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Risk of commodity price, production cost and time to build in resource economics

Kuangyuan Zhang, Richard Olawoyin (), Antonio Nieto () and Andrew N. Kleit ()
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Richard Olawoyin: Oakland University
Antonio Nieto: Pennsylvania State University
Andrew N. Kleit: Pennsylvania State University

Environment, Development and Sustainability: A Multidisciplinary Approach to the Theory and Practice of Sustainable Development, 2018, vol. 20, issue 6, 2521-2544

Abstract: Abstract Real option theory has been extensively applied to natural resource extraction modeling and risk management, which proves to be a significantly more powerful method than the traditional ones such as discounted cash flows. This research attempts to extend a proposed real option model based on optimized price threshold strategy for gold mining operations. Besides exploring the risk from commodity price, the research also examines the effects of a declining stochastic production costs, due to technology innovation in the long term. The extended real option model further examines how the time to build a gold mine can impact the optimized price threshold strategy. Sensitivity analysis and numerical evidence show that, (1) innovation in mining technology will boost the mine’s profitability and also shift the optimized price threshold; (2) mining operators can hedge a significant level of risk by treating time to build properly. Further discussions are provided on mining investment strategy and policy implication for resource extraction.

Keywords: Option pricing; Commodity price; Risk management; Resource assessment; Time to build (search for similar items in EconPapers)
Date: 2018
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