Real options decision framework: Strategic operating policies for open pit mine planning

Abstract

This paper presents a first approach towards the development of a dynamics decision-making tool (DDMT) for open pit mine planning projects. In this paper, a decision framework, the so-called real option decision framework (RODF), is developed based on a real-options approach with practical applicability to a mining investment project. Four strategic operating options namely, deferral options, maintain options, expand options, and shutdown options, are assumed for mining operations. We illustrated the proposed framework and developed methods for a hypothetical gold mine. The standard discounted cash flow (DCF) method was carried out to analyze the project values without options. The real option valuation (ROV) approach was calculated for the deferral and expand options. We used a system dynamics (SD) modeling method to solve real options problems and the discrete-event simulations were used to simulate the potential values of the projects. The findings are that investors are prone to lose an opportunity to invest if relying on traditional DCF-NPV rules as they suggest accepting the project if and only if NPV is greater than zero. However, results obtained from real options suggest that the project has a value to an investor across different time horizons. The insight is that it is of paramount importance to find an optimal time to exercise a strategic option. It is indicated that strategic options such as the deferral option may yield a higher value than the base case (DCF-NPV) mine option because project risks can be hedged, whereas the expand option may also offer additional value to mine operators. However, such extra-additional values can only be captured through managerial flexibility.