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Optimal exploration investments under price and geological‐technical uncertainty: a real options model

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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 optimized 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.

We apply the model to a copper exploration prospect and find that a significant fraction of total project value is due to the operational, development and exploration options available to project managers.

Document Type: Original Article

DOI: http://dx.doi.org/10.1111/1467-9310.00208

Affiliations: 1: Ingenieria Industrial y de Sistemas, Pontificia Universidad Católica de Chile, Chile, 2: Anderson School, University of California at Los Angeles

Publication date: April 1, 2001

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