Evaluating natural resource projects with embedded options and limited reserves

Abstract

This study proposes a Dynamic Option Simulation (DOS) approach to evaluate natural resource investment projects that contain several embedded options and limited reserves. To construct a practical pricing model, DOS combines simulation and dynamic programming techniques that can value natural resource investments with multi-variable, early exercise, various embedded options and finite reserve properties. A copper mine project offers a demonstration; the mine holder may temporarily close, reopen and abandon the mine at specific times before the expiration date. The mine holder may also accelerate mining speed to be optimal, referred to as the acceleration option. Numerical analyses of the copper price and interest rate effects on the copper mine value suggest that DOS can efficiently assess complex, multiple-variable, American-style real options problems.