The Indian Economy Blog

July 21, 2007

Oil Bonds

Filed under: Banking,Business,Energy — Karthik @ 12:54 am

Once again, the petroleum minister Murli Deora has requested the finance minister to issue oil bonds. In what is becoming common practice now, the money thus raised is going to be used to “compensate the firms for selling below cost”.

For starters, this move is simply bad financial practice, for it violates one of the basic principles of corporate finance – that the cash flows of the source of funds should approximately match the cash flows of the application of funds. it is quite an extreme case of violation here – with long term bonds being used to finance immediate expenses.

Leaving theory aside, while this measure, at the moment, may solve the cash flow problems, there is much doubt about the future. By issuing bonds, the firms are simply taking on more debt, which has to be repaid some day. What these bonds are doing is to just postpone the losses, and also, in a way, amortize them over several years.

Now, it is easy to see that issuing oil bonds is akin to taking on a personal loan. It is just like a loan to spend on a wedding, or to go on a holiday – or any other loan which is used to fund an expense, and not an investment. And if you have been to a bank and cared to look at their different products, you will notice that interest rates for personal loans are significantly higher than those for say home loans or car loans, which cover investments rather than expenses.

In context of this analogy, it would be interesting to compare the coupon offered by these oil bonds to the coupon offered by bonds which have been issued in order to fund investments. While business sense says that the coupon for oil bonds be much higher, I’m not sure if it is going to be the case in practice (I don’t have the figures. If you do, please leave a comment).

Now, in case we had functional corporate bond markets in India, they would have ensured that these oil bonds traded below par (assuming the coupon is similar to that for debt raised for investment) in order to account for the fact that they cover an expense and not an investment. However, the absence of such markets and government control over a large part of the financial sector enable the oil firms to get away with a low coupon.

Government owned financial institutions such as PSU banks (beautifully referred to as “SOBs” or “state owned banks” by Percy Mistry), LIC, UTI, etc. will be forced to subscribe to these issues. By subscribing at a price above the “fair market value”, these SOBs, LIC, etc. are forced to bear part of the burden arising from selling petroleum below cost.

To stretch things a little, a part of every rupee you save on account of lower fuel prices will be extracted from you by the SOBs (lower interest rates for deposits, higher rates for loans), LIC (a higher premium), etc. (the rest will go from the taxes you pay). What is effectively happening is that a part of the burden of petroleum subsidies is being redistributed, to users of public sector financial institutions and also to the taxpayers.

And as if all this was not enough, repeated usage of oil bonds would result in degradation of credit-worthiness of the oil firms, which would force them to increase the coupon rate for further debt issues, thus increasing their cost of capital, which could create much more trouble in the future.

To sum up, it seems like the issue of oil bonds will create a much bigger mess than the one it is supposed to solve. It might be useful for the government to look at alternate ways of handling this situation. Of course, it must be mentioned that the mess is not immediate – it will show up a few years down the line when the government would have probably changed. Who cares about such long-term mess-ups?


  1. The APM (Administrative Prices Mechanism) is supposed to have been scrapped 5 years ago, but still continues in India. Though, I’m not sure who is going to foot the final liability, it is clear that common man is going to suffer for oil users, by having the government redistribute the costs. So, it is a robbing Peter to pay Paul, wherein common poor (very small percentage of Indians use gasoline or Diesel) subsidize those who drive cars or use electricity. While I could understand raising Kerosene prices can be politically costly, there is no case for not raising Petrol or LPG prices. These prices should be taken completely out of APM and should reflect global prices, everyday, along with Jet Fuel and industrial fuels.

    Diesel subsidies should also end and govt shoudl make sure the Oil PSUs break-even on Diesel over a period of a month, while Kerosene could be raised by a couple of rupees and rest shared between all the governments – Central, State, local, etc.

    But, nothing is possible without a support from Left, and they oppose anything that could do good to India. Right now, the government is screwing India, just because our fellow Bengalis and Keralites choose to elect stupids to Indian parliament.

    Comment by Balaji Viswanathan — July 21, 2007 @ 4:15 am

  2. Hi,

    Would like to point out something that I found quite intriguing.

    We all know the one of the main reasons for such high prices are the astronomical taxes that are imposed on them ( 100 – 150% ).

    Most or atleast a very large chunk of this money goes to the states.

    Everybody seems to agree that the best way to curb prices is to rationalize and/or lower taxes. The Government is compensated for the lower tax rate by the fact that oil prices are high to effectively they get similar absolute returns. That is everybody but the government.

    They Think it is a better idea to tinker with oil prices and subsidise the loss of the companies.

    Why do they do this?

