Avoiding risk
Commodity Bonds avoid the issue of currency exchange risk since the interest paid is not in any currency, but instead in a set amount of a specified physical product.
It usually would be sold at auction with the proceeds going to the bond owners — or to be more precise, to whoever holds the right to receive that particular interest payment. Avoiding currency exchange risk going forward may be the main reason buyers might prefer this type of bond, though the prospect of the commodity rising in price in the years to come will also entice buyers.
As for why a government might want to issue this type of bond, avoiding currency exchange risk — its currency dropping in value relative to others in coming years — is certainly a major factor, yet there is another excellent reason as well.
Economic Development
Commodity bonds can foster industry development and job creation, which usually would be cumulative. After all, the government must buy the commodity in question from local producers, who in turn are buying the inputs needed to produce whatever it is. And doing so locally ― either by choice or due to the supply contract requiring local sourcing.
Producers with multi-year contracts with the issuing government for a good part of their output should have little difficulty obtaining private financing. Of course, they will want to be producing more than the contracts call for. Having a solid base of output, anything additional should be at a lower unit cost than otherwise and thus likely profitable even at a lower price. Very likely also, the suppliers they use will be the same local ones, thereby further boosting the local economy.
Politicians love to take credit for this sort of thing, as voters are generally approving of more employment, because it often results in greater consumer spending and so more income for a wide array of businesses. Numerous are the voters who then benefit to some extent. So issuing commodity bonds looks to be a good re·election strategy, though some bond commodities would be more significant than others.
Biofuels
Suppose that product is biofuels, and let’s confine it to liquid furnace fuels comparable to what is currently in use. Notice how general the wording can be, that it is not stated as one specific fuel only.
Similarly, were fuel intended for blending with gasoline, or replacing gasoline, in today’s car engines, tying the bonds to bioethanol would be a mistake. Instead, having bond payments in “a biofuel suitable for a gasoline engine,” provides room for future supply contracts to be in biofuels other than ethanol. [Di·propyl ketone is an example.]
After all, the bond term is likely to run fifteen or more years, and surely the current obsession with bioethanol will at some point end. Financial types feel safe with bioethanol, despite it being inferior as an engine fuel and relatively expensive to process. Get them comfortable with a biofuel of greater energy density that blends well with gasoline, plus is cheaper to make, and bioethanol will be scorned.
Liquid furnace fuels now are typically a particular cut of the output from a petroleum refinery, something which might otherwise have been made into diesel fuel. So as liquid furnace fuels become more biofuel than fossil fuel, the petroleum refineries will want to be making more diesel fuel instead, but only if they can sell it all profitably.
Though hidden from sight, the fuel of a furnaces is burnt in open air, the exhaust going up a chimney. Burning a fuel in an external combustion (EC) engine is the same. EC engines could replace diesels in most places, such as in hybrid transit buses. These would be cheaper to buy than an all·electric bus and require no special infrastructure. Even when the energy store is electric batteries, the hybrid bus has far fewer of them and therefore much lower cost battery replacement.
When the burner of an EC engine is functioning properly the exhaust is fairly benign. Having much cleaner emissions than a diesel, the air quality in cities would be much improved. Similarly, for the benefit of better air quality on the health of urban dwellers. …Hybrid cars, buses, delivery vans, and other road vehicles should all have an EC engine instead of a gasoline engine. Indeed, they should not be registered for use on the roads unless they do.