Evaluating mine plans under uncertainty: Can the real options make a difference?

Over the last few years, many studies have presented the real options valuation (ROV) as a promising technique of valuing natural resource investments under conditions of uncertainty. Apart from the common conclusion that the ROV is better than the conventional net present value (NPV) method in integrating the value of management flexibility and proper handling of cash flows risk, there is a lack of procedures for testing the usefulness and advantages of the ROV over the static NPV method in practice. Arguably, it is not yet clear whether the ROV can deal with the complexity of mining projects and whether it can really be applied to make decisions that improve project value. This work aims to take steps towards filling the gap in existing literature by dealing with the above-mentioned concerns. First, this paper proposes a simulation-based ROV method that can handle multiple uncertainties as well as the variability of cash flow parameters that characterize mining projects. Second, the paper presents an example for investigating the impact ROV may have on project profitability, by improving the decision making process. A case study of selecting the most profitable design and production sequence for an actual Australian gold mine under multiple sources of uncertainty is provided. Both the conventional NPV method and the proposed real options technique are applied to evaluate the various technically feasible mine plans with fixed schedules so as to select the most economically appealing one. The results show that the design based on value maximization indicated by the static NPV method is different from that of the ROV. Comparing the design values estimated based on the actual market data recommended by both techniques shows that the value of the ROV-based design is 11-18% higher than the value of the NPV-based design. (C) 2007 Elsevier Ltd. All rights reserved.