Journal of Mining Science, Vol. 47, No.

2, 2011

INCORPORATING GEOLOGICAL AND MARKET UNCERTAINTIES AND

OPERATIONAL FLEXIBILITY INTO OPEN PIT MINE DESIGN

S. A. Abdel Sabour and R. Dimitrakopoulos

UDC 539.3

This work outlines a procedure for integrating uncertainty and operational flexibility into open pit mine
design selection. A multi-criteria design ranking system based on advanced uncertainty and financial
modeling techniques such as Monte Carlo simulation and real options is proposed. A case study at a
copper mine is provided.
Mine design, economic evaluation, real options, Monte Carlo simulation
INTRODUCTION

The ultimate goal in open pit mine planning is to define an optimum mine design and a life-ofmine (LOM) sequence of production. In this respect, the conventional method for open-pit planning starts
with modeling the orebody based on the borehole data and geological information. Then, the mining field
is divided into blocks of regular volume. Based on a deterministic metal price, each block is assigned a
value equal to the gross value of its metal content minus the applicable production, processing and
refining costs. The optimum production plan is determined by applying different optimization algorithms.
Commonly, there may be alternative technically feasible mine plans available that meet operational and
technical constraints. The selection among those plans is then based on economic reasons. This is carried
out by evaluating each of the possible mine plans and comparing their economic attractiveness so as to
select the most economically appealing one. The basic assumption in most previous work is that metal
prices and/or metal content of ore blocks are known with certainty [1 5]. Nevertheless, the reality in the
mining industry is much more complex than this simple assumption may suggest. In practice, mine
planners cannot know with certainty the quantity and quality of ore in the ground. In addition, both future
metal prices and foreign exchange rates cannot be known with certainty.
An example for geological uncertainty is illustrated in Fig. 1, showing 20 simulations for the
possible metal content of an ore block at a copper mine. It is obvious that the possible copper content is
highly uncertain. While the conventional average indicates that the block contains 34 tonnes of copper,
the simulations show that the copper content is uncertain and could be as low as 8 tonnes or as high as
114 tonnes. Ignoring such uncertainty could result in substantial losses especially when considering the
capital-intensive nature of mining investments. As reported by Vallee [6], shortcomings in geological
modeling and financial analysis were the key factors that caused a loss of $1.4 billion to the Canadian
mining industry in the early 1991.
The second major source of risk affecting mine project profitability is related to the uncertainty about
market behavior of metal prices and exchange rates. Figure 2 shows, for example, the average monthly
market prices of copper over the period 1996-2009 in current US dollars. It is obvious that these prices
are highly volatile and do not keep a constant trend, which makes it speculative to define deterministic
forecasts for future metal prices. Exchange rate is also another contributor to project risk. Figure 3 illustrates
how the average monthly exchange rates of the Canadian/USA currencies are uncertain. Therefore, it is
difficult for mine planners to have precise forecasts for these key variables over the life of a mine.
COSMO-Stochastic Mine Planning Laboratory, Department of Mining and Material Engineering, McGill
University, E-mail: sabry.abdelhafezabdelsabour@mcgill.ca; E-mail: roussos.dimitrakopoulos@mcgill.ca,
Montreal, QC, Canada.
1062-7391/11/4702-0191

