Valuing Multi-zone Deposits with Modern Asset Pricing (Real Options)

2001

Richard Poulin, David Laughton,

Conventional project valuation techniques, such as discounted cash flow (DCF) method, are more frequently being criticised for the manner in which they consider the interacting effects of uncertainty and project structure (including management flexibility) on project value. Modern asset pricing (MAP; it is often called “real options valuation” when applied to the analysis of flexibility) is a more general valuation framework that corrects many of the shortcomings of common valuation methods. MAP mining applications have been published that treat the ore deposit as a homogenous entity. While useful for demonstration purposes, this is inadequate for practical application in industry. This paper presents a MAP valuation example that allows for the heterogeneous nature of an ore deposit. It also includes a geological uncertainty model that allows management to learn about the grade of the deposit as mining proceeds. The mine planner’s decision is more heavily influenced by ore zone characteristics than would be suggested by a standard DCF analysis. The example presented is a pit pushback project where mine planners are considering the development of an adjacent low-grade zone for which the actual grade is uncertain. Two important management options are built into the analysis. First, management may develop the pushback at discrete time points while mining operations in the high-grade reserves are ongoing. Second, once the pushback has been developed, management may elect to high-grade in response to low mineral prices by temporarily closing the low-grade zone at discrete time points. Both these decisions are affected by the resolution of geological uncertainty. The model presented here extends the ability of mine planners to describe actual project structure while using the MAP valuation framework that is already noted for its capacity to combine project uncertainty and risk insights with a dynamic project description.

Keywords: Multi-zone mine, Pit expansion, Real options, DCF, Valuation