Optimal exploration investments under price and geological-technical uncertainty: a real options model

This article develops a real options model for valuing natural resource exp loration investments (e,g, oil or copper) when there is joint price and geo logical-technical uncertainty. After a successful several-stage exploration phase, there is a development investment and an extraction phase. All phas es are optimized contingent on price and geological-technical uncertainty. Several real options are considered. There are flexible investment schedule s for all exploration stages and a timing option for the development invest ment. Once the mine is developed, there are closure, opening and abandonmen t options for the extraction phase. Our model maintains a relatively simple valuation structure by collapsing price and geological-technical uncertain ty into a one-factor model. We apply the model to a copper exploration prospect and find that a signifi cant fraction of total project value is due to the operational, development and exploration options available to project managers.