Resources Policy 38 (2013) 212–223

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Resources Policy
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An uncertainty based multi-criteria ranking system for open pit mining

cut-off grade strategy selection
Yousuf Azimi a,n, Morteza Osanloo a, Akbar Esfahanipour b
a
Department of Mining and Metallurgical Engineering, Amirkabir University of Technology, Tehran, Iran
b
Department of Industrial Engineering, Amirkabir University of Technology, Tehran, Iran

a r t i c l e i n f o a b s t r a c t

Article history: Cut-off grade strategy (COGS) is a concept that directly influences the financial, technical, economical,
Received 7 December 2011 and environmental issues in relation to the exploitation of a mineral resource. Despite the simple
Received in revised form definition of cut-off grade, the COGS problem is one of the complex and complicated problems in the
26 October 2012
mine planning process. From the optimization point of view, the COGS with an objective of maximizing
Accepted 22 January 2013
the present value of future cash flows is a non-linear and a non-convex problem that even in its
Available online 15 March 2013
deterministic form can be solved using approximate optimization methods. This optimization problem
JEL classifications: will also be more complex and complicated under uncertainty conditions. This paper proposes an
D81 uncertainty based multi-criteria ranking system to investigate the problem of COGS selection
C63
considering metal price and geological uncertainties. The proposed system aims at selection of the
G13
best COGS among technically feasible alternative COGSs under uncertainty circumstances. Our
L72
Q32 developed system is based on integrating metal price and geological uncertainties as well as operating
flexibility to close the mine early. We incorporate this operating flexibility into the proposed system
Keywords: using a Monte Carlo based real options (RO) valuation model. For this purpose, in addition to the
Open pit mining expected value, other risk criteria are considered to rank the alternatives. These risk criteria include
Cut-off grade strategy (COGS) abilities of strategies in producing extra profits, minimizing losses, and achieving the predefined goals
Least-Squares Monte Carlo real options of the production. In this study, the technically possible COGSs are generated using the Lane
valuation comprehensive algorithm. To demonstrate the effectiveness of the proposed system, we utilize data
Metal price uncertainty of an Iranian gold mine. Results show that the proposed system outperforms conventional methods in
Geological uncertainty
the sense that it shows significantly lower average mis-ranking than the other methods and also selects
Multi-criteria ranking system
a strategy with a higher value. The sensitivity analysis of the proposed system relative to the gold price
shows that the system is highly dependent on the parameters of the stochastic process used to model
the evolution of the metal price. Therefore, special consideration should be given in estimating
stochastic process parameters.
& 2013 Elsevier Ltd. All rights reserved.

Introduction further processing or taking to the waste dump (Dagdelen, 1992).

Taylor (1972) defines the cut-off grade as an operating control
that could be used to choose one of the two possible actions that
are going to take place on a specified amount of rock. In other
words, it determines the routing of the specific materials inside a
reserve. Conventionally, in open pit mine planning and design,
two types of cut-off grades are defined: (1) the break-even mine
cut-off grade, which is used to determine if a block of material
deserves to be mined or not while trying to determine the
ultimate pit limits; (2) the milling cut-off grade, which deter-
mines how the mined block should be treated, such as sending for
n
Corresponding author. Tel.: þ98 914 108 6522.
E-mail addresses: yoosfazimi@gmail.com (Y. Azimi),
morteza.osanloo@gmail.com (M. Osanloo), esfahaa@aut.ac.ir (A. Esfahanipour).
The milling cut-off grade, which is also known as the cut-off grade
strategy (COGS) or exploitation strategy has a determinant role on
the optimality of the mining operation. The most comprehensive
model of COGS optimization was developed by Lane (1988). His
model reveals that optimum COGS depends not only on the
economic parameters but also on all the salient technological
features of the mining operation and ore-body (Cairns and
Shinkuma, 2003).
The goal of an open pit mine planning is to find an optimum
plan resulting in the highest Net Present Value (NPV) while
meeting several technical and operational constraints. Hence, once
the geologic block model is built, a mine planner performs the
planning by answering the three following questions (Dagdelen,
2007): (1) Should a given block in the model be mined or not?;
(2) If it is to be mined, when should it be done?; (3) Once it is
mined, how should it be processed (OR: where should it be sent?)?

