Optimal Exploration Investments Under Price and Geological-Technical Uncertainty: A Real Options Model

29 Pages Posted: 31 Dec 2000

See all articles by Gonzalo Cortazar

Gonzalo Cortazar

Pontificia Universidad Catolica de Chile

Eduardo S. Schwartz

Simon Fraser University (SFU); University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

Jaime Casassus

Pontificia Universidad Catolica de Chile

Date Written: August 2000

Abstract

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.

Suggested Citation

Cortazar, Gonzalo and Schwartz, Eduardo S. and Casassus, Jaime, Optimal Exploration Investments Under Price and Geological-Technical Uncertainty: A Real Options Model (August 2000). EFMA 2000 Athens. Available at SSRN: https://ssrn.com/abstract=251650 or http://dx.doi.org/10.2139/ssrn.251650

Gonzalo Cortazar (Contact Author)

Pontificia Universidad Catolica de Chile ( email )

Departamento Ingenieria Industrial y de Sistemas
Av. Vicuna Mackenna 4860
Santiago
Chile

Eduardo S. Schwartz

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1953 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jaime Casassus

Pontificia Universidad Catolica de Chile ( email )

Av. Vicuna Mackenna 4860
Instituto de Economia
Santiago
Chile
(56-2) 2354 4319 (Phone)

HOME PAGE: http://economia.uc.cl/profesor/jaime-casassus/

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