Optimal Exploration Investments Under Price and Geological-Technical Uncertainty: A Real Options Model
29 Pages Posted: 31 Dec 2000
Date Written: August 2000
This article develops a real options model for valuing natural resource exploration investments (e.g. oil or copper) when there is joint price and geological-technical uncertainty. After a successful several-stage exploration phase, there is a development investment and an extraction phase. All phases are optimised contingent on price and geological-technical uncertainty.
Several real options are considered. There are flexible investment schedules for all exploration stages and a timing option for the development investment. Once the mine is developed, there are closure, opening and abandonment options for the extraction phase. Our model maintains a relatively simple valuation structure by collapsing price and geological-technical uncertainty into a one-factor model.
A computational implementation of the model applied to a copper exploration prospect shows that a significant fraction of total project value is due to the operative, the development and the exploration options available to project managers.
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