    Could this be an indirect way to subsidizing the state governments? a large portion of the taxes go to the states. So effectively the Central Government is indirectly subsidizing the sate governments.

    This could also be a convenient bookkeeping exercise for the government as the tax revenues are higher by keeping the taxes on oil high. This allows them to show a lower budget deficit etc etc. I’m not sure how the oil bonds are treated in the budget but im sure they have managed to keep it in a convenient place.

    Just my thoughts. Does it add up?


    Comment by Tee Jay — July 23, 2007 @ 11:15 am

  3. ..This is a great multi-faceted issue to analyze and understand how inter-twined the underlying goals are, and how creative the solutions could be to fit our indian context::

    1) CONSUMPTION: From the economy’s perspective, the lower the imports.. the better the balance-of-payments/trade-surplus would be. But, with Petrol/Diesel becoming a necessity for house-hold owing to majority of the working class relying on personal transport and indirect-material-transportation-cost associated with diesel trucks…it’s a commodity that will be in CPI basket with decent weight and would have to be monitored.

    POSSIBLE SOLUTION: Govt can create a model where states and/or cities investing/setting an efficient public transportation would be strongly incentivized as studies have clearly shown that countries carrying good public transportation had lower per capita fuel consumption. Once you provide this, the weight of fuel in CPI basket can come down and non-essential-splurge of fuel could be taxed through congestion(time/permiter) taxes you see in countries like singapore and UK.In essence, provide an alternative to typical-households before you tax the consumption.

    2) CPI/WPI/PPI: Good amount of totally valid discussion is in different blogs on the accuracy, applicability, transparency, usage of these different inflation metrics in indian context. CPI, despite the fact that this is still not reflective of typical household consumables and not a resonable metric to look at, as the criteria is better than WPI.

    QUESTION: Now, should govt. be manipulating the market (Oil bonds, etc.) each time a commodity in CPI basket shows price distortion (or) handle the CPI at the macro-economic level by leaving the control-knobs to RBI??

    A) If distortion is artificial (price gouging, etc.) >> step in and correct the situation. [Examples: Wheat, Cement]
    B) If distortion is global and supply-driven and is inevitable >> make policy changes to cut down the demand and incentivize alternative commodities and/or leave it to macro-economic-policy-drivers like RBI.
    [Examples: Petrol, Cement]

    The federal govt. can make these kind of guidelines as part of National-Commmodity-policy, just like security policy and evolve this under independent body with out any politicking and mud-slinging by opposition during these market distortions forcing the ruling-party to haphazardly invent short-term price-smoothing tricks (Oil Bonds!) that create more damage in the long term.

    Any takers? Montek? Manmohan? Chidambaram? RBI Team?

    Comment by Krishna Moturi — July 25, 2007 @ 1:50 pm

  4. [...] INDIA: Oil Bonds: [...]

    Pingback by Agenda & Objectives: « Siva Moturi’s Economic Policy Critique Blog — August 1, 2007 @ 2:38 am

  5. The oil bonds are not borrowings of OMCS. But they form part of their revenue. Oil bonds are expenditure of the union govt.

    Under the scenario of rising prices of crude, there are two options with the govt., either to increase prices of perto products in tandem, or to make good losses of OMCS by giving them assistance in one form or other. Of the above two options, what option the govt should follow depends upon the merits and demerits of the options. It can rely entirely on one option or may choose a bit of one and a bit of the other.

    For the Govt. the oil industry as a whole is one unit, which comprises all govt. owned companies viz., upstream companies, downstream companies and stand alone refineries.

    In the year 06-07 the govt. issued oil bonds of about Rs 24000 crores, which is roughly about ½ percent of GDP. Oil industry has always been a rich cash cow for the govt. as every year it milks huge revenues from it in the form of indirect tax, direct tax, and dividends.

    Last year the average price of basket of crude imported by India was about $ 66 per barrel. Even at such a high price of the crude, the union govt. was not only able to do away with any price increase in petro products(whatever price was increased was rolled back), but able to keep intact its oil revenues of indirect taxes(both central and state govts).

    To give oil bonds of Rs 24000 crores it had to sacrifice only its revenue of direct tax and dividends from the oil industry. Last year it got about Rs 22000 crores in the form of income tax, dividend, and dividend tax from IOC, ONCG, HPCL, BPCL AND GAIL. And about 2000 crores it must have got from OIL.

    So it would be seen that there was not much ill effect on the fiscal health of the union if it had to issue oil bonds of Rs 24000 crores. Figure of this order appears to be well sustainable from its oil revenues, even if it becomes a permanent practice. From another angle it is tantamount to rise in fiscal deficit by about ½%.

