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Brent vs WTI Crude Oil: What a Benchmark Actually Is

Brent and West Texas Intermediate are not two prices for the same barrel. Each one is a specification: a stated quality of crude oil, delivered at a stated place, under a stated arrangement. Two of them exist because oil is not a single substance and cannot be moved from one place to another instantly, so a barrel of one chemistry sitting in one place is a genuinely different good from a barrel elsewhere.

Two things established earlier do most of the work here. When a national reserve had to write down what it was going to store, a grade turned out to be a definition and not a price. A price, separately, is settled between somebody who wants to sell and somebody who can walk away. Wherever two different goods are traded, then, two different prices form. The second idea, applied twice, is where two benchmarks come from.

The place to start is a wedding, with no oil in it at all. A household three streets over is feeding four hundred people and rings a supplier to order one hundred kilos of rice. The supplier does not begin with money. He begins with two questions: which rice, and where it has to be delivered. A named variety unloaded at the wholesale yard on the edge of town is one thing to quote for. A lorry and two pairs of hands have to be paid, and the yard has sacks standing there today while the kitchen has none. The same variety carried across the city and up three flights of stairs to a kitchen is a different thing to quote for. Two goods, two quotes, and one word, rice, sitting innocently over both of them. Everything below is that conversation with crude oil in place of the rice.

Where the rupee amounts come from. Every barrel count and every rupee amount below belongs to the Republic of Sankhya, an invented country carried right across this sequence so the arithmetic ties up from one subject to the next. The Rs 80/- a barrel that separates the two references further down was chosen to make the arithmetic visible rather than read off a market. A real difference between two references moves daily and belongs to a source that carries a date.

What is Brent, once it is read as something other than a number?

Brent is a specification, and that one word carries everything below. The name does three jobs at once: it names a kind of crude oil, it names where that crude is handed over, and it names the arrangement under which the handover happens. All three are written down in a contract document that anybody can open and read. Publication is what makes the name usable by two strangers who have never met.

Take the quality first. Brent describes a light crude carrying little sulphur contenthow much sulphur is dissolved in the oil. Oil with very little of it is called sweet, and oil with a lot is called sour. The difference matters because sulphur has to be taken out before the fuel can be sold, and taking it out costs money and needs equipment.. The published document fixes the exact density band and the exact sulphur limit that a cargo has to meet. The density band and the sulphur limit belong to the document itself rather than to anybody's summary of it.

Take the place next. Brent is waterbornehanded over onto or from a ship rather than into a pipe. A waterborne good can be loaded at a terminal and carried to any buyer with a working port. A good that can only travel by pipeline is in a very different situation.. The oil is loaded at terminals serving North Sea fields, so a cargoone shipload of a commodity, treated as a single lot for the purposes of a contract. A cargo has a size, a loading window and a named vessel, and it is the unit in which seaborne oil actually changes hands. leaves by sea. Take the arrangement last. The contract states how and when the barrels change hands, in what quantity, and what follows if either side does not perform.

Naming Brent is naming a definition, and the number a report attaches to it is the price of that definition on that day rather than the definition itself. A report saying that a figure moved is saying that the price of one particular written-down thing moved. Change the written-down thing and the good is no longer the same one, however similar the two look from a distance.

BRENT, SET OUT AS THE THREE THINGS IT ACTUALLY STATES the three rows below are what Brent states; no price, level or date appears among them THE QUALITY what kind of oil a light crude carrying little sulphur. The published contract fixes the exact density band and the exact sulphur limit. Both numbers belong to that document. THE PLACE where it is handed over waterborne. The oil is loaded at terminals serving North Sea fields, so a cargo leaves by ship and can be carried to any buyer with a working port. THE DELIVERY on what terms the contract states how and when the barrels change hands, and what follows if either side does not perform. It is a published document, not a private deal. THE NUMBER IN A REPORT IS NOT THE DEFINITION. It is the price of that definition on that day. Change the definition and the quote is for a different good.
Brent states a quality, a place and a delivery arrangement, and the number a report attaches to the name is the price of that written-down definition rather than the definition itself.
Try it out

Before the second definition arrives, fix the first one. Brent is which of these?

