The Application of Strategic Real Options for the Evaluation of a Mining Project

Abstract

In the last 20 years, the mining industry has undergone substantial changes: price volatility of commodities, the introduction of new technologies, and the ever-increasing influence of external factors (sustainability, social problems). However, when it comes to assessing mining projects, engineers still use the same methods, such as NPV and IRR, to quantify the value of a project. In that sense, this study has three objectives: Understanding the limitations of the traditional model, analyzing the use of Real Options as an alternative to assess the value of a mining project under uncertain circumstances, and delving into the details of risk management in the mining industry. An open-pit case study is presented. Real Options are compared to the traditional methodologies to understand the situations where it is suitable to apply this tool. Two case studies are presented: one when the NPV is close to zero, and the other one, the NPV is far greater than zero. The results showed that using Real Options only adds value for projects with an NPV close to zero, while it has a detrimental effect when the NPV is very high. This new tool will enable investors to make better decisions under unpredictable market conditions.