0301-4207/$ - see front matter & 2013 Elsevier Ltd. All rights reserved.
http://dx.doi.org/10.1016/j.resourpol.2013.01.004
 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
Describing the solution of the above-mentioned questions, as
discussed thoroughly in the literature (Dagdelen, 2007; Osanloo
et al., 2008), is out of the scope of this paper. However, the
solution for the third question carries the same solution for the
COGS optimization problem. Conventionally, planning is done in a
circular manner as shown in Fig. 1. Hence, any wrong COGS will
certainly lead to wrong planning, inefficient performance of
different stages of the mining operation, and considerable losses.
Traditionally, a constant price trend and a grade tonnage curve
estimated from the kriged grades are used in open pit mine
planning. But the real situation is much more complex, where
mining investments are often associated with diverse sources of
both endogenous and exogenous uncertainties. Recently, much
research has tried to address the issue of geological and market
related uncertainties in the mining industry where their adverse
effects could cause substantial losses of millions of dollars
(Osanloo et al., 2008).
In this respect, some outstanding work has been done incorpor-
ating geological uncertainty in long term mine planning using
simulation based optimization and stochastic programming meth-
ods (Dimitrakopoulos and Abdel Sabour, 2007; Gholamnejad and
Osanloo, 2007; Osanloo et al., 2008). While market related uncer-
tainties in mining investments are resolved employing the modern
stochastic valuation method, known as Real Option (RO) valuation.
The RO valuation is an alternative approach to the conventional
Discounted Cash Flow (DCF) model. Brennan and Schwartz (1985)
applied the RO analysis in the mineral industry for the first time, and
since then it has been extended by researchers considering various
types of flexibilities and employing different analytical and numer-
ical methods. Researchers have confirmed that the RO valuation
performs better than the DCF approach under uncertainty condi-
tions. It also provides a basis for developing flexible mine plans by
valuing the strategic and managerial flexibilities in response to
uncertain market conditions (Mardones, 1993; Trigeorgis, 1996;
Frimpong and Whiting, 1997; Samis and Poulin, 1998; Abdel
Sabour and Poulin, 2006; Samis et al., 2006; Dimitrakopoulos and
Abdel Sabour, 2007; Cortazar et al., 2008; Akbari et al., 2009).
Despite the usefulness of these methods, they suffer from
some important shortcomings. These shortcomings include mak-
ing subjective judgments in the decision making process, con-
sidering constant market conditions, and the weakness of the
conventional DCF approach in valuing managerial flexibilities
inherent in the mineral industry. Although the RO valuation is
able to value managerial and operating flexibilities, like conven-
tional methods, it does not necessarily prescribe the best alter-
native among the available alternatives and the results are often
interpreted subjectively.
Fig. 1. Steps of traditional planning by circular analysis (Dagdelen, 2007).
213
Recently, according to the new developments in the simula-
tion based RO valuation, researchers have attempted to develop
multi-criteria ranking systems with the aims of minimum sub-
jective judgments, sound quantification of uncertainties and
valuation of management flexibilities for appraisal of investments
in minerals industry (Abdel Sabour et al., 2008). To select the best
alternative in such a system, besides the expected value of
alternatives other economical and operational risk indicators
should also be considered in the evaluation process.
One of the earliest studies on incorporating uncertainties in
calculation of the COGS is the work by Dowd (1976). He devel-
oped a stochastic dynamic programming model in which price
uncertainty was modeled as a stochastic Markov process. Despite
some operational simplifications considered in regard with con-
centrating and refining plant capacities, it seems that Dowd’s
model has the potential to be extended to a more general model.
Krautkraemer (1988) studied the optimal response of the COGS
based on anticipated and unanticipated price changes using
optimal control theory. He provided some useful theoretical
discussions, but his model is not general and does not seem
applicable in a real life mining conditions. Recently, McIsaac
(2008) and Thompson (2010) employed golden search optimiza-
tion inside simulation based models considering metal price
uncertainty to find a robust fixed cut-off grade and a fixed mining
rate for the whole life of the mining operation in metalliferous
underground and open pit mining, respectively. However,
employing a fixed cut-off grade throughout the whole mining life
time will certainly lead to non-optimal operations and misuse of
mining, milling, and refining capacities.
The contribution of this paper is to propose a multi-criteria
ranking system to select an optimum COGS, incorporating geolo-
gical and metal price uncertainties while considering the operat-
ing flexibility to abandon the mine early under adverse economic
conditions. In this regard, the Lane comprehensive algorithm
(Lane, 1988) is used to generate technically feasible alternative
COGSs. The price and geological uncertainties are quantified using
the stochastic process and geostatistical simulations, respectively.
The Least Squares Monte Carlo (LSM) RO valuation model is
applied to valuate alternative strategies. Also, the usefulness of
the proposed methodology and its sensitivity to the estimated
parameters of the price stochastic process are investigated. In the
next sections, the mechanism of the employed ranking system
adapted for selection of the COGS is outlined and applied to an
Iranian gold mine under price and geological uncertainties.
Methodology
In this paper to enhance the decision making process under
uncertainty, a multi-criteria ranking system is proposed for
selection of the cut-off grade strategy for an open pit mining
operation, while integrating geological and market uncertainties
and the operating flexibility to close the mine early. This selection
system is based on multiple value statistics and cash flow
characteristics incorporating a value of management flexibility
in reacting to the new information. Fig. 2 shows the employed
methodology in this study. This contains five main steps as
follows: (1) modeling of metal price uncertainty using stochastic
processes; (2) modeling of geological uncertainty using a spatial
stochastic simulation method called ‘‘conditional simulation.’’
(the uncertainty related to the ore quantity and quality is termed
as the geological uncertainty); (3) generating the technically
feasible COGSs using the Lane algorithm in conjunction with the
simulated equally probable realizations of the ore-body and metal
prices; (4) valuation of alternative strategies using the newly
developed simulation based RO valuation known as Least Squares
214 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
Fig. 2. The proposed multi-criteria ranking system for selection of COGS for open pit mining.
Monte Carlo which is used to incorporate the value of operating
flexibility under multiple uncertainties. The method is mainly
based on simulating multiple realizations of the uncertain vari-
ables and making the optimal decision at each period using value
expectations; (5) applying a multi-criteria ranking system to
select the best COGS. The last step employs statistics of cash flow
distribution functions including upside potential, downside
potential, value statistics and probability of completion. The
following sections provide the theoretical basis for the proposed
methodology.
Modeling the price uncertainty
There are many stochastic processes that can be used in
quantifying market uncertainty of commodity prices. The most
commonly used processes are the Geometric Brownian Motion
(GBM) as shown in Eq. (1) and the Mean Reverting Process (MRP)
as shown in Eq. (2) (Dixit and Pindyck, 1994):
dP ¼ aP dt þ sP dz
dP ¼ ZðlnPln PÞP dt þ sP dz
where P is the price of a metal, a is the expected trend, s is the
standard deviation, dz is an increment in a standard wiener
process, dt is an increment of time and Z is the speed at which
the price reverts to its long term equilibrium level of P. Generally,
the GBM is suitable for variables that exhibit a constant trend,
such as precious metal prices and security prices while the MRP is
appropriate for modeling variables that have a long term equili-
brium level, such as base metal prices (Schwartz, 1997). The
advantage of stochastic process modeling is that the selection of
appropriate process and calculating corresponding parameters
are based on analysis of the historical market prices of a metal.
After selecting the appropriate model and its parameters, in the
simulation process it is important to generate sample paths
according to the Markov property (Dixit and Pindyck, 1994), in
which only the current information is sufficient to forecast the
future value of a variable. Simulating price paths based on this
property enhances time connectivity, reduces unrealistic shifts
throughout the single Markov and simultaneously guarantees the
naturally respected confidence level according to the probability
function at each time interval (Dixit and Pindyck, 1994).
As assumed by Schwartz (1997), the gold price P evolves
according to the GBM process. According to the lognormal
distribution, future prices for Pt can be generated as follows:
pffiffi
Pt ¼ P 0 expfða0:5s2 Þt þ Nð0,1Þs t g ð3Þ
where N(0,1) is the standard normal distribution random variable.
Modeling the geological uncertainty
During the past two decades, conditional simulation has been
used as a complementary tool for modeling of geological uncer-
tainty in the strategic mine planning and design (Osanloo et al.,
2008). The main idea behind this technique is the use of
conditioning data to produce equally probable realizations of
the in-situ ore-body based on the borehole data. The geostatistical
simulation is a generalization of the concepts of Monte Carlo
simulation to include three-dimensional spatial correlation to
ð1Þ
ensure the following: (1) the simulated values of each variable
are the same as the measured values of those variables at sampled
ð2Þ
locations; (2) all simulated values of a given variable have the
same spatial relationships as observed in the data values, i.e.,
spatial correlation; (3) all simulated values of any pair of variables
have the same spatial interrelationships as observed in the data
values, i.e., spatial cross-correlation; and (4) histograms of the
simulated values of all variables are the same as those observed
for the data (Dowd, 1997).
Several conditional simulation algorithms are available in the
literature. This research employs the well published Sequential
Gaussian Simulation (SGS) to generate in-situ ore-body realiza-
tions. Therefore, Datamine software that benefits the GSLIB codes
for SGS is used to generate equally probable realizations of the
in-situ ore-body (Datamine, 2007). More details about the SGS
can be found in Deustech and Journel (1998).
Generating alternative feasible COGSs
The Lane’s original model based on Bellman dynamic pro-
gramming was published on 1964, and then it was extended to
 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
a more comprehensive model in 1989, which considered the
effects of economic parameters variations on the COGS. The Lane’s
model results in making the best use of capacities of mining
operation to maximize the present value. Many researchers have
used this model as the basis for their work (Whittle and Wharton,
1995; Ataei and Osanloo, 2003, 2004; Osanloo and Ataei, 2003;
Bascetin, 2007; Rashidinejad et al., 2008), while others employed
different operational research methods to solve the COGS
problem (Akaike and Dagdelen, 1999; Cetin and Dowd, 2002;
Cairns and Shinkuma, 2003; Azimi and Osanloo, 2011; Azimi
et al., 2011).
As in Lane (1988), suppose that for a resource with amount of
R, there is a small decrement of r as extraction, and then the cash
flow of c per unit of extracted resource can be computed while the
strategy o is given to exploit r during the time t. According to the
Lane’s algorithm (1988) Eq. (4) is the fundamental equation for
determining the optimum COGS:
 
