

Conclusion:

• The outstanding oil bonds (as on April 1, 2018) which will be discharged only between 2022-2026 is Rs. 13, 0923 crore while Majority of bonds are yet to mature in 2022 the fuel taxes (imposed on petrol/diesel like central excise and state VAT) can’t be reduced in future also so that these bonds may be paid in cash raised through this tax. Deregulation of prices will be one of the remedy to solve this energy triggered resource constraint, should also incentivize the use of bio fuels, solar energy to reduce the dependency on crude oil.