Mineral asset valuation under price uncertainty using real options

Abstract

Production scheduling under commodity price uncertainty has suffered from an exponentially increasing problem size as simulations and real options flexibility are used to generate and evaluate production schedules. The use of unsupported commodity price behavior mechanisms and fundamental problems in risk adjustment have resulted in incorrect treatment of commodity price risk in production scheduling. Previous work on this subject has considered both the real options and production scheduling components yet has failed to honor both simultaneously and integrate them completely. The proposed methodology maintains a problem size similar to that of a deterministic solution yet fully adjusts the production schedule for market attitudes towards commodity price risk. Five economic scenarios consisting of the proposed methodology, price simulations and traditional discounted cash flow (DCF) are explored using a commercially available production scheduling package. It is concluded that the proposed methodology provides a supportable and risk adjusted basis for production scheduling. Using simulations shows that mine plans cannot be evaluated against price paths as has been done in previous work; yet results in an impossibly large problem size when done correctly. As the traditional DCF scenarios are heuristically selected they are unsupportable and consequently result in unsupportable production schedules and valuations.