dV dV
¼ Maxo fctF g and F ¼ dV þ ð4Þ
dR dT
where d is the discount rate, t ¼t/r is the time taken to work
through one unit of the resource, V is the maximum present value
of a resource at a time (T), dV/dR is the economic value added by
mining and processing of one unit of resource, and F is the
opportunity cost. The optimum cut-off grade at each period is
determined by maximizing Eq. (4) with respect to o, and
considering the capacity limiting constraints of the three main
stages of mining operation, namely mining, milling and refining
or marketing capacities. Accordingly, the optimization problem in
Eq. (4) is divided into six sub-problems and the optimum cut-off
grade at each period is the one that provides the greatest change
in the present value of the mining operation. Finally, the set of
selected optimum cut-off grades for the whole mining lifespan is
known as the optimum COGS. As can be seen from Eq. (4), there is
a circular dependency between F and PV that is handled by
considering two streams of exploitation policies of V and W. It
is supposed that the second stream (W) commences at the end of
the first period of the stream V. Fig. 3 shows the flowchart of the
Lane’s (1988) algorithm used to develop a Matlab based code to
generate feasible COGSs. More details on Lane’s algorithm can be
found in Lane (1988) and Azimi (2012).
Simulation based RO valuation
Generally, the value of an option can be estimated using either
analytical or numerical methods. Analytical methods are only
suitable for valuing simple options as the one developed by Black
and Scholes (1973). But, numerical methods started to generate
greater interest in assessing complex options such as American
type options with multiple uncertain state variables. The most
widely known numerical techniques are finite difference
(Schwartz, 1977), binomial lattice (Cox et al., 1979), and Monte
Carlo simulation (Boyle, 1997). Amongst them, the Monte Carlo
technique has superior performance in dealing with dimension-
ality difficulties encountered in the problems employing multiple
and complex uncertain state variables.
Monte Carlo simulation was originally proposed by Boyle (1997)
for pricing of European options as a forward intuition technique and
extended for pricing of American options by combining the simplicity
of forward induction with the ability of backward induction in
determining the optimal option exercise policy. In this regard,
Longstaff and Schwartz (2001) developed a promising method of
Least Squares Monte Carlo (LSM) simulation for valuing path depen-
dant American options. Recently, the Monte Carlo RO valuation
method has also been introduced as an alternative to the DCF
215
valuation technique in real capital investment and LSM is one of
the promising methods in this regard.
Longstaff and Schwartz (2001) assumed that American options
can be exercised at discrete early exercise dates. The time to maturity
T is divided into K discrete times (0ot1 rt2 ryrtK ¼T) and N
simulated paths are generated under the risk-neutral measure. Like in
any American option valuation procedure, the optimal exercise policy
decision at any point in time tK is obtained as the maximum of the
immediate exercise value of I(o; tK) and the expected continuation
value of F(o; tK). Given that the expected continuation value depends
on future outcomes, the procedure must work its way backwards,
starting from the end of the time horizon T. The put option payoff
C(o; tK) can be interpreted as the Bellman equation of dynamic
programming as follow:
Cðo; t k Þ ¼ max½Iðo,t k Þ,Fðo,t k Þ ð5Þ
The immediate exercise value of I(o; tK) along the path o is
simply the difference between the exercise price of H and the
stock price of S(o; tK). At the expiration date along the sample
path o the expected continuation value is as follows:
Cðo; t k ¼ TÞ ¼ max½ðHSðo,TÞÞ,0 ð6Þ
But at any early exercise time tK oT, assuming that the option
is not exercised until after tK and the option holder following the
optimal stopping strategy for all x, tK oxrT, under the risk-
neutral pricing measure Q, the expected continuation value of
F(o; tK) based on the information b at time tK is as follows:
2 3
X
k  Z tj 
Fðo; t k Þ ¼ EQ 4 exp  rðo,xÞdx Cðo,t j ; t k ,T9btk 5 ð7Þ
j ¼ kþ1 tk
where C(w,tj; tK,T) is the remaining cash flows and r(o,x) is the
risk-free discount rate. The main contribution of the LSM method
is to estimate the expected conditional continuation value at tK  1,
tK  2,y, t1 by regressing the discounted future option values on a
linear combination of M basis functions Lj (S) such as Laguerre
polynomials, trigonometric series, or simple powers of the stock
price S such as
X
M
Fðo; t k Þ ¼ aj Lj ðSÞ ð8Þ
j¼0
After the regression, the optimal obtained coefficients aj are
used to estimate the expected continuation value Fð ^ o; t k Þ. For all
in-the-money paths at time tK, the optimal exercise policy is
obtained by choosing the maximum between the immediate
exercise value and the estimated continuation value at time tK.
Consequently, the cash flows along the path o from time tK to
time T are revised. For out-of-the-money paths, the option payoff
is zero. The recursion proceeds backward until time t1. After the
exercise decisions are determined at each exercise date along all
the paths, the value of the option is estimated by discounting the
cash flows to time zero at the risk-free rate and averaging over
the number of paths, N.
Abdel Sabour and Poulin (2006) extended the LSM to value
mining investments under multiple market uncertainties, which
was further developed by Abdel Sabour et al. (2008) to evaluate
the mining extraction scheduling under both multiple market and
geological uncertainties. Cortazar et al. (2008) have also extended
the approach to cover the three-factor risk models which is more
suitable for long-term commodity real options. The extended LSM
method is mainly based on simulating multiple realizations of the
uncertain variables and making the optimal decision at each
period using value expectations.
In this study, the operating flexibility to close the mine early is
integrated into the value estimate of the COGS taking into account
the geological and metal price uncertainties. In order to evaluate
216 Y. Azimi et al. / Resources Policy 38 (2013) 212–223