What is West Texas Intermediate, given exactly the same room?

West Texas Intermediate is also a specification. The shape of the answer is identical even though every entry in it differs, so it is worth reading in the same order. West Texas Intermediate states a quality, it states a place, and it states an arrangement for handing the oil over. If the first definition felt like a lot of machinery for one word, the second will feel the same, and the repetition is the point.

The quality is also a light crude carrying little sulphur, but written to its own published limits, in its own document, with its own numbers. Close in kind is not the same as identical, and a refinerythe plant that takes crude oil and separates it into things people actually buy, such as petrol, diesel, jet fuel and the feedstock for plastics. Each plant is built for a band of crude and runs badly on anything outside it. that has been built around one set of limits is not indifferent between the two. The place is where the two part company most visibly. West Texas Intermediate is delivered inland, into tankage at Cushing, Oklahoma, where several pipelines meet. Nothing goes to sea at the moment of delivery. A barrelthe volume unit oil is counted in. A barrel is a fixed quantity, so a figure quoted per barrel and a figure quoted per tonne are two different measurements and cannot be compared without converting one of them. handed over there sits in a tank connected to pipes, not on a ship pointed at a customer.

The arrangement is written down in the same spirit. How and when the barrels move, into whose tank, on what timetable, and who carries the consequence if somebody does not deliver. Both definitions are published because a definition that only one side can read is of no use to the other side, and the whole value of a benchmark is that two strangers can agree to it without negotiating it.

West Texas Intermediate is a grade first and a number second, exactly as Brent is, and the two differ in both their stated quality limits and their stated place of delivery. With both definitions set out, one question asks itself. Why would anybody keep two of these things going at once?

WEST TEXAS INTERMEDIATE, THE SAME THREE ROWS, DIFFERENT ENTRIES identical shape to the figure above, which is the comparison; no price, level or date is stated here either THE QUALITY what kind of oil also a light crude carrying little sulphur, but written to its own published limits, in its own document. Close in kind is not the same as identical. THE PLACE where it is handed over inland. Delivery is into tankage at Cushing, Oklahoma, where several pipelines meet. Nothing goes to sea at the moment the barrels change hands. THE DELIVERY on what terms again written down: how and when the barrels move, into whose tank, and on what timetable. Anyone dealing in it can read the same document. A GRADE FIRST AND A NUMBER SECOND, EXACTLY AS THE OTHER ONE IS. Different stated limits and a different stated place, so the two definitions describe two different goods.
West Texas Intermediate states its own quality limits and hands the barrels over inland at Cushing, Oklahoma, so the same three rows produce a different good rather than a second quote for the first one.
Try it out

Both definitions are now set out. What does a contract actually turn on when it names one of them?

What does a benchmark actually specify, then?

Three things, and both definitions have now been seen doing it. The quality tells both sides what liquid is arriving. The place tells both sides where it turns up. The delivery arrangement tells both sides when it turns up, in what quantity, and what happens if it does not. A benchmark states those three and nothing else. A price sits outside the list, and a market settles a price later, on top of the definition.

The three together buy something specific. A futures contractan agreement made now to hand over a stated quantity of something at a stated later date on stated terms. Because the terms are standard, one contract is interchangeable with another, and standard terms are what make a futures contract tradeable. Futures as a subject are covered separately. for oil can say what it is about in roughly nine words: a stated quantity of barrels, a named specification, a stated month. The meaning sits in a published document neither of them wrote, so both sides understand every one of those words identically. Delete the definition and that same contract has to carry a long description instead, and every line of that description is something a counterpartythe other side of an agreement. For a party that has agreed to buy something, the counterparty is whoever agreed to sell it, and the word is used because from the seller's seat the buyer is the counterparty. can argue about before a single barrel moves.

Because the definition is written down once and published once, a contract can say what it is about in a few words instead of describing a barrel from scratch, and that economy of description is the entire reason benchmarks exist. Everything else people do with a benchmark is downstream of that one saving.

