“Re-Invent” our Approach on the Economics of Mining Project for Improved Investment Decision , Perhapi Conference, October 2013, Jogjakarta

December 29, 2013 • Tell FriendsPrinter Friendly

Along with the rising crude price in mid-year 2008, commodity prices like coal also experience a significant increase exceeding $ 100/ton whereby it is never expected before.
However when global crisis occurred at the end of 2008, coal prices decreased significantly. This condition has made many mining project was delayed while waiting for the situation strengthen.

The fluctuation of coal price in 2008 is understandably due to the mining industry facing a high risk of prices fluctuations in the future.
The other fact is that in dealing with situations of low coal prices, management undertook efforts to minimize the risk of losses by delaying the project development. These facts should be considered when we evaluate a mine project.

Currently, business practitioners used “one size fits all” single corporate discount rate method for valuing uncertainty in the project valuation. This method is known on static Discounted Cash Flow (DCF)

This methodology has a limitation in recognizing uncertainty during project life and some biased in its assumption, i.e.:

1. It is assumed future cash flows to be certain to happen.
2. Project risk does not change throughout its life
3. It is assumed once the project is undertaken, it will not be affected by any future managerial decision.

Over the last two decades, valuation professionals have been actively investigating how to improve DCF method by better representing mining industry complexities in their cash flow models. One of the new approaches that had been implemented in mine project evaluation is using Real Options Analysis.

On this new approach, we can move beyond the static “now or never” decision framework that is implicit in most current analysis to an explicit modeling and analysis, to examine the effects of the contingent decision sequences that actually occur in most business situations.

This paper will discuss the application of Real Options method for integrating the probabilistic model of coal forward pricing and strategic decision options in a coal mine project

The objective of this paper is to see the possibility of using Real Options Analysis for improved investment decision in mining project.

Using a real case of coal project acquisition in Kalimantan, the result shows that improper risk assessment on cash flow uncertainty properly and ignoring managerial flexibility can generate misleading project value estimates. Real Options method is more likely to reveal a true picture of investor expectations on the value of this asset than DCF method.

This paper makes the conclusion that RO can be applied for improved investment decision on mine project in Indonesia.

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