A Reactive Approach for Mining Project Evaluation under Price Uncertainty

Projects in the mining industry are undertaken with the objective of maximizing economic value, which is near-universally measured by the Net Present Value (NPV), considering all capital expenditure and operating cash flow. This industry is usually considered high risk because of historically volatile commodity prices (directly impacting revenues) and the fact that very large capital expenditures are required upfront for the construction of processing, mining and transport infrastructure. In order to optimize overall investment returns in a mining project, it is thus essential to use the best possible project valuation method so that the sizing of initial capital expenditures are appropriate to the expected returns and risks. A commonly used method for mining project evaluation calculates the expected NPV of a mine plan based upon the expected future commodity price given the current spot price. This method often undervalues a mining project since it ignores future price uncertainty and does not allow for managerial flexibility or optionality. This paper presents an alternate approach to mining project evaluation – the “reactive” approach. This “reactive” approach emulates a strategy that a real operating mine would undertake over its mine life by modifying the mine plan in each new period in response to the latest information on metal price. This paper also demonstrates that the “reactive” approach can estimate the mine project value more accurately by recognizing additional value due to the presence of management flexibility and optionality.