Flexibility in aluminium production: A real option model

This thesis investigates the value of flexibility in production of aluminium. By the use of real option theory we present a switching option model that measures the value of switching between two modes of production, open and closed. The value of the option is derived through a Least Square Monte Carlo Simulation, by modelling a stochastic process of the underlying risk factors of production, as suggested by Longstaff and Schwartz. Accounting for costs related to switching between modes of production the model derives at an optimal strategy of production. The analysis reveals that the flexibility embedded in real options adds a significant value to the aluminium plant. The result is consistent for several changes in underlying parameters of the model. Further analysis reveals that the value is heavily dependent on the sourcing of power. When including a fixed contract of power for the lifetime of the aluminium plant, we find that the value of a flexible production is significantly reduced