WHAT A CONTRACT HAS TO SAY, WITH THE DEFINITION AND WITHOUT IT the two columns describe the same agreement about the same barrels WITH THE DEFINITION PUBLISHED one thousand barrels of the named specification for a stated month Nine words. Both sides already agree what every one of them means. WITHOUT IT, WRITTEN FROM SCRATCH the density band, stated exactly the sulphur limit, stated exactly the place of delivery, named the tank or the terminal, named the timetable for handing over who inspects, and to what standard what happens if either side fails and each one agreed with the other side Eight lines, and every line is something to argue about first. THE SEVEN LINES THE TWO SIDES DO NOT HAVE TO WRITE OR AGREE THAT ECONOMY OF DESCRIPTION IS WHY BENCHMARKS EXIST AT ALL. The definition is written once and published once, and referred to in a few words for ever afterwards.
A published definition lets a contract describe itself in about nine words, while the same agreement written from scratch needs eight separate lines that both sides must first agree on.
Try it out

Name the set. A benchmark specifies which three things?

Why do two benchmarks exist rather than one price for oil?

Two reasons, and they stack. The first is chemistry. Crude out of the ground is not one liquid wearing different labels. Crude varies in how heavy it is and in how much sulphur it carries, and a refinery is a physical plant built around a band. Feed a refinery something outside that band and it either cannot run at all or runs worse and produces less of what it was built to produce. A refiner on one coast is therefore not indifferent between two barrels. Two barrels nobody is indifferent between are not interchangeable, and two goods that are not interchangeable are two goods.

The second reason is that oil sits somewhere. Moving oil takes a ship or a pipeline. Ships and pipelines cost money and take days rather than seconds. Distance is not a small technicality bolted onto the first reason. Distance is the reason a price can form at all in one place independently of another place. Buyers and sellers who are actually present at a location settle with each other, and somebody a fortnight away by sea is not in that room.

Two goods in two places are two goods, and a single world price for oil would require oil to be one substance sitting everywhere at once. A cargo can move between the two places, and that possibility pulls the two toward each other. The two are not welded together, though. Moving the cargo costs money and takes time, and that cost and that time are exactly what stops the two prices from meeting.

TWO CHEMISTRIES IN TWO PLACES, AND WHAT SITS BETWEEN THEM no level is drawn for either place; the drawing is about separation, not about size PLACE ONE a crude of one stated chemistry bought and sold at this place by people who are present here a price is settled here PLACE TWO a crude of a different chemistry bought and sold at that place by people who are present there a different price is settled there costs money takes days CONNECTED, BUT NOT WELDED TOGETHER A cargo can move from one place to the other, which pulls the two toward each other. Moving it costs money and takes days, which is exactly what stops them meeting. TWO GOODS IN TWO PLACES ARE TWO GOODS. A single world price for oil would need oil to be one substance sitting everywhere at once, and oil is neither one substance nor in one place.
A price settles between the buyers and sellers actually present at a place, so two chemistries in two places produce two prices, connected by the possibility of moving a cargo and separated by what that movement costs.
Try it out

Why do two benchmarks exist rather than one price for oil?

Why do the two not move together perfectly?

Because what separates them is not a constant. Two things sit in the gap between the two definitions, and both of them can change on their own. The first is what it costs to move a barrel between the two places. Freight, fuel and how busy the route is all move that cost. The second is how much demand there is for one chemistry against the other. Which refineries are running, what they are running for, and what else is available to them all move that demand.

Go back to the rice. The difference between the yard price and the doorstep price is a lorry and two pairs of hands. When diesel gets dearer, that difference widens. Nobody has signalled anything about rice, and nothing has been revealed about the harvest. A cost that sits between two places changed, and the difference between two prices moved because of it. The whole mechanism is that plain.

The difference between the two is a fact about geography and grade, not a signal about anything. One discipline goes with that. How big the difference is, which of the two sits above the other, and what the difference has been doing lately are levels and directions, and a level or a direction belongs to a source that carries a date. A figure of that kind goes stale within the day, so it is read at the source rather than remembered.

