Economic viability and risk management of auger mining in Indonesia using real option valuation under volatile market conditions

Abstract

Coal is one of the commodities that contribute the most to Indonesia's GDP, as well as to other coal-exporting countries such as Australia, China, India, and others. Currently, many coal companies in Indonesia face challenges in optimizing their coal reserves to increase profitability. One method that has proven effective from both technical and economic perspectives is auger mining. However, with global coal prices declining in 2023 after experiencing a significant increase following the pandemic in 2022 (Iea, 2023), the economic feasibility of auger mining for companies, particularly in the long term, has come into question. This research is the first study aimed at assessing the economic feasibility of auger mining using DCF simulation, Monte Carlo Simulation (MCS), and Real Option Valuation (ROV) Binomial Lattice, based on a real-case problem under uncertain coal market conditions, and evaluating the risks of its implementation.

This study aims to assess the feasibility of auger mining based on three scenarios: Auger Type A (higher productivity with higher mobilization cost) under Standard and Aggressive Utilization, and Auger Type B (lower productivity with lower mobilization cost) under Standard Utilization. Based on the analysis using the DCF method, all three scenarios yield positive economic values (NPV, IRR, and PI). However, the Auger Type A Standard Utilization scenario was selected for further analysis using the MCS and ROV methods, as it is considered the most realistic scenario both technically and in terms of medium-level economic valuation compared to the other two scenarios. According to the DCF analysis, the Auger Type A Standard Utilization scenario has an NPV of $1.71 million, with a break-even point that is relatively close to the base-case coal price ($52.24/ton), decreasing by only $5.27 (10.08 %). The risk of the project having a negative NPV in the future is 25 % (MCS) and 38 % (ROV). The ROV – Binomial Lattice analysis provides an added option value of $0.16 million if the project is terminated at any future point.

Based on these results, the auger project does have a positive NPV but is considered moderate-to-high risk. Therefore, several recommendations are needed to improve the project's valuation and minimize risks, such as minimizing operational costs, including the break-even coal price in work contracts, optimizing the values of Physical Availability (PA) and Utilization Availability (UA), and negotiating flexibility for terminating the project in the future if the NPV becomes negative.