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Analyzing operational real options in metal mining investments with a system dynamic model

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  • Jyrki Savolainen
  • Mikael Collan
  • Pasi Luukka

Abstract

This article presents a detailed system dynamic (SD) model of a metal mining investment that is usable in ex-ante profitability and operations management analysis. We show how the SD model can be used to analyze the profitability effect of three operational real options: the option to temporarily close production, the option to abandon production, and the option to increase production through cutoff grade change. The SD model allows for intuitive modeling of the multiple interactive real options and arriving at results that are difficult, or impossible, to reach with commonly used spreadsheet software. We also analyze the effect of mining project debt ratio to the project value and show that correctly choosing the debt ratio affects project profitability. The effect on the project value of using three different future metal price scenarios with two different stochastic processes is illustrated to highlight the importance of correct process selection in modeling future metal price paths. A realistic case of a high-cost nickel (Ni) metal mine is used as a basis for the presented numerical illustration of the model.

Suggested Citation

  • Jyrki Savolainen & Mikael Collan & Pasi Luukka, 2017. "Analyzing operational real options in metal mining investments with a system dynamic model," The Engineering Economist, Taylor & Francis Journals, vol. 62(1), pages 54-72, January.
  • Handle: RePEc:taf:uteexx:v:62:y:2017:i:1:p:54-72
    DOI: 10.1080/0013791X.2016.1167988
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    File URL: http://hdl.handle.net/10.1080/0013791X.2016.1167988
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    Cited by:

    1. Natalia Morozko & Nina Morozko & Valentina Didenko, 2020. "The Use of Real Options in Assessing the Development of Small Energy in Russia," International Journal of Energy Economics and Policy, Econjournals, vol. 10(4), pages 205-211.
    2. Acquah-Andoh, Elijah & Putra, Herdi A. & Ifelebuegu, Augustine O. & Owusu, Andrews, 2019. "Coalbed methane development in Indonesia: Design and economic analysis of upstream petroleum fiscal policy," Energy Policy, Elsevier, vol. 131(C), pages 155-167.

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