WHAT SITS IN THE GAP, AND WHY THE GAP DOES NOT HOLD STILL the middle box is empty: no size, no direction and no recent movement belongs in it SPECIFICATION ONE a stated quality at a stated place on stated terms THE DIFFERENCE not its size not its direction not what it has been doing SPECIFICATION TWO a different quality at a different place on its own terms WHAT IT COSTS TO MOVE A BARREL between the two places: freight, fuel and how busy the route is. THIS CAN ITSELF CHANGE HOW MUCH DEMAND THERE IS for one chemistry against the other: which plants are running, and for what. THIS CAN ALSO CHANGE A FACT ABOUT GEOGRAPHY AND GRADE, NOT A SIGNAL ABOUT ANYTHING. Two things sit in the gap and both of them move on their own, so the gap moves without anybody announcing it.
What separates the two specifications is the cost of moving a barrel between the places and the demand for one chemistry against the other, and because both of those move on their own the difference does not hold still.
Try it out

Why do the two not move together perfectly?

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What happens to Sankhya's oil bill when only the reference changes?

Time to make the idea cost something. The Republic of Sankhya buys 36.5 crore barrels of crude a year, or exactly 0.1 crore barrels a day, and at Rs 4,000/- a barrel its annual oil bill is Rs 1,46,000 crore. Against Sankhya's nominal outputthe money value of everything an economy produced in a year, counted at the prices actually paid rather than adjusted for inflation. Nominal output is the denominator most national figures are set against. of Rs 17,47,200 crore that bill is 8.36 per cent, and against its goods importsthe value of physical things a country bought from abroad in a year, as distinct from services such as software or shipping. Oil sits inside this line rather than beside it. of Rs 3,85,000 crore it is 37.92 per cent. All of those figures are carried in from earlier in this sequence.

Now hold the barrels completely still and change nothing except which specification the contract was struck against. Suppose the second reference stood Rs 80/- a barrel away from the first, at Rs 3,920/- a barrel. The Rs 80/- was chosen to make the arithmetic visible. A real difference between Brent and West Texas Intermediate changes size on its own and can sit either way round. The same 36.5 crore barrels now cost Rs 1,43,080 crore, a bill lower by Rs 2,920 crore, which is 2.00 per cent of the first bill because Rs 80/- is 2.00 per cent of Rs 4,000/-.

The same year, the same barrelsReferenced to specification oneReferenced to specification two
Barrels bought in the year36.5 crore barrels36.5 crore barrels
Referenced amount a barrelRs 4,000/-Rs 3,920/-
Annual oil billRs 1,46,000 croreRs 1,43,080 crore
Share of nominal output of Rs 17,47,200 crore8.36 per cent8.19 per cent
Share of goods imports of Rs 3,85,000 crore37.92 per cent37.16 per cent
Difference in the annual billRs 2,920 crore, the second bill smaller than the first

Read the last row slowly. It is doing more than it looks. Sankhya did not buy less oil. Sankhya did not experience a shock, a saving or a stroke of good fortune. One word in one contract changed, and Rs 2,920 crore appeared in the arithmetic. The difference is 0.17 per cent of everything the country produced in the year. The point is not the size of the gap. The point is that choosing a reference has an arithmetic consequence, and the consequence is entirely mechanical.

THE SAME 36.5 CRORE BARRELS, TWO REFERENCES, TWO ANNUAL BILLS the Republic of Sankhya, invented; the difference of Rs 80/- a barrel is invented as well Rs 1,46,000 crore Rs 2,920 crore the invented difference, across a whole year Rs 1,43,080 crore REFERENCE ONE 36.5 crore barrels at Rs 4,000/- THE INVENTED DIFFERENCE Rs 80/- a barrel, invented REFERENCE TWO 36.5 crore barrels at Rs 3,920/- The vertical scale starts at Rs 1,40,000 crore rather than at zero, so a difference of 2.00 per cent is large enough to see.
The same 36.5 crore barrels produce a bill of Rs 1,46,000 crore under one reference and Rs 1,43,080 crore under the other, a difference of Rs 2,920 crore that comes from the choice of reference and from nothing else.
Try it out

The same 36.5 crore barrels give Rs 1,46,000 crore under one reference and Rs 1,43,080 crore under the other. What changed?

