A Comparison of Pricing Models for Mineral Rights: Copper Mine in China

Abstract

Purchasing mineral rights to allow a corporation to extract minerals is a large investment and potentially very profitable. Generally, the assessment and valuation process is conducted by an official organization at the nation's governmental level. From a corporation perspective it is thus crucial to calculate an accurate value of the right to exploit a mineral product or what we call ``mineral right''. In this work we compare three valuation methods and we compare their results in case of pricing a copper mine in China. We explain and apply the official valuation method based on a simple Discounted Cash Flow (DCF). We present what we believe is a more accurate valuation based on the term structure of future mineral prices: the so called modified Discounted Cash Flow (mDCF) method. Finally, we contrast with a method based on real options which considers the mineral right as a swaption. We implement two real options models: the classical Black model and a more modern Miltersen and Schwartz model. We highlight and discuss differences and commonalities between the three valuation methods. Finally, we make a recommendation for future financial reporting based what we learn from the three methods.

Keywords: Mineral Rights, Mining Valuation, Futures, Real Options

JEL Classification: 91B32, 91B62, 91B70