What does Differentials mean?
The discount allowed for delivery of a commodity of lower grade than the basis grade specified in the futures contact. If delivery is of a higher grade, the differential is the premium payable. Similarly the term differential is used to indicate discount or premium for delivery at a location other than that specified in the futures contract.
This refers to the premium paid for commodity grades that are better than the basis grade, OR the discount that is given for commodity grades that are below the basis grade.
Futures Knowledge Explains Differentials
Most futures contracts specify the price for differential grades, so if there is a discrepancy in the quality then the new price is already known. Commodities are not homogeneous, for example in the grain market sometimes the moisture content or quality can dramatically affect the time before it starts to deteriorate.
Deliverable grade of the commodity and location for delivery are specified in the futures contract and agreed upon by both parties. These are to be met while making delivery of the commodities. But sometimes it becomes difficult to exactly match. So premium or discount is allowed for some deviation. For example, in case of futures contract for Brent crude oil, a deviation in the chemical specifications of the delivered crude oil from standard Brent is settled through premium or discount.