Benchmark Prices and Physical Premiums
It's all called "crude oil", but oil from different fields and ports sells at different prices. Physical price = benchmark + quality premium/discount + freight.
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Text version · Physical Commodities, lesson 6: “Benchmark Prices and Physical Premiums”
It's all called "crude oil", but oil from different fields and ports sells at different prices. Physical price = benchmark + quality premium/discount + freight.
Benchmark price: the anchor everyone shares
There are hundreds of crude oils in the world, and they can't all be quoted separately. Buyers and sellers pick a liquid, transparent benchmark price as an anchor, then negotiate their own physical premium / discount.
Quality decides premium or discount
Light sweet crude is easier to refine into gasoline and diesel, so it's worth more than the benchmark (a premium); heavy sour crude needs extra desulfurizing and has to sell at a discount. Metals and grains are priced by purity and moisture in the same way.
Freight: the further away, the pricier
Goods have to be shipped from where they're produced to the buyer, so freight is part of the price too: delivered price = benchmark + quality premium / discount + freight. When shipping is tight, freight soars and distant buyers' costs rise with it.
Key takeaways
- Physical deals are often anchored to a recognized benchmark (such as the front-month futures price), with a premium or discount added.
- Better quality (lighter, lower sulfur) is worth more; poorer quality sells at a discount.
- The further from the buyer, the higher the freight. Delivered price = benchmark + quality premium/discount + freight.
- Even when the benchmark doesn't move, premiums and discounts shift with local supply, demand and shipping capacity.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Example: high sulfur · freight $3.2”: what are the quality discount and freight? What's the delivered price?
- Switch the top to “Light sweet”: with the same benchmark and freight, how much higher is the delivered price?
- Click “Tight shipping”: what does freight become? How far above the benchmark is the delivered price?
- Keep quality and freight the same and drag the “Benchmark price” from $80 to $90: how much does the delivered price rise? Did the premium / discount change?
Quiz and explanations
- 1. The benchmark oil price is $80. A crude grade trades at a $2.50 discount for high sulfur, and freight to the refinery is $3.20. What's the refinery's delivered price?
- Answer: $80.70.$80 − $2.50 + $3.20 = $80.70.
- 2. All else equal, which crude is usually worth more?
- Answer: Light, low-sulfur crude.Light, low-sulfur crude is easier to refine into gasoline and diesel, so it usually trades at a premium.
- 3. Shipping is tight and freight rises from $3 to $6, while the benchmark doesn't change. A distant buyer's delivered price will…
- Answer: Rise by $3.Freight is part of the delivered price, so the extra $3 goes straight onto it.
Terms in this lesson
- benchmark price (Benchmark Price): A widely accepted reference price, such as a crude oil futures front-month price; physical deals are often priced off it plus or minus a premium or discount.
- freight (Freight): The cost of shipping goods from where they're produced to the buyer; the farther and tighter the shipping capacity, the higher the freight and the delivered price.
- physical premium / discount (Physical Premium / Discount): How much a physical deal is priced above (premium) or below (discount) the benchmark, reflecting quality, delivery location and local supply and demand; not the same as a futures curve's contango or backwardation.