Play with it

Set the difference yourself and watch two bills come out of one set of barrels

The barrels are locked at 36.5 crore for the year, and specification one is anchored at Rs 4,000/- a barrel because that is where the Sankhya bill was struck. The controls set how far apart the two references stand, and which side of the first one the second sits on. At their opening settings the panel reproduces the two figures from the table above exactly.

Rs 80/- a barrel
ONE SET OF BARRELS, TWO REFERENCES, TWO ANNUAL BILLS the distance between the two references is invented and set by the controls; no real price or difference is shown HELD CONSTANT THROUGHOUT 36.5 crore barrels a year specification one at Rs 4,000/- a barrel Rs 2,920 crore REFERENCED TO SPECIFICATION ONE Rs 1,46,000 crore at Rs 4,000/- a barrel REFERENCED TO SPECIFICATION TWO Rs 1,43,080 crore at Rs 3,920/- a barrel 36.5 crore barrels a year, unchanged in both columns. The vertical scale starts at Rs 1,38,000 crore rather than at zero.
Bill, specification one
Rs 1,46,000 crore
Bill, specification two
Rs 1,43,080 crore
Difference in the year
Rs 2,920 crore
Difference as a share of bill one
2.00 per cent

Or jump straight to one of these:

Educational illustration. Assumptions on screen: the distance between the two references is whatever the control is set to and moves only here; specification one is anchored at Rs 4,000/- a barrel because that is where the Sankhya bill was struck; the barrels are held at 36.5 crore for the year throughout. Neither specification is better, more representative or more reliable than the other, and the arithmetic runs the same way whichever one a contract names.

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What does a benchmark leave out?

A benchmark does not give the cost of the barrel a particular refinery buys. The refinery's barrel is very often a different grade, lifted at a different place, on a contract agreed between two named parties with their own terms in it. The benchmark turns up inside that contract as an anchor, with an amount added or taken off to account for the grade being different and the place being different. So the benchmark is genuinely in there, and it is genuinely not the answer.

Think about the sentence people actually say out loud, some version of oil is at such and such today. The sentence is doing something quietly dishonest. The sentence takes the price of one written-down definition at one place and applies it to every barrel on earth, and most barrels neither meet that definition nor sit anywhere near that place. The figure was never wrong. The sentence wrapped around it was too wide.

A benchmark is a reference point and not a universal price, and quoting one as the price of oil overstates what it covers. There is nothing defective about the benchmark in this. A reference point is exactly what it was built to be, and the whole economy of description set out earlier depends on it staying narrow. A definition that tried to cover every barrel everywhere would have to be so loose that nobody could contract on it.

WHAT THE BENCHMARK COVERS, AND WHAT A REFINERY ACTUALLY BUYS the arrow points one way on purpose: the benchmark is referenced by the contract, not equal to it WHAT THE BENCHMARK COVERS one stated quality at one stated place under one stated arrangement and nothing outside that REFERENCED BY NOT EQUAL TO WHAT A REFINERY BUYS a different stated quality lifted at a different place on its own contract with its own terms in it A REFERENCE POINT, NOT A UNIVERSAL PRICE. The barrel a refinery buys is priced by reference to a benchmark, with an amount added or taken off, agreed between the two parties to that contract and nobody else.
A benchmark covers one quality at one place on one arrangement, while the barrel a refinery buys is a different grade at a different place on its own contract that merely references the benchmark.
Try it out

Does a benchmark price the barrel a particular refinery buys?

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What does an analyst check before comparing two oil figures?

Which specification each figure references, and that check comes before any arithmetic at all. The check is the same discipline as reading which way round a currency quote runs before subtracting one from another. Two numbers that look like the same measurement can be measurements of different things, and the resemblance is what makes the mistake so easy. An oil figure without its specification attached is not a usable number. The figure has to be identified before it can be used.

