Journal of Commodity Markets 13 (2019) 30–39 Contents lists available at ScienceDirect Journal of Commodity Markets journal homepage: www.elsevier.com/locate/jcomm Real option valuation of open pit mines with two processing methods Matías Siña * , Juan Ignacio Guzmán Pontificia Universidad Católica de Chile, Chile ARTICLE INFO Keywords: Real option valuation Mining projects Price uncertainty ABSTRACT This paper proposes a real option model for valuing open pit mines with two processing methods under commodity price uncertainty. The model considers the flexibility that open pit mines have in order to decide if the ore being mined will be processed or sent to the waste dump. In addition, it enables to maximize the net present value of the mine through the use of the mining sequence and the extraction rate as decision variables. A numerical example is used to illustrate the model and the effect that price uncertainty has in the design of a mining project. The main result obtained is that an open pit mine can significantly enhance its value under a design that considers two processing methods instead of one. 1. Introduction Mining consists in the extraction, processing and commercialization of the ore contained in a finite and heterogeneous mineral deposit. Surface deposits are usually extracted through open pit mining instead of other mining method because it can lead to a higher production rate and lower mining cost. In addition, open pit mines have the flexibility in order to decide if the ore being mined will be processed or sent to the waste dump. Under commodity price uncertainty this option is similar to a financial European call option because the mine will decide to process and recover part of the metal contained in the ore body only if the spot price enables to obtain profit. On the other hand, if the ore cannot be processed with profit when it is extracted it will be sent to the waste dump. The value of the option previously described increases if the mine can choose between two processing methods instead of one for the reason that it will have a greater flexibility to respond to different market scenarios. In practice an open pit mine can have more than a single processing method for a specific ore type. This is, for example, the case of a sulphide copper mine in which the ore can be processed through a bioleaching or milling method (Montiel and Dimitrakopoulos, 2013). The case described has an economic justification if one of these methods enables the mine to achieve a lower processing cost and recovery of the metal contained in the ore. The reason for this is that the mine will increase the amount of ore that can be processed with profit. On the other hand, if the ore can be processed economically through both methods the mine will choose the one that enables to obtain more profit. It is important to notice that the profit that can be obtained through each processing method for a certain ore grade depends on the price of the commodity it contains at the moment it is extracted. Consequently, under commodity price uncertainty the optimal processing method for a certain ore grade can change dynamically over time. In order to estimate correctly the net present value (NPV) of a mining project this source of managerial flexibility needs to be considered through the development of a real option valuation (ROV) model. This work aims to contribute to the existing literature that studies the use of ROV through the development of a model for valuing * Corresponding author. E-mail address: mnsina@uc.cl (M. Siña). https://doi.org/10.1016/j.jcomm.2018.05.003 Received 1 November 2017; Received in revised form 10 May 2018; Accepted 10 May 2018 Available online 21 May 2018 2405-8513/© 2018 Elsevier B.V. All rights reserved.