Commodities, or tangible goods, are traded every day around the world. Many of those trades are paid for with commodity financing options such as letters of credit and revolving credit facilities. Knowing which commodities and loans are best suited for your business will help keep you in good standing with business partners when you are looking for this type of financing.
What Are Commodities?
The direct meaning of commodities is products, not services, used in trade or commerce. Oil and gas, agriculture, and manufacturing items purchases are things you will be financing. Some common examples include barrels of oil and bushels of wheat. The trades of these items are considered inflation-proof investments because as the price of goods and services goes up, so does the price of the materials used to manufacture them. For example, inflation will mean that it costs more to buy a loaf of bread, increasing the demand for wheat flour and raising the cost of a bushel of wheat. So, if you own a hundred bushels of wheat, the value of those bushels rises with inflation.
How Is Commodity Trade Financed?
Most companies prefer to pay for commodities with either a letter of credit, L/C, or a revolving credit facility, RCF. Using a letter of credit for your commodity financing means sending a letter from your bank, as the buyer, to the seller’s bank stating that the money will be transferred once the goods arrive. This payment-on-delivery option offers more security than using open credit lines because if the seller is acting in bad faith, the goods will never arrive, and your bank will not send the money.
Major commodities and oil traders use a revolving credit facility to finance transactions. This type of credit is granted by a consortium of banks and allows major firms to borrow funds up to a maximum amount and then pay the money back time and again. Since it is a revolving credit, it works similar to your credit card, just on a much larger scale. Companies needing to make financially significant commodities purchases prefer an RCF to open credit because a consortium of banks can spread the risks among multiple partners instead of one bank.
Commodity financing options available to you and your company will broadly reflect how many trades you make and how large those trades are. Major commodities traders will opt for revolving credit facilities because the maximum amount they can borrow is higher. Smaller trading firms or individuals will usually ask their bank for a letter of credit.