    But the same time it is true that the govt. should not be this passive as regards taking politically distasteful decision of raising prices of petro products. If not in its entirety at least to certain level, say 50%, it should raise the prices. After all this is the original and proper way. And if you do not follow proper way, in short run you can push the things somehow without much discomfort, but in long run there could come up feeling and sense of suffocation, apprehension and confusion for all the concerned viz., the oil industry, the new investors, the govt., the public and the taxpayers.

    Comment by BHARAT PITTI — August 8, 2007 @ 4:41 pm

  6. the oil bonds issued in 06-07 attract an interest rate of

    Comment by kris — August 9, 2007 @ 2:45 pm

  7. Oil facts by Bharat Pitti

    Govt. OMCs viz., IOC, HPCL and BPCL need about 2 Million Barrel Oil daily. Their combined under recovery for rise in each dollar of crude price is $2 Million or Rs 8 crore.

    At the current selling prices of their finished products, there is no under recovery for Crude at about 51 $ per Barrel.

    In H-1 2007-08, the average price of Indian basket was about $69 per barrel thus resulting into daily under recovery of Rs 144 crores and total under recovery of about Rs 26208 crores.

    The daily under recovery for the given prices of Indian basket in H-2 comes out to be as under:

    Under Recovery
    Crude Per Daily Total-H2 Total-H1 Total-07-08 Barrel
    $ 80 232 Crore 42224 Crore 26208 Crore 68432 Crore
    $ 85 272 Crore 49504 Crore 26208 Crore 75712 Crore
    $ 90 312 Crore 56784 Crore 26208 Crore 82992 crore
    $ 95 352 Crore 64064 Crore 26208 Crore 90272 crore

    The estimated under recovery of about 55000 crores as estimated by the Govt. for the year of 20007-08 is based on Crude prices of 70$ per Barrel for the entire year of 2007-08.

    Currently when the Indian basket is ruling around $90 per barrel, the daily under recovery of OMCs is about 312 Crores.

    Your comments are welcome to

    Comment by BHARAT PITTI — November 9, 2007 @ 11:15 am

  8. Government owned oil companies in India suffer losses as the prices of petroleum products are administered by the government. Even when the oil prices increase the government is not in a position to rise the prices automatically due to fear of loss of popularity. So the government issued oil bonds to cover the losses or to put it simply the loss was covered by the government without paying a single rupee from its funds. The oil companies can raise loans against the bonds but can they cash the same is a moot question.

    Comment by ajay — May 15, 2008 @ 11:14 am

  9. i still do not understand the mechanism of these oil bonds. i have tried hard searching the net. but so far not succeeded.

    Comment by karpakarajan — May 31, 2008 @ 1:36 am

  10. I have also been trying to understand how these oil bonds work and it makes my head spin!

    I studied the financial statements of IOC for 2007-08 and here is what I understood.

    IOC makes a loss selling petroleum product due to govt. restrictions on pricing (i.e. administered price regime). The govt. of India “compensates” this loss by issuing special oil bonds.

    IOC shows these bonds as income on its P&L (the IOC P&L statement for 2007 – 2008 shows an income of Rs.13,943 CR this way). Hence, immediately the loss is converted to a profit!

    IOC also shows these bonds as investment on its balance sheet (Schedule G of IOC balance sheet for 2007 – 2008 shows investment worth Rs. 14,308 in these GOI special bonds). This is instructive. This means that without paying a penny for these bonds, IOC invested in these GOI bonds! If you think about it, the real investment is the losses IOC incurred to oblige the govt.

    Now, if IOC just sits on these bonds, it will get a cash flow (around 7% – 8%) from GOI by way of interest payment on these bonds. Also upon maturity, the GOI will actually have to redeem these bonds from IOC (maturity periods are anywhere from 2009 to 2026 as per Schedule G). i.e. upon maturity the GOI has to actually cough up cash compensation for the losses IOC has incurred in 2007 – 2008!

    Instead, what IOC does is, it sells these bonds in the secondary bond market to mutual funds, LIC and other such financial institutions. Thus, the bonds are converted into hard cash (Schedule G says IOC made Rs. 6,503 Cr this way in 2007- 2008). This is how IOC gets hard cash to compensate for its losses immediately. (Of course, upon maturity the GOI has to still pay cash to whoever holds these bonds at that time).

    I hear IOC sells these bonds at a loss (
    I also hear that RBI in stepping in to buy these bonds at full value ( Not clear what the implication of all these is.

