Letters of Credit for Refinery Crude Oil Purchases

When a refinery or trader buys a cargo of crude oil, the seller usually wants a documentary letter of credit (LC) from a bank it trusts. The LC is the buyer's bank's promise to pay the seller when it presents documents that comply with the credit, typically the bills of lading or a letter of indemnity, the commercial invoice, and quantity and quality certificates from the loading port. For the buyer, the LC uses its bank credit line instead of cash. For the seller, it replaces the buyer's credit risk with the bank's.

How a crude oil LC works

1. The refinery signs the purchase contract, which states that payment will be by LC.
2. The refinery asks its bank to issue the LC in favour of the seller, usually before the loading window.
3. The seller's bank advises the LC and, if requested, confirms it.
4. The cargo loads. The seller collects the documents and presents them to the bank.
5. The bank checks the documents against the LC. Under UCP 600, banks deal with documents, not goods, and have up to five banking days after presentation to decide whether a presentation complies.
6. If the documents comply, the bank pays at sight or on the deferred date in the credit, and debits the refinery's line.

Documents usually required

The LOI clause

Crude cargoes often arrive before original bills of lading have passed through the banks. Many crude LCs therefore allow the seller to present its own letter of indemnity in place of the bills, promising to deliver the originals later and to indemnify the buyer. The issuing bank will only agree if it is comfortable with the seller's credit. See letters of indemnity for missing bills of lading in oil trades.

Quantity tolerance and pricing

Crude cargoes are rarely loaded to the exact contract quantity. UCP 600 says that "about" or "approximately" in relation to the amount, quantity or unit price allows a tolerance of up to 10% either way. Contracts usually set their own tolerance at the seller's or vessel's option, and the LC should match it.

Many crude contracts price on an average of benchmark quotes around the bill of lading date, so the final price is not known at loading. The LC should allow a provisional invoice and set a maximum amount, or provide for a later adjustment. If the LC amount is too low for the final price, the seller may not be paid in full under the credit. See crude oil grades and benchmarks for pricing.

Sight, deferred and usance LCs

A sight LC pays when compliant documents are presented. A deferred payment LC pays a set number of days later, for example 30 days after the bill of lading date, which gives the refinery time to process and sell products before the bank debits it. A seller holding a deferred LC can sometimes discount it with a bank to receive cash earlier. See Financely's page on usance letter of credit issuance and refinancing.

Confirmation

If the seller does not accept the risk of the issuing bank or its country, it will ask for a confirmation from another bank. The confirming bank adds its own promise to pay. Confirmation costs money and depends on the confirming bank's appetite for the issuing bank's risk.

What the issuing bank reviews

• The refinery's credit, existing LC line and utilisation.
• The purchase contract, grade and pricing basis.
• The seller's identity and sanctions screening of the seller, the vessel and the origin. See vessel and sanctions screening in crude oil trade finance.
• Insurance arrangements.
• For deferred LCs, how the refinery will fund payment on the due date.

Back-to-back and trader structures

Traders sometimes buy crude under an LC and sell to a refinery that pays by its own LC. The trader may use the incoming LC to support the outgoing one. Banks look closely at the matching of documents, dates and amounts. See back-to-back LC facilities for oil and refined products and how commodity traders finance the gap after LC issuance. For product cargoes rather than crude, see letters of credit for refined product cargoes.

Timing: when to open the LC

Sellers usually require the LC to be issued and advised a set number of days before the first day of the loading window. If the LC is late, the seller may refuse to load, and the buyer may face demurrage or lose the cargo. Refiners should apply to their bank as soon as the purchase is agreed, with the draft LC text already checked against the contract. A bank that receives a complete application, with the contract, the seller's details and screening information, can usually issue faster than one that has to ask for documents piecemeal.

Common LC problems on crude cargoes

• LC issued after the loading window opens, delaying loading.
• Document list that does not match the delivery term or inspection plan.
• LC amount too small for the final price after the pricing period.
• No LOI clause, so the seller cannot present when bills are late.
• Discrepancies in names, dates or quantities between documents.

How Financely helps

Financely helps refiners and traders structure LC terms, prepare the bank application and, where the existing bank line is not enough, approach other issuing or confirming banks and capital providers. Financely acts as advisor and arranger only. It does not issue LCs or lend. See letter of credit structuring for import and export transactions and the oil and gas trade finance advisory. For the wider picture, read crude oil trade finance explained.

Frequently Asked Questions

How does a letter of credit work for a crude oil purchase?

The buyer's bank issues an LC promising to pay the seller when it presents compliant documents, usually bills of lading or an LOI, the invoice and quantity and quality certificates. The bank checks the documents, not the oil.

What documents are needed under a crude oil LC?

Typically a commercial invoice, full set of original bills of lading or a seller's letter of indemnity, certificates of quantity, quality and origin, and any other documents named in the credit.

What is a deferred payment LC for crude?

An LC that pays a set number of days after shipment or presentation, for example 30 days after the bill of lading date, giving the refinery time to process and sell products before payment.

Can Financely issue a letter of credit?

No. Financely is an advisor and arranger. It helps structure LC terms and approaches banks that may issue or confirm. It does not issue instruments or lend.

Financely is an advisor and arranger. It does not lend, issue instruments or take title to cargo, and no financing outcome is promised. This article is general information, not legal, tax or sanctions advice.