Option pricing: A new approach to valuing mining projects

CIM Bulletin, Vol. 90, No. 1009, 1997

M. Armstrong and A. Galli Centre de Géostatistique, École des mines de Paris Fontainbleau, France

Option pricing is used in finance for valuing options to buy (or sell) shares at some future date because it provides a convenient framework for quantifying values subject to uncertainty. As one of the main sources of uncertainty in mining is the price (sales) of the metal, this approach can also be used for valuing mining projects. The first part of this paper reviews options and option pricing; the second part presents the approach developed by Brennan and Schwartz (1985) for using option pricing to value natural resources. Several applications of this methodology have been published; these are described. From a mining point of view, the assumptions made by Brennan and Schwartz are too simplistic. The weaknesses are discussed with a view to improving an apparently promising new way of assessing the value of projects.
Keywords: Mineral economics, Option pricing, Valuing options.