Mining and Quasi-Option Value

19 Pages Posted: 13 Jul 2015

See all articles by Christopher Costello

Christopher Costello

University of California, Santa Barbara (UCSB) - Donald Bren School of Environmental Science & Management

Charles D. Kolstad

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: July 2015

Abstract

We study the timing-of-extraction problem facing a decentralized mine owner when extraction entails environmental damage. As expected, when the environmental damage from mining is known, the socially optimal timing will depend on the magnitude of the damage relative to these costs in the rest of the world. But when environmental damage is uncertain, and these costs are revealed over time, a quasi-option value arises. We show that even if expected environmental costs are identical to those in the rest of the world, any uncertainty over these costs will cause the social planner to optimally delay mining until better information arrives. We show conditions under which it is optimal to postpone the mining decision indefinitely, and conditions when it is optimal to postpone only for a finite duration. The analysis leverages a crucial observation that distinguishes the non-renewable resource problem from the traditional quasi-option value framework. In the traditional framework, the presence of an irreversible investment and uncertainty can help nudge the decision maker to preserve an option, but it by no means implies the decision maker should always preserve the option. In contrast, for a non-renewable resource model, the arbitrage condition underpinning the Hotelling rule suggests that in the absence of uncertainty, the marginal mine owner is completely indifferent between mining immediately and at any point in the future. Thus, for our problem, any uncertainty will convince her to defer the mining decision.

Suggested Citation

Costello, Christopher and Kolstad, Charles D., Mining and Quasi-Option Value (July 2015). NBER Working Paper No. w21325. Available at SSRN: https://ssrn.com/abstract=2629932

Christopher Costello (Contact Author)

University of California, Santa Barbara (UCSB) - Donald Bren School of Environmental Science & Management ( email )

4670 Physical Sciences North
Santa Barbara, CA 93106-5131
United States
(805) 893-5802 (Phone)
(805) 893-7612 (Fax)

Charles D. Kolstad

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
5
Abstract Views
140
PlumX Metrics