A Letter of Credit (LC) is the dominant payment instrument in international commodity trade. It aligns the interests of buyer and seller by placing payment control with a trusted third party — the bank — that releases funds only when contractually specified documents are presented.
How an LC Works in Commodity Trade
- Contract signed — Buyer and seller agree on price, volume, delivery terms (Incoterms), and payment via LC
- Buyer instructs bank — Buyer's bank (issuing bank) opens the LC in favour of the seller, specifying required documents and expiry date
- LC transmitted — Issuing bank sends the LC to seller's bank (advising bank) via SWIFT MT700
- Goods shipped — Seller ships the commodity and collects the required transport and quality documents
- Documents presented — Seller presents compliant documents to their bank within the LC validity period
- Payment released — Advising bank checks documents against LC terms; if compliant, payment is made to seller
- Documents released to buyer — Buyer receives the original Bill of Lading and can take delivery of the goods
Types of LC Used in Commodity Trade
| Type | Description | Common use |
|---|---|---|
| Irrevocable LC | Cannot be amended or cancelled without all parties' consent | Standard for all commodity transactions |
| Confirmed LC | Seller's bank adds its own payment guarantee on top of issuing bank's | When buyer's bank has lower credit rating or is in a risky jurisdiction |
| Transferable LC | Beneficiary can transfer all or part of the credit to a second beneficiary | Back-to-back trading chains with middlemen |
| At Sight LC | Payment made immediately upon compliant document presentation | Spot cargo sales, CIF delivery |
| Usance / Deferred LC | Payment deferred 30–180 days after sight or shipment | Gives buyer time to sell goods before paying |
LC vs SBLC in Petroleum Trade
In petroleum transactions, the standard payment structure is:
- DLC (Documentary Letter of Credit) — primary payment mechanism, drawn upon shipment
- SBLC (Standby LC) — performance guarantee, only called if buyer fails to open the DLC or defaults on payment
Many fraudulent traders request an SBLC before they will provide any POP or FCO, then "monetise" the SBLC for personal gain. Legitimate sellers never require an SBLC before presenting POP and signing a contract.
Frequently Asked Questions
- What is a letter of credit in commodity trade?
A Letter of Credit (LC) is a written commitment by a bank to pay a specified sum to the seller (beneficiary) upon presentation of documents that prove shipment and compliance with the contract terms. In commodity trade, the LC ensures the seller gets paid once goods are shipped and the buyer gets the documents needed to claim the goods.
- What is the difference between an LC and an SBLC?
An LC (documentary credit) is the primary payment instrument — it is intended to be drawn on to pay for goods. An SBLC (Standby Letter of Credit) is a secondary instrument, intended as a guarantee of last resort only if the buyer defaults. In petroleum trade, large deals typically use irrevocable DLC (Documentary LC) for payment, while SBLC is used as performance security.
- What documents are required to draw on an LC?
Standard documents for a commodity LC draw: (1) Bill of Lading (original, endorsed), (2) Commercial Invoice, (3) Packing List / Weight Certificate, (4) SGS Quality & Quantity Certificate, (5) Certificate of Origin, (6) Fumigation Certificate if required. The LC terms specify exactly which documents are required and any specific wording.
- What does UCP 600 mean?
UCP 600 (Uniform Customs and Practice for Documentary Credits, 2007 Revision) is the set of rules published by the International Chamber of Commerce (ICC) that governs how documentary letters of credit operate globally. Almost all modern LCs are issued subject to UCP 600. It standardises how banks examine documents and resolve discrepancies.