Fig. 3. Flowchart of the Lane algorithm for determination of optimum COGS.

the mining operations under the flexible operating mode, it is
assumed that the mining operation status can be changed at some
certain discrete dates per year with a time step of Dt apart.
Conditional to N simulated metal price paths according to the
Markov property and M ore-body models, the cash flows at each
discrete date are defined based on the amount of production, the
metal price and the unit production cost.
Then, recursively starting from the last time step towards the
first period at any period t (between zero and T), a status that
maximizes the mining expected value is chosen as the optimum
operation policy conditional to a sample price path of nAN and
ore-body mAM. Due to the computational complexities, the price
realizations, N is much larger than the number of ore-body
realizations M. Therefore, to have N possible grades and tonnages
 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
for each strategy, N independent draws are generated randomly
from the M simulated ore-body models.
Let CVO denote the continuation value of ‘‘open mining’’ status.
As described in Longstaff and Schwartz (2001), CVO is a function of
the uncertain state variable and can be estimated as the linear
combination of basis functions of uncertain variables. Given that P
denotes the price of the metal and G denotes ore-body character-
istics (i.e., tonnage and grade) simulated by the ore-body model
m, the expected continuation value of mining is approximated as
X
N
EðCV O 9n,m,tÞ ¼ ai Li ðP n,t ,Gm,t Þ
i¼0
The parameters of these functions are estimated at each time
period by regressing the sum of the discounted value of cash
flows beyond time t onto their basis functions. After estimating
the basis functions parameters, the expected mine value at the
time t for each simulated sample path n is approximated as the
sum of the expected continuation value and the cash flow of
mining operation CF(n,m,t) during the time period t.
EðV9n,m,tÞ ¼ EðCV O 9n,m,tÞ þ CFðn,m,tÞ
At any time t based on the expected mine value (E(V)), the
decision whether to keep the mine open or to close it early is
taken as follows:
Keep the mine open if
EðV9n,m,tÞ 4 K a
Close the mine if
EðV9n,m,tÞ r K a
Fig. 4. Flowchart of the LSM algorithm considering managerial flexibility to close the mine early under metal price and geological uncertainties.
217
where Ka is the abandonment cost. This optimization process is
carried out for all simulated realizations of metal prices through-
out all time periods. After revising the cash flows according to the
determined optimum operating policy at the discrete exercise
points throughout all simulated metal price paths, the strategy
value at time zero is determined by discounting the cash flows at
the risk-free rate and averaging over the number of simulated
metal price paths. Besides the expected value, various statistics
for the overall value as well as annual cash flows of mining
strategy value can be generated throughout this analysis. These
ð9Þ statistics will be employed within a multi-criteria ranking system
in order to select COGS under geological and price uncertainties.
The flowchart of the LSM algorithm used in this paper is shown
in Fig. 4.
Multi-criteria ranking system
Multi-criteria ranking system is an effective tool enhancing the
role of objective interpretations against subjective interpretations
when a decision making problem exists. In this paper, based on
ð10Þ
the available information at the initial planning time, the following
aspects are considered to select the best exploitation strategy.
(1) Upside potential that indicates the ability of alternative
strategies to gain possibly more profit than those expected
ð11Þ if outcomes were favorable.
(2) Downside risk that reflects the difference between strategies
in minimizing negative cash flows risk throughout the mine
ð12Þ life time.
218 Y. Azimi et al. / Resources Policy 38 (2013) 212–223