    The ugly part is this: GOI has issues bonds without actually borrowing from anybody. This goes against the definition of a bond. More specifically the GOI has issued bonds to IOC without directly borrowing any money from IOC. The borrowing is indirect – IOC made a loss to oblige the government and that is akin to the GOI borrowing from IOC and hence the GOI issues these bonds to IOC. This is the crux of the matter.

    Bottom line is, the oil bond is a GOI bond and hence is a govt. debt which has to be repaid some day. I hear that this debt stays off-budget and hence does not reflect in the revenue or fiscal deficit ( I haven’t figured that out yet.

    At least, this is my understanding. I hope and believe I got most of it right.

    Comment by Kishore Kumar — July 7, 2008 @ 12:26 pm

  11. Oil bonds will not hide inflation in long run. Oil bonds will draw savings from people and thus less money available for others and thus inflation.

    Comment by satish — July 7, 2008 @ 1:03 pm

  12. Oil bond is nothing but “postponing the pain & Problem for another other day”

    This is the way Indian government deals with losses for subsidizing petrol price.

    It works like this.

    Let us say the actual petrol price/cost is Rs50 but The government controlled oil companies are forced by the government to sell petrol at Rs40.

    Who will cover the loss of Rs10 – If it continues for a few months the companies will go broke and bankrupt.

    The government steps in and issues a bond (Borrows/loans from the market)Investor attracted by the guaranteed interest buy the bonds.

    The government pays the interest on the loan/bond.

    At some stage the (Some) government has to repay the loan.

    It is called sweeping the dirt under the carpet.
    It is no different from drawing cash from one credit card to pay the other credit card.

    One day it will blow up,but at that time it the problem of the next goverment.

    My commonsense says it is not a good Idea to use this sytem commonly.

    This system can be used scarcely for short time in small amount while the price is adjusted to reflect real world oil price.

    Comment by Galicula — July 10, 2008 @ 9:57 am

  13. I was recently in Gujarat and saw a lot of petrol pumps closed which belonged to both Relaince and Essar

    I was wondering if the GOI was bailing out the state oil companies why not the private ones also after all they have also invested money and want to sell the product in the market

    look at all the wasted investment laying around

    I dont understand the oil bonds but would my father loan me money knowing full well that its going down the drain?????

    We have excellent money managers in the government but i guess votes count more than the country???

    with the left out of the government now will everyone wake up?????

    if you are giving out money to the oil SOBS why not me? my hands are also opened wide

    Comment by alok — August 10, 2008 @ 6:02 pm

  14. Baffling mystry of profits by Govt. Oil Marketing Companies in Q-3 2008-09

    Quarter-3 results of three OMCs make one believe that these companies came out with robust profit, except HPCL that even after that mystry returned loss of Rs 418 crores PBT. And the share prices of these companies are continuously on upswing after their Q3 results.

    But the story of the profits of these companies is something else and it is surprising that market has completely given a blind eye and indulged into joy ride as the way the share prices of these companies are going up and up.

    In the quarter three, these three companies got excess support by about Rs 8581 Crores from upstream companies and the Govt. oil bonds.

    For this quarter total under recovery of these three companies were about Rs 13522 crores only. But against that, they got reimbursement of Rs 22103 crores, being Rs 6066 crores from upstream companies and Rs 16037 crores oil bonds. Thus they were given excess reimbursement by Rs 8581 crores and that went about Rs 1750 crores to HPCL, Rs 2098 crores to BPCL and Rs 4733 crores to IOC.

    The declared PBT of these companies were Rs (-)418 crores HPCL , Rs 803 crores BPCL and Rs 2967 Crores IOC.

    Without the excess reimbursement of the said Rs 8581 crores, normal PBT for the quarter would have been Rs (-) 2168 crores HPCL, Rs (-)1295 crores BPCL and Rs (-)1766 crores IOC.

    So it is very surprising to see the run in the share prices of these companies after the kind of results they have actually given.

    Another baffling fact is that, HPCL has logged out the worst performance but the share price of this company has run the most of all.

    Comment by BHARAT PITTI — February 10, 2009 @ 6:42 pm

  15. Now RBI has stopped Open Market Operations for purchase of oil bond from PSU OMCs. What will happen to them in case they dont find any buyer
    for bonds they are holding.

    As these bonds are longterm bonds. What will happen at the time when these bonds get matured for payment.

    from where govt is going to raise money for paymet of these bonds.

    Now these bonds have been monetiesed by the oil compaies by selling them in secondary market there by
    utilising investible surplus of the economy for paying the crude oil bill which was not born by the real users of the product.

    This has restricted your capital formation and slowing down of the growth rate of the economy.


    Comment by SANDEEP PADTE — March 9, 2009 @ 3:08 pm

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