Managing a High Uncertainty Scenario through a Real Option Assessment: Evidence from a Copper Concentrate Trader

Abstract

Commodity markets are highly volatile markets where uncertainty management is critical for success. Certain commodities, such as copper concentrates, experience even higher levels of volatility and uncertainty. This is fundamentally due to the absence of a reference market that allows for a transparent price discovery, along with many factors affecting the price and trade of any commodity. Traders also lack the possibility of fully hedging their exposure to copper concentrate prices as there is no derivative market directly available for the commodity. Consequently, this paper analyses the copper concentrate trading business resorting to the Real Options methodology to assess the high volatility and uncertainty which dominates in this area of commodity markets. The results obtained indicate that this method can be applied by copper concentrate traders to separate the price uncertainty from their business operative and financial planning for the future. This provides them with a reliable tool to lower the level of uncertainty affecting their long-term goals, as well as keeping the risk that they are taking under control. It also gives them higher managerial flexibility.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Data from January 2010 to December 2020 for LME daily spot Copper prices and COMEX daily spot gold and silver prices have been obtained from Thomson Reuters’ Eikon tool DataStream from January 2010 to December 2020.

2 Historical annual benchmark values from 2010 to 2021 obtained from Díaz-Borrego et. al (2021) have been used to estimate expected annual TC benchmark levels.

3 Forecasts and distribution fittings have been obtained using Oracle’s Crystal Ball add-in for Microsoft Excel.

4 As observed from non-publicly available and confidential economical and financial data employed as a reference.

5 Concentrate prices need to be expressed in USD/DMT as they are quoted internationally in these units regardless of their origin.