(3) Statistics of the estimated operation values which includes the design is above or below that average. The indicator related to the
average, lower and upper limits at a certain confidence level. expected value for a design m, EVIm is calculated as follows:
(4) Probability of completion, which is the probability that the ! !
XM X
M
mine will operate as planned throughout its planned life. EVIm ¼ 100 EV m  EV m =M = EV m =M ð17Þ
m¼1 m¼1
For simplicity, these criteria are considered to have equal The upper limit indicator (ULIm) of the expected value at a
weight in this paper while different weight can be acquired based predefined confidence level is
on the mining company policies. The method of calculating every ! !
individual corresponding indicator is explained in details as XM XM
ULIm ¼ 100 ULm  ULm =M = EV m =M ð18Þ
follows. m¼1 m¼1

ULIm indicates to what extent the difference in performance

Upside potential indicator
between design m and the average of all designs is significant
The upside potential measures the ability of a strategy to
compared to the overall expected mine value. The lower limit
obtain possibly more profit than those expected if outcomes were
indicator (LLI) of the expected value at a predefined confidence
favorable. Therefore, the upside potential indicator (UPI) for a
level is:
mine design m during a production year t can be computed as ! !
follows: XM XM
!! ! LLIm ¼ 100 LLm  LLm =M = EV m =M ð19Þ
þ
XM
þ
XM m¼1 m¼1
þ þ
UPIm,t ¼ 100 DCF m,t pm,t  DCF m,t pm,t =M = EV m =M
m¼1 m¼1 The value statistics indicator (VSI) for each design is then
calculated by summing up the indicators corresponding to the
ð13Þ
expected value, the upper, and the lower limits of expected value,
þ
where DCF is the expected annual discounted positive cash flow, as follows (Abdel Sabour et al., 2008):
p þ is the probability that those cash flows will be positive and
VSIm ¼ EVIm þULIm þ LLIm ð20Þ
EVm is the overall expected value of design m calculated by the
simulation based RO model outlined above. A positive indicator
denotes that a design has the potential to generate positive net Probability of completion indicator
cash flows during year t higher than the average of all designs and Insurance options such as the early abandonment of mines
vice versa. This process is repeated for all production years and that limit further losses may lead to uncompleted production
the total UPI for design m is the summation of the annual plans which can result in economic and social inconveniences.
indicators, as follows (Abdel Sabour et al., 2008): Therefore, the relative abilities of various mine designs to sustain
X
T unfavorable economic conditions and perform as planned
UPIm ¼ UPIm,t ð14Þ throughout the anticipated project life are the criteria expressed
t¼1 by the probability of completion indicator (PCI). The PCI for a
mine design m in a production year t is calculated as follows:
!  !
Downside risk indicator X M XM 
 
Considering the uncertainties inherent in the minerals industry, PCIm,t ¼ 100 POm  POm,t =M = POm,t =M 
m¼1
m¼1

