Letters of Credit in Oil Trading, in Plain Terms

An oil cargo can be worth millions, and the buyer and seller often sit on different continents and have never worked together. The seller doesn't want to ship before being sure of payment. The buyer doesn't want to pay before being sure the cargo was shipped. A letter of credit is one of the oldest tools in trade finance for solving that problem.

In simple terms, a letter of credit (LC) is a written undertaking from the buyer's bank to pay the seller, as long as the seller presents documents that match the LC's terms exactly. Most LCs are issued under the ICC's rules, known as UCP 600, so everyone works from the same rulebook.

How it protects both sides

The seller relies on a bank's commitment instead of the buyer's promise. The buyer knows payment is only released against documents showing the cargo was shipped on the agreed terms. Banks deal in documents, not in the oil itself, so precise paperwork matters.

The main steps

• Contract: buyer and seller agree the sale terms, including that payment will be made by LC.
• Issuance: the buyer asks its bank to issue the LC in the seller's favor.
• Advising and confirmation: a bank in the seller's country passes the LC on, and may add its own confirmation so the seller also has a local bank's undertaking.
• Shipment: the seller loads the cargo and gathers the shipping documents.
• Presentation: the seller presents the documents to the bank within the deadline the LC sets.
• Examination and payment: under UCP 600, banks have up to five banking days to check the documents. If they comply, payment is made at sight or on the agreed deferred date.

The documents financiers look for

• Commercial invoice matching the LC's description, quantity and price.
• Bill of lading, usually a full set of originals, showing the cargo was loaded.
• Certificates of quantity and quality from an independent inspector at the load port.
• Certificate of origin and, where the terms require it, an insurance certificate.
• Letter of indemnity, often accepted in oil trading when original bills of lading are not yet available, if the LC allows it.

The most common reason an LC payment is delayed is a discrepancy: a date, a spelling or a quantity that doesn't match. Every discrepancy means another round of questions, and sometimes a waiver from the buyer.

Where a partner helps

In energy and commodity trade finance, the LC is only as strong as the preparation behind it. Mahala Holdings is not a bank and does not issue letters of credit. We help structure the transaction and the document flow so it fits how financiers decide, with financing arranged with institutional partners. The goal is a clean file, realistic timelines and fewer surprises at presentation.

Next in this series: how structured commodity finance differs from a plain loan.

Mahala Holdings is an independent trade-finance partner and does not lend, guarantee or provide funding itself. Nothing here is an offer of finance or financial advice. Learn more at https://mahalaholdings.com or write to inquiries@mahalaholdings.com.