2011 Pleiades Publishing, Ltd.

191

Fig. 1. Geological uncertainty of a copper ore block

Integrating geological uncertainty into open pit mine planning was first introduced by
Dimitrakopoulos et al. [7]. Subsequently, efforts have been devoted to develop a risk-based
optimization approach for long-term mine planning considering geological uncertainty. Results have
shown significant improvements in NPV of the project in terms of 26 28 % over the conventional
approach. In addition, chances of deviating from production targets have been significantly minimized
[3, 8 12].
For the other source of risk which is related to market variables, real options valuation (ROV)
technique can provide a promising tool for integrating market uncertainty into open pit mine planning.
More details on real options valuation can be found in [13 17], among others. ROV, similarly to the
conventional net present value method (NPV) calculates the discounted, net present value of future
cash flows. The two techniques differ in the way they apply discounting and in the way they deal with
operating flexibility. Conventional NPV applies a single discount rate to all cash flow components. As
shown in Fig. 4, metal price is more volatile than operating costs which makes applying a single
discount rate for both revenues and costs an oversimplification. Differently, ROV allows for
differential discounting based on the specific risk of each cash flow component.
Given such a volatile metal market the management flexibility to readjust to the new information
could be of significant value. Such value cannot be captured in the conventional NPV analysis while it
can be captured in the ROV. When applying the same discounting procedure, the value of the operating
flexibility, which is the difference between the estimates of NPV and ROV, is directly related to project
profitability and metal price volatility. As depicted in Fig. 5, at low metal prices, the difference
between the two techniques is significant while at high prices the difference diminishes. Figure 6
illustrates the relation between volatility and operating flexibility. It is obvious that at low volatility
levels, the value of flexibility is not significant and the two methods produce almost the same result. As
the volatility increases, the difference between the two estimates widens.

Fig. 2. Average monthly copper prices

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Fig. 3. Exchange rate uncertainty

Fig. 4. Canadian operating cost indices of open pit, underground and processing
(http://costs.infomine.com) and copper price (http://minerals.usgs.gov) over the period 1991 2008

Fig. 5. Relationship between the difference

between NPV and RO and project profitability

plant

Fig. 6. Relationship between the difference

between NPV and RO and volatility

This paper builds on the work of Dimitrakopoulos et al. [10] by quantifying and integrating the
market uncertainty related to metal prices and exchange rates into mine planning. In this respect, the
article aims to develop a system for mine plan selection based on multiple value statistics and cash
flows characteristics incorporating the value of management flexibility to react to the new information.
In the next sections, the proposed selection system will be briefly outlined. Then, it will be applied,
along with the conventional methods of selection, to select a preferred design for a copper mine.
Finally, an investigation of the usefulness of the developed system will be provided.
A SYSTEM FOR MINE DESIGN SELECTION UNDER UNCERTAINTY

First, it is worth noting that the different alternative mine designs could result from different
available production scenarios, different LOM sequences, and so on. In this study, the procedure
described in Dimitrakopoulos et al. [10] for generating different mine designs based on simulating
multiple orebody realizations is used. The mine design selection system, or ranking system, proposed
in this work takes into account multiple sources of uncertainty simultaneously and integrates the
operating flexibility to revise the ultimate pit limits based on the new information. The proposed
system consists of three main steps: uncertainty quantification, design valuation and design ranking.
Uncertainty Quantification. In this step, both the geological and market uncertainties are
quantified. First, the geological uncertainty is explored by simulating multiple orebody realizations
based on the borehole data using conditional simulation [18, 19]. Market uncertainty about metal prices
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and foreign exchange rates is quantified using also stochastic modeling based on historical market
behaviour. Examples of stochastic models include geometric Brownian motion (GBM) model in
Equation (1) and the mean-reversion model in Equation (2) [20]:
dP
= dt + dz ,
(1)
P
dP
= ( ln P) dt + dz ,
(2)
P
where P is the price, is the expected trend, is the standard deviation, dz is an increment in a
standard Weiner process and dt is an increment of time. In Equation (2), is the logarithm of the long
term equilibrium level of metal price and is the reversion speed. Figure 7 show examples of the
GBM and MR process, respectively. It is worth noting here that the stochastic models in Equations (1)
and (2) are provided as examples for illustration purposes only. Other models can replace the above
ones without having effect on the ideas and concepts presented in this work. The advantage of the
simple models presented in Equations (1) and (2) over the more complex models is that the model
parameters can be easily estimated from historical data. More details about stochastic models and
parameter estimation can be found in [20], among others.
Valuation of Mine Designs. The economic valuation model is based on real options valuation
using the least squares Monte Carlo method. This method was developed by Longstaff and Schwartz
[21] for valuing American style securities and extended by Abdel Sabour and Poulin [22] to valuing
capital investments under multiple market uncertainties and extended further to valuing mining
investments under multiple market and geological uncertainties [23 25]. It is assumed that there is M
different feasible mine designs and each design has H different grades and tonnages equal to the
number of generated orebody realizations. For market variables, a large number of correlated
realizations, N, are generated using the stochastic models and taking into account the correlation
coefficients between those variables. The decision whether to keep or revise the originally defined pit
limits is taken at discrete regularly-spaced time points based on the expected continuation value, CV,
such as:
Keep the pre-defined pit limits if:
E (CV n, t ) > 0 ;
(3)
Revise the pre-defined pit limits if:
E (CV n, t ) 0 .