there is a probability of producing negative cash flows during some   !
XM  XM
periods of the mine life time, even if we expect positive value at the  
  DCF m,t =M = EV =M ð21Þ
mine design time. The downside risk indicator (DRI) accounts for m ¼ 1  m¼1 m
such probabilities and reflects the difference between designs in
minimizing risk of negative cash flows throughout the mine life. The where POm,t is the probability that the mine will produce the
expected negative cash flows DCF  along with their corresponding scheduled amount of metal in year t if the design m is selected,
probabilities p  that result from the economic valuation model are DCFm,t is the expected discounted cash flow in year t. The overall
used to calculate the DRI for a design. During a production year t, the PCI indicator of design m throughout the mine life is
DRI of a design m is calculated as X
T
!! ! PCIm ¼ PCIm,t ð22Þ
XM XM
t¼1
DRIm,t ¼ 100 DCF  p 
m,t m,t  DCF 
p 
m,t m,t =M = EV m =M
m¼1 m¼1 A positive PCI indicator means that design m will perform
ð15Þ better than the average of all designs in year t and vice versa. It is
The DRI value for a design could be negative or positive. A important to note that at the planning time in the conventional
greater DRI for design indicates higher capability of minimizing NPV valuation method, operating flexibilities to revise the pre-
negative cash flow risks. The overall DRI for design m is as follows defined strategies are not considered. Therefore, this indicator is
(Abdel Sabour et al., 2008): ignored in the calculation of the NPV based multiple ranking
system. After estimating the above described four indicators for
X
T
each mine design, the total ranking indicator (TRI) is simply the
DRIm ¼ DRIm,t ð16Þ
t¼1
summation of these four indicators. The designs are then ranked
according to the TRI and the design with the highest TRI will be
selected as the best strategy under uncertainty conditions.
Value statistics indicator
The value statistics indicator (VSI) accounts for the overall
expected present value of future cash flows as well as the Implementation of the proposed COGS selection method
confidence limits estimated at a specified confidence level.
As with the above described indicators, the performance of each To demonstrate the applicability of the proposed system
mine design is compared to the average of all designs and an in selection of a COGS under geological and price uncertainties,
indicator is assigned to reflect whether the performance of each the proposed ranking system was applied to an Iranian gold mine
 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
Table 1
Economical and technical information for the Iranian gold mine.
Costs Mining cost ($/ton)
Milling cost ($/ton)
Refinery ($/ton)
Fixed cost ($/year)
Capacities Mining throughput (ton/year)
Milling throughput (ton/year)
Marketing throughput (kg/year)
which is extracted by the open pit mining method. In order to
verify the efficiency of the proposed method with actual data of
the uncertain variables, only a part of an actual gold reserve with
available production blast holes data is used for analysis pur-
poses. It is assumed that the actual grade of an ore block equals
the average grade of the blast holes measured within that block.
This part of the gold reserve was a low grade zone that was
extracted during the last three years of the mining operation
between 2006 and 2010. The block model and geostatistical
realizations of the desired part of the mining reserve were
produced, employing the exploration phase drill holes data using
Datamines software. The block dimensions in the block model
were considered 10 m  10 m  5 m. The other necessary eco-
nomic and technical parameters used are listed in Table 1.
Throughout the analysis, free market conditions were considered
and taxation, inflation, salvage value and capital expenditure
were ignored. Furthermore, no stockpile option was considered
to store intermediate grade material for later treatment.
In order to assess the efficiency of the proposed ranking
system, the mining exploitation strategies will be also ranked
according to the following three ranking methods along with the
proposed multi-criteria ranking system.
 the expected value estimated by the RO valuation
 the expected value estimated by the conventional DCF
valuation method
 the NPV based indicator, summation of the defined indicators
except the PCI since the conventional DCF method cannot
consider the managerial flexibilities.
Generation of technically feasible COGS
Different alternative strategies could be generated in a number
of ways according to the objectives of the mining company and
economical and social conditions. One way, which is applied in
this study, is to use the Lane’s algorithm considering different
possible realizations of the in-situ ore-body and metal price
paths. Therefore, 300 independent technically feasible COGSs
were derived using independent combinations of 10 realizations
of the in-situ ore-body with 30 realizations of gold price paths.
The price paths were generated by Monte Carlo simulation using
GBM stochastic process, while the geostatistical simulation was
employed to generate the realizations of the in-situ ore-body.
Selection of the best COGS
In order to select the best strategy incorporating gold price and
geological uncertainties, the generated strategies were valued
using two different valuation techniques. The first one is the LSM
RO valuation in which operating flexibility to close the mine early
was integrated in valuation of strategies. Despite the high price
condition from 2006 to 2010, the reason for considering the
operating flexibility to close the mine early was the lower quality
219
Table 2
Economic and stochastic process parameters for copper mine valuation.
2.6 Stochastic process parameters Gold price and valuation parameters
14
1,000,000 P0 (ton/$) 18,991,110.33
2,000,000 a (%) 7
s (%) 20
250,000
Abandonment cost ($) 0
150,000
Risk free interest rate (%) 10
300
of the gold grade in the considered zone of the reserve.
The second technique is the conventional DCF valuation method,
in which the operating flexibility to close the mine early is
ignored.
In the RO valuation, the first five terms of the Laguerre
polynomials were used to estimate the expected value of the
mining continuation value conditional on the time and simulated
realization values. To integrate the gold price and geological
uncertainties, 20,000 independent scenarios were produced by
combining 20,000 stochastically simulated price paths using Eq.
(1) with 20,000 independent draws from 30 geostatistically
simulated in-situ ore-body realizations. The relevant economic
data are listed in Table 2.
An illustrative example of the four realizations of the in-situ
ore-body is shown in Fig. 5. Applying both valuation methods, the
corresponding periodical and overall cash flows distribution
functions were obtained for each COGS. Then the aforementioned
stochastic orders described in Section 2.5 and expected values of
strategies estimated by both valuation methods were used to rank
the strategies under uncertainty circumstances.
As explained before, the proposed multi-criteria ranking sys-
tem evaluates the strategies based on their TRI values which are
calculated using the four measures of UPI, DRI, PCI and VSI. As the
operating flexibilities cannot be valued by the DCF valuation
method, the PCI has the same value for the all strategies. There-
fore, the term PCI was not considered in calculation of the TRI
using the DCF valuation method. Evaluating the 300 alternative
COGSs by the LSM RO and the DCF valuation models, the first 10
high rank strategies based on the four ranking methods are listed
in Table 3.
It is obvious from Table 3 that the strategies 34 and 231 are
the best alternatives for the DCF based TRI and the DCF expected
value methods, respectively. On the other hand using the RO
valuation, strategies 108 and 138 are the best alternatives of the
RO based TRI and the RO expected value methods, respectively.
The term ‘‘best’’ here is used for the strategy with the highest rank
or the highest expected present value. As can be seen from
Table 3, different ranking results are obtained using different
ranking methods. The RO expected value and the RO based
indicator have similar rankings for eight exploitation strategies
among the 300 alternatives, while the two ranking measures of
the DCF method have no similar rankings for any of the 300
alternative strategies.
Verifying the ranking methods using actual data
To assess the efficiency of the ranking systems under uncer-
tainty the alternative COGSs values were calculated using the
actual data of the gold price and grade tonnage curve. Using the
actual tonnage grade curve and actual gold market data between
2006 and 2010, all of the strategies were valued and ranked
according to their PV at the beginning of 2006. In this respect, the
10 best strategies based on their PV are listed in Table 4.
Comparing the results in Tables 3 and 4, it is seen that among
the implemented ranking systems, only the best strategy (i.e.,
strategy 138) selected by the RO based TRI method is among the
220 Y. Azimi et al. / Resources Policy 38 (2013) 212–223

Fig. 5. 3D views of four simulated ore-body models of the considered part of the gold reserve. The simulation models were generated using the Sequential Gaussian
Simulation (SGS).