The habit shows up wherever somebody works with these figures. A research analyst modelling a refining business reads which reference the business itself is exposed to. A business buying one grade and selling products priced off another carries that gap in its margin whether it wants to or not. A policy economist reading a national import bill reads which reference the bill was struck against, for exactly the reason the Sankhya arithmetic showed: the same barrels give two different totals. A lender sizing a working capital line against oil inventory reads which specification the inventory is valued at.

And an ordinary household reading a headline is doing a smaller version of the same thing. When a report says oil moved, the useful next question is not what will happen to petrol. The useful next question is which oil. The barrel in the headline and the barrel that becomes fuel at the pump down the road are connected by a chain of grades, contracts, refining and taxes, each with its own arithmetic.

Two figures describing different specifications are not comparable however similar they look, so the specification is checked before the comparison is made and not after it goes wrong.

Try it out

A reader sees an oil figure in one report and a different figure in a second report, and says oil moved. What has to be checked first?

India

Where an Indian reader goes for the actual documents

India buys most of its crude from abroad, so which reference an Indian figure is struck against is a live question rather than a technicality. Official import and consumption statistics are published by the Petroleum Planning and Analysis Cell under the Ministry of Petroleum and Natural Gas, and those publications state which references they are reporting against. India also holds a strategic crude reserve, and the grades held in it are a matter of published record. The contract specifications behind Brent and West Texas Intermediate are published by the exchanges that list them. Every level, capacity, date and assessment attached to those things belongs to its own source, where it carries a date.

The failure: comparing two figures that describe two different goods

Here is how it actually happens, and nobody involved is careless. A reader looks up an oil figure in one report on a Monday and a second figure in a different report on the Friday. Both figures are correct. Both are published. Both are unmistakably about crude oil. The regular readers of each report already know which specification it quotes, so neither report says so anywhere prominent. The reader subtracts one from the other and reports that oil moved.

The subtraction measured the difference between two goods. A difference between two goods is not news about oil and is not a movement at all. Worse, the reader has now built a habit. The next comparison will be made the same way, and the error will be different in size every time, so it will never be big enough to look obviously wrong. The fix is one line of checking. Read which specification each figure references, and only subtract two figures that reference the same one.

THE ARTEFACT: A SUBTRACTION BETWEEN TWO DIFFERENT GOODS no figures are shown on the card, because the fault is in the comparison and not in either number WORKING NOTE First report: quoted against specification one Second report: quoted against specification two Reported: oil moved by the difference between them. The two figures describe two different goods. WHY NOBODY CATCHES IT Both figures are correct. Both are published. Both are about crude oil. Neither report says which specification it uses. THE FIX IS ONE LINE OF CHECKING. Which specification each figure references is checked before one is subtracted from the other.
Both figures on the note are correct and both are published, and the error lives entirely in the subtraction between them, which is why a reader who checks neither specification never sees anything wrong.

What is covered elsewhere. The strategic crude reserve that references a grade is dealt with separately, as are supply shocks and the chain that carries a crude price through to fuel at a pump.

Two numbers that look alike can measure different things. See what an analyst checks.

Where is the actual specification written down?

Every definition described above exists as a document somebody publishes, and that publication is the whole reason a benchmark works. The documents themselves, rather than any summary of them, are where the current position is read, and the date on whatever is read matters.

What to look forThe document or bodySite
The published contract specification behind one of the two referencesIntercontinental Exchange, contract specification documentsice.com
The published contract specification behind the other referenceCME Group, contract specification documentscmegroup.com
What India imports, and which references its statistics report againstPetroleum Planning and Analysis Cell, published statisticsppac.gov.in
Policy documents on crude, refining and the strategic reserveMinistry of Petroleum and Natural Gas, publicationsmopng.gov.in
Where an oil bill sits inside a national external accountReserve Bank of India, published reportsrbi.org.in

The Republic of Sankhya and its trading partner Marut are invented.
Educational material. Not advice on any investment, tax, budget or market position.

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