Fig. 7. Geometric Brownian motion (); mean reverting process (b)

194

(4)

According to Equations (3) and (4), if the expected present value at time t and sample path n is
positive, the optimum decision is to keep the pre-defined pit limits until next decision time. Otherwise,
if the expected present value is negative, the original plan should be revised and the current pit limit at
time t should be the final pit limit. Estimating the expected CV requires knowing the function that
relates the present value of future mining operations beyond time t to the states prevailing at time t.
This function could be in different forms such as the simple power series, Laguerre polynomials or
linear combinations of different forms [21]. The parameters of this function can be estimated at each
time using least squares regression.
This process is performed throughout the simulated paths N at each period and the cash flows are
defined based on the optimal decision reached. If the time step is set to be one year, the outputs of the
valuation model are: the annual discounted cash flows, the probability that the mine will be producing
every year, the expected value of positive annual cash flows with their corresponding probabilities and
the expected value of negative annual cash flows with their corresponding probabilities. These statistics
are produced for each design in addition to the expected overall present value for each design along
with its confidence limits at a specified level of confidence. These statistics are used to rank the
different designs as explained in the following section.
Indicators for Ranking of Mine Designs. The ranking procedure proposed in this study aims to
gather multiple value and risk analysis indicators into one quantitative measure while integrating real
industry complexities such as uncertainty and operating flexibility to revise pre-defined pit limits. The
proposed design ranking system for selecting the best open pit design based on the information
available at the initial planning time takes into account the following aspects:
Upside potential that measures the ability of designs to capture possibly more profits than those
expected if outcomes were favurable.
Downside risk that reflects the difference between designs in minimizing negative cash flows risk
throughout mine life.
Probability of completion, which is the probability that the mine will be open throughout its
planned life.
Statistics of the estimated values which includes the average, lower and upper limit at a certain
confidence level.
After estimating the above described four indicators for each mine design, the total ranking
indicator is the summation of these four indicators. The designs are then ranked according to the total
indicator and the design with the highest indicator can be identified. In this work, the average
performance of all feasible mine designs will be used to compare and rank these designs. However, one
can replace these averages depending the objectives specific to a given mining project. In addition, the
above mentioned ranking criteria are given in this study equal weights. Different weights can be given
to those criteria if considered appropriate.
CASE STUDY: SELECTING A DESIGN FOR A DISSEMINATED COPPER DEPOSIT

The proposed design ranking procedure explained in the previous section is applied to a
disseminated copper deposit. It is assumed that there are alternative technically feasible mine designs
available to decision-makers. These different mine designs could be generated by a number of ways.
One way, which is applied in this study, is to use the method described in Dimitrakopoulos et al. [8] for
generating different designs from the multiple orebody simulations. To investigate the efficiencies of
the valuation techniques and the proposed ranking system in assessing alternatives under uncertainty,
the mine designs will be assessed based on the following four ranking measures, namely the:
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 expected value estimated by the conventional NPV valuation method;