Table 3
The first 10 high rank strategies using the mentioned four ranking methods.

Rank E (DCF) TRI (DCF) E (RO)a TRI (RO)

Strategy E (PV)b Strategy TRIc Strategy E (PV) Strategy TRI

1 34  503,868.39 231 506.48 108 166,005 138 2254.17

2 18  508,043.56 232 504.38 138 164,692.4 298 2045.95
3 57  510,017.27 238 502.11 176 161,375.3 176 2025.73
4 10  516,513.26 240 498.47 98 160,562.7 108 2024.30
5 24  516,606.36 234 492.71 4 153,680 260 1941.93
6 97  516,610.76 236 488.32 83 149,934.3 98 1891.95
7 260  517,782.78 237 486.93 144 139,701.6 4 1879.05
8 94  518,989.31 233 485.33 290 135,082.5 125 1831.03
9 189  519,132.95 235 482.95 191 120,631.5 250 1781.81
10 60  519,857.04 239 480.12 195 118,818.2 299 1778.23

a
Real options valuation.
b
Expected value of present value ($).
c
Total ranking indicator.

Table 4 study has a higher value than the best strategy proposed by the
The first 10 high rank strategies based on their PV using actual data. other ranking systems.
To have a comparison of overall performance of the ranking
Rank Strategy PV ($) systems, a term of average mis-ranking (amr) was calculated.
1 141 2,893,768.74
The amr is defined as the average value of the absolute differences
2 80 2,892,505.25 of alternative ranks in a specified ranking system and their
3 59 2,892,146.00 corresponding actual rank. The amr can be calculated using the
4 138 2,891,553.46 following formula:
5 4 2,891,553.46
6 5 2,891,513.15
!
X
S
7 10 2,891,191.41 amr ¼ 9Ract i Ri 9 =S ð23Þ
8 69 2,891,191.41 i¼1
9 135 2,890,842.20
10 6 2,890,622.79 where Ract i and Ri are ranks of the ith strategy estimated by the
actual ranking and one of the mentioned ranking systems,
respectively. S is the total number of the possible strategies.
Table 5 A higher amr indicates that the method can result in a misleading
The amr of the four ranking systems. decision while a lower amr suggests an efficient performance for
the method. The amr was calculated for each of the four ranking
Ranking methods E (DCF) TRI (DCF) E (RO) TRI (RO)
systems and the results are shown in Table 5.
Average mis-ranking (amr) 72.15 80.15 45.96 31.82
Evaluating COGSs based on the RO expected values reduced
the amr from 72.15 in the NPV analysis to 45.96. This amr has
been reduced further to 31.82 when using the RO valuation based
10 strategy with the highest actual PV. As shown in Table 4, indicator that ranks COGSs using multiple risk criteria while
strategy 138 is the fourth strategy with the highest PV. But none considering the flexibility to close the mine early. The results of
of the best strategies selected by the other methods are among Tables 4 and 5 reveal that under uncertainty circumstances, the
the 10 actual best strategies among the 300 alternatives. There- COGSs real values using the actual data can be significantly
fore, the strategy selected by the proposed ranking system in this different from those estimated at the planning time. As shown
 Y. Azimi et al. / Resources Policy 38 (2013) 212–223 221

in Table 3, the values of the strategies using the DCF model are necessarily have a declining trend as described by Lane (1988).
negative while these strategies all have positive PV. Furthermore, the selected COGS by the proposed ranking system
The estimated distribution function of cash flows is usually has more present value than the three other conventional ranking
assumed to be approximately symmetrical around the expected methods.
value when no operating flexibility is considered in the valuation.
Therefore, integrating multi-criteria ranking systems without
considering the operating flexibility to react to the new informa-
tion will not necessarily assure improvement in the decision Sensitivity analysis of the proposed system on the parameters
making process. As is shown in Table 5, application of the DCF of the GBM process
based multi-criteria ranking system does not improve the selec-
tion process for the case studied here. A sensitivity analysis was performed to measure the depen-
On the contrary, using the RO valuation instead of the dency of the proposed system on the estimated parameters of the
conventional DCF technique can improve the economic based GBM stochastic process. Therefore, 30 COGS alternatives were
decision process. The results show that integrating multiple risk generated and used to analyze the sensitivity of the proposed
criteria with the flexibility to revise the originally taken decisions system to the drift and volatility of the GBM process. In this
regarding the early closure of the mine can significantly change respect, the amr of the RO based multi-criteria ranking system
the decision and improve the selection process. However, in was calculated relative to the actual gold prices from 2006 to
addition to the higher value of the selected alternative and lower 2010 and actual grade tonnage curve. To consider the stochastic
mis-rank of the proposed system overall performance, the RO
valuation used by the proposed system estimates the values of x 107
the strategies better than the DCF model. Some of the results on 4.5
the ranking systems performance are in agreement with the
results of the research published recently by Abdel Sabour et al.
(2008). 4
The COGS 138, as the best strategy selected by our proposed
ranking system, is illustrated graphically in Fig. 6. It is seen that Actual gold price
under the uncertainty conditions the selected COGS does not 3.5
Gold price ($/t)

Hypothetical gold price 1

2.5

1.5
Hypothetical gold price 2

1
0 1 2 3 4
Year

Fig. 6. COGS 138, selected as the best strategy using the proposed system. Fig. 8. Hypothetical actual gold price.

