April 10th, 2017, 9:23 pm
NAV or discounted cashflows are fine in the absence of optionality but the value of mine, especially in the early stage of buying the claim, concession, or rights is unknown and dependent on multiple decisions. For example, the decision to exercise the option to invest in exploration would be contingent on a priori expectations of the volume of recoverable material and the realized price of the material if there is anything down there. That option to explore does have value as a function of the chance and extent that the price of the commodity fluctuates and reaches a high value. A second stage real option of investing in opening the mine also exists and has a value that depends on the amount of found reserves, cost of opening the mine, and future price of the commodity. Real option theory and methods are a way of modeling these decisions that are contingent on unknown variables which may be a function of volatile economic conditions or other uncertainties that will be revealed in the future.
Hedging really isn't possible in the early stages of a mine if the amount of recoverable material is unknown. Also, even the amount is known, hedging would only be used if the current price of the commodity were high and the mine owner wanted to lock in revenues. If the current price of the commodity is below the cost of extraction & refining, the mine seems to have a negative NAV. But under real options theory, the mine might be worth a lot if the price of the commodity is volatile and might readily jump above the cost of extraction & refining at some point during the duration of the option.
If the mine will definitely be profitable, you don't need real options theory. But if the NAV looks low or negative but might be very high if prospecting results or prices turn out favorably then real options help you evaluate the value of having the right to prospect or open the mine in the future.