NPV-based indicator explained above, except the probability of completion indicator since the
NPV of the mine calculated at the planning time before starting production does not consider the
flexibility to revise pit limits in the future,
expected value estimated by the real options valuation; and
real options valuation (ROV) based indicator which upside potential, downside risk, probability
of completion and value statistics.
It is assumed that the mine was planned and mined out in the past. Therefore, it is possible to
compare the design assessed based on the actual market realizations to that estimated by the four
methods listed here. No capital expenditures are considered since it is assumed that production
operations are carried out by contractors. This copper mine is assumed to be planned in 1992, started
production at the beginning of 1993 and closed at the end of 2000. The economic data prevailing at the
planning time (1992) are listed in Table 1. Both of the copper price and the exchange rate are modeled
with the mean reverting process in Equation (2). Except the initial copper price and the initial exchange
rate, all parameter estimations are based the historical data from 1970 to 1992. The overall income tax
rate is assumed to be 40 % with no loss offset. At the planning time, there were 10 mine designs
estimated by feeding the 10 simulated orebody models into Whittle Software that uses the nested
Lerchs-Grossman algorithm to generate the optimum mine design [26]. Figure 8 shows sections for
10 designs. Each of the designs has 3 pushbacks.
Each of the 10 designs has been evaluated using Monte Carlo method with 20 000 correlated
simulations for the copper prices and the exchange rates throughout the 8-year mine life. Two valuation
techniques are applied. The first technique is the conventional NPV method that does not take into
account operating flexibility to revise pit limits. The second one is the ROV in which the flexibility to
revise pit limits is integrated and the optimum decision is made based on the expected value conditional
on time and the simulated paths. To focus on the value of operating flexibility only, the same
discounting procedure was applied for both the conventional NPV and the ROV methods. Therefore,
the difference between the two techniques here is owed solely to the difference in the way they handle
flexibility in pit design. Figures 9 and 10 show the expected design values, P10 and P90 estimated by
the conventional NPV and the ROV, respectively. Based on the NPV, design 6 has the highest expected
value, highest P10 and lowest P90. If the decision is based on the NPV results, design 6 is the one that
should be selected. Real options results in Figure 9 indicate that Design 10 has the highest expected
value, the highest P90 and the fourth highest P10. This could make it the best selection from ROV
point of view.
TABLE 1. Economic Parameters for the Copper Mine
Item
Risk-free interest rate, %
Inflation, %
Initial copper price, $US/lb
Volatility, %, copper price
Reversion speed of copper price
Long-term copper price, $US/lb
Initial $US/$CAN rate
Volatility, %, $US/$CAN
Reversion speed/year, $US/$CAN
Long-term, $US/$CAN
196

Description
9.20
6.70
1.07
20.00
0.19
1.00
1.20
4.00
0.08
1.25

Fig. 8. East-West sections showing the pushbacks of the 10 alternative mine designs

The advantage of the Monte Carlo method is that it provides multiple statistics for the overall value
as well as annual cash flows that can be used to carry out advanced risk analysis. These statistics were
used to construct a ranking system. Following the proposed design ranking procedure outlined above, a
NPV-based indicator and a ROV-based indicator have been calculated for each design. Figure 11
depicts the calculated total ranking indicators (TRI) based on the valuation results of NPV and ROV.

Fig. 9. Designs valuation with the conventional NPV: a P90; b average value; c P10
197

Fig. 10. Designs valuation with the real options: a P90; b average value; c P10

Table 2 summarizes the results of the four design ranking measures (the NPV in Fig. 9, NPV
indicator in Fig. 11, ROV in Fig. 9 and ROV indicator in Fig. 11). The last column of Table 2 lists
design ranking based on the actual market data over the mine life (Y 1992 Y 2000). As indicated in
Table 2, design 6 is ranked the 1st based on NPV, while based on the actual market data it is ranked the
7th. Based on ROV, design 10 is ranked the 1st while it is ranked the 2nd based on the actual market
data. Comparing the rank for all other designs, it is obvious that design ranking based on ROV is closer
to the ranking based on actual market data. Another important conclusion can be drawn from Table 2 is
that, for the conventional NPV analysis, design ranking based on the NPV expected value is almost
identical to that of the NPV-based indicator and differs from those of the real options expected value
and the ROV-based indicator. The ROV expected value and the ROV-based indicator have similar
ranking for 5 mine designs and different ranking for the remaining 5 designs.