9 5.5

Run 1 Run 1
8
Run 2 5 Run 2
Average mis−ranking (amr)
Average mis−ranking (amr)

Run 3 Run 3
7
4.5 Run 4
Run 4
6
Run 5 Run 5
4
5

3.5
4

3
3

2 2.5
0.05 0.1 0.15 0.2 0.25 0.3 0.05 0.1 0.15 0.2 0.25 0.3
Drift Volatility

Fig. 7. Sensitivity of the proposed ranking system to the estimated values of the (a) drift and (b) volatility.
222 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
12
Average mis−ranking (amr) 10
Hypothetical gold price 2
8 8
Hypothetical gold price 1
6
Actual gold price
4
2 3
0.05 0.1 0.15 0.2 0.25
Drift
Fig. 9. The effect of the actual gold price trend on the response of the proposed system performance to the variation of GBM process parameters (a) drift (b) volatility.
nature of the generated price paths this analysis was repeated five
times, and the results are shown in Fig. 7.
Fig. 7 shows that as the drift and volatility of the GBM process
is increased, the amr of the proposed ranking system will be
decreased. This improvement in the performance of the proposed
system could be due to the higher trend of the gold price from
2006 to 2010. The gold price is modeled in a more representative
manner by increasing the parameters of the GBM process. There-
fore, as closely as the stochastically generated price paths resem-
ble the real condition, the result of the ranking system will be
similar to the real condition. However it is impossible to have a
ranking system with zero mis-ranking.
In justification of the stated reason, two other hypothetical
gold price trends were also considered as depicted in Fig. 8.
Considering the hypothetical gold prices as the actual gold prices,
the performance of the proposed ranking system was assessed
against the variation of drift and volatility of the GBM process,
and the results are shown in Fig. 9.
As Fig. 9 shows, for the first hypothetical trend in which gold
prices had an increasing trend, the variation of the amr is the
same as described for the actual gold prices from 2006 to 2010.
But for the second hypothetical gold price showing a decreasing
trend with time, the amr of the proposed ranking system
increases by an increase in the parameters of the GBM process
(drift and volatility). This result obtained since majority of the
simulated price paths may not be a good representative of the
considered decreasing actual price trend.
Therefore, according to the results, for a gold mining operation
if the market condition is expected to be improved in the future;
considering higher drift and volatility for the GBM process may
result in improvement of the decision process and vice versa.
Nevertheless, it is impossible to exactly know whether the price
will be increased or decreased or both in the future. Hence,
considering the high sensitivity of the valuation results and
proposed ranking method to the estimated parameters of the
chosen stochastic process, it is recommended that a professional
econometrician be retained to parameterize metal price processes
for any valuation exercise.
Finally it should be mentioned that the results of this study are
specific to the case study discussed herein and the data fed into
the valuation model. Different results might be obtained if other
economic condition or other operating flexibilities were consid-
ered in valuation. Therefore, the results cannot be generalized to
11
10
Average mis−ranking (amr)
Hypothetical gold price 2
9
7
Hypothetical gold price 1
6
5 Actual gold price
4
0.3 0.05 0.1 0.15 0.2 0.25 0.3
Volatility
prefer the proposed methods over the other methods, and more
investigation is needed.
Conclusion
Cut-off grade is a geological/technical concept that embodies
important economic aspects of the mining venture and plays an
influential role in the optimality of mine planning and design.
In this paper, a multi-criteria ranking system was proposed for
selection of COGS cut-off grade strategy (COGS) for an open pit
mining operation under metal price and geological uncertainties.
The proposed ranking system is based on the multiple risk and
cash flow characteristics measures of each COGS. In the proposed
system, alternative COGSs were valuated using a simulation
based real option (RO) valuation model. The RO valuation benefits
the proposed system with the valuation of operating flexibilities
inherent in the mineral industry and consequently offers better
evaluation of different alternatives. Hence in this study, to avoid
unwanted losses in unfavorable market conditions, the insuring
operating flexibility to close the mine early was considered in the
valuation. In this study, the Lane’s comprehensive algorithm was
applied to generate the technically feasible COGSs while metal
prices and geological uncertainties were resolved using stochastic
processes and geostatistical simulation, respectively.
To explore the advantages of the proposed system, it was
applied to select the COGS under uncertainties for an Iranian gold
mine along with three other ranking methods including the RO
valuation expected value, the Discounted Cash Flow (DCF) valua-
tion expected value and the DCF based multiple criteria ranking
system. Comparing the performance of the ranking methods with
the actual rank of alternatives calculated using actual values of
uncertain variables revealed that the average mis-rank of the
proposed system is lower than the other three ranking methods.
The results also suggest that selection procedure may be
improved when incorporating uncertainty and operating flexibil-
ity. It was seen that under the uncertainty conditions, the selected
COGS would not necessarily have a declining trend as described
by Lane (1988). Furthermore, the results of the sensitivity analysis
showed that the integrity of the proposed system is highly
dependent on the parameters of the price stochastic process.
It also concluded that when the market prices are expected to
increase in the future, using higher drift and volatility may
 Y. Azimi et al. / Resources Policy 38 (2013) 212–223
improve the ranking results and vice versa. Further extensions
could be included considering more risk analysis criteria as well
as more operating flexibilities. At last, the proposed system
suggests a framework that would enhance the quality of the
decision making process in mineral recourse industry by providing a
more informative and certain platform for project evaluation.
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