What are Oil Bonds?
Oil bonds are government bonds that can be used in countries that use government-controlled oil pricing structures to compensate oil companies for the losses they incur in those countries, as a result of the government's oil price controls. The government of India is particularly well known for the oil bonds it issues to oil companies that it owns.
The government issues to these companies such oil bonds to compensate them for losses that they incur when the government cannot allow them to raise their oil prices fast enough to keep up with global oil prices, when global oil prices happen to be on a sharp upward trend.
The Global Oil Market
The nature of the global oil market is a very volatile market, where oil prices can often rise by double digit percentage points in a single day. This is because, apart from the demand and supply forces that affect oil prices, the price of oil is also affected by the deliberations of OPEC (Organization of the Petroleum Exporting Countries), which is a group that controls global prices.
It is in appreciation of the volatility of the global oil market and the effects of changes in oil prices across the economy that governments are usually wary of letting supply and demand control the markets. One of the measures that governments take to protect the general population from the effects of global oil price fluctuations is to issue oil bonds to companies whose oil prices they control, so these companies can continue selling the oil products they stock at reasonable prices---even when there is a huge and sudden rise in global oil prices.
Selling Oil Bonds
Oil bonds, like all government bonds, can be cashed upon maturity (where the oil company claims money from the government on account of the bond). But because they take too long to mature, and the companies need the money in the bond to keep themselves afloat, the standard practice is to sell the oil bonds (which are like any other government bonds) to the financial institutions that specialize in trading such bonds. The bonds are bought at a discount for the financial institution to make a profit on the maturity of the bond.
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