Fig. 11. Design indicators based on the NPV and the real options results
198

TABLE 2. Designs Ranking for the Copper Mine

Rank

1
2
3
4
5
6
7
8
9
10

NPV expected
value
Design 6
Design 10
Design 7
Design 5
Design 2
Design 1
Design 9
Design 3
Design 4
Design 8

NPV-based TRI

ROV expected value

ROV-based TRI

Actual data ranking

Design 6
Design 10
Design 7
Design 5
Design 2
Design 1
Design 9
Design 3
Design 8
Design 4

Design 10
Design 7
Design 2
Design 6
Design 3
Design 5
Design 1
Design 4
Design 9
Design 8

Design 10
Design 2
Design 7
Design 3
Design 4
Design 5
Design 1
Design 6
Design 9
Design 8

Design 2
Design 10
Design 7
Design 4
Design 5
Design 3
Design 6
Design 9
Design 1
Design 8

The results show that under the conditions of uncertainty, design values based on actual market
data can be significantly different from those estimated at the planning time. Consequently, using the
expected value to rank possible mine designs may result is sub-optimal decisions. Therefore, it is
important to integrate multiple risk and cash flow analysis into mine design selection process.
However, given the multiple sources of uncertainty associated with mining investments, the multiple
risk and cash flow analysis could be useless if the management flexibility to react to the new
information is not considered. As shown in Tables 2, the NPV-based indicator using multiple risk and
cash flow analysis generated almost the same decision as the NPV expected value. This is because
when no flexibility to revise pit limits is considered, the distribution of any estimated measure may
assumed to be approximately symmetrical around the expected value and no significant change in the
decision nor any improvement in the selection process might be achieved. To the contrary, when
integrating the flexibility to revise the originally taken decisions regarding the ultimate pit limits, the
efficiency of the selection process was significantly improved when considering multiple risk and cash
flow analysis measures. Effort has to be devoted to integrate more risk analysis measures as well as
more operating flexibilities, such as the flexibilities to expend, contract and switch production inputs in
order to improve further the process of mine planning under uncertainty.
The results of this study are specific to the case study presented herein and the data fed into the
valuation model. Different results might be obtained if the mine was assumed to be started and finished
at different calendar times. In addition, the valuation results are sensitive to the chosen stochastic
model for describing the evolution of a market variable and its estimated parameters. In this respect, it
is worth stressing that the ROV is a valuation rather than a price forecasting technique. Like the static
NPV, or even any other system, the outputs are dependent on the inputs.
CONCLUSIONS

This paper outlined an uncertainty-based procedure for selecting optimum open pit mine design
under geological and market uncertainties. A case study of a copper deposit was provided to explore
the difference between the conventional and the proposed approach. In this respect, the proposed
system has been applied to rank possible designs at a copper mine. The results showed that there is no
significant difference in the design ranking of the conventional analysis when incorporating multiple
indicators. Differently, uncertainty-based design ranking showed a significant difference which
indicates the importance of incorporating uncertainty and operational flexibility into mine design
selection. In addition, benchmarking the techniques using actual market data showed how incorporating
199

uncertainty and flexibility could improve design ranking process. Future extensions could include
integrating more risk analysis measures and other types of management flexibilities such as the
flexibility to revise the cut-off grade with time so as to improve the design selection process even
further.
ACKNOWLEDGEMENTS

The work in this paper was funded from NSERC CDR Grant 335696 and BHP Billiton, as well
NSERC Discovery Grant 239019, McGill's COSMO Lab and its industry members AngloGold
Ashanti, Barrick, BHP Billiton, De Beers, Newmont, Vale and Vale Inco.
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