**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**Form 20-F**

**o**                                   Registration Statement pursuant toSection 12(b) or (g) of the Securities Exchange Act of 1934

**or**

**x**                                 Annual report pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934 for the fiscal year endedDecember 31, 2006

**or**

**o**                                   Transition report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934

**or**

**o**                                   Shell company report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934

**Commissionfile number 333-119497**

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**MECHEL OAO**

(Exact name of Registrantas specified in its charter)

**RussianFederation**

(Jurisdiction ofincorporation or organization)

**Krasnoarmeyskaya Street 1,Moscow 125993, Russian Federation**

(Address of principalexecutive offices)

Securities registered or tobe registered pursuant to Section 12(b) of the Act:

| Title of Each Class                                                         | ** ** | **Name of Each  Exchange on Which Registered** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------|
| **AMERICAN  DEPOSITARY SHARES, EACH ADS  REPRESENTING THREE COMMON SHARES** | ** ** | **NEW YORK  STOCK EXCHANGE**                   |
| **COMMON SHARES, PAR VALUE  10 RUSSIAN RUBLES PER SHARE**                   | ** ** | **NEW YORK STOCK EXCHANGE(1)**                 |

 

Securities registered or to be registered pursuant toSection 12(g) of the Act:

**NONE**

(Title of Class)

Securities for which there is a reporting obligation pursuantto Section 15(d) of the Act:

**NONE**

(Title of Class)

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Indicate the number ofoutstanding shares of each of the issuer’s classes of capital or common stockas of the close of the period covered by the annual report.

35,462,954 ADSs

12,886,303 GDS

416,270,745 common shares

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.

| o Yes |   | x No |
|------------|--------|-----------|

 

If this report is an annualor transition report, indicate by check mark if the registrant is not requiredto file reports pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934.

| o Yes |   | x No |
|------------|--------|-----------|

 

Note—Checking the box abovewill not relieve any registrant required to file reports pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934 from theirobligations under those Sections.

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

| o Yes |   | x No |
|------------|--------|-----------|

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large acceleratedfiler x                 AcceleratedFiler o                 Non-acceleratedfiler o

Indicate by check markwhich financial statement item the Registrant has elected to follow:

| o Item 17 |   | x Item 18 |
|----------------|--------|----------------|

 

If this is an annualreport, indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

| o Yes |   | x No |
|------------|--------|-----------|

 

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(1)              Listed, not for trading or quotationpurposes, but only in connection with the registration of ADSs pursuant to therequirements of the Securities and Exchange Commission.

 

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**TABLE OF CONTENTS**

| CAUTIONARY  NOTE REGARDING FORWARD-LOOKING STATEMENTS |   | 3                                                                             |
|-------------------------------------------------------|--------|-------------------------------------------------------------------------------|
| *Item 1.*                                             |   | Identity  of Directors, Senior Management and Advisors                        |   | 4 |
| *Item 2.*                                             |   | Offer  Statistics and Expected Timetable                                      |   | 4 |
| *Item 3.*                                             |   | Key  Information                                                              |   | 4 |
| *Item 4.*                                             |   | Information  on the Company                                                   |   | 38 |
| *Item 5.*                                             |   | Operating  and Financial Review and Prospects                                 |   | 84 |
| *Item 6.*                                             |   | Directors,  Senior Management and Employees                                   |   | 122 |
| *Item 7.*                                             |   | Major  Shareholders and Related Party Transactions                            |   | 128 |
| *Item 8.*                                             |   | Financial  Information                                                        |   | 129 |
| *Item 9.*                                             |   | The Offer  and Listing                                                        |   | 130 |
| *Item 10.*                                            |   | Additional  Information                                                       |   | 131 |
| *Item 11.*                                            |   | Quantitative  and Qualitative Disclosures and Market Risk                     |   | 150 |
| *Item 12.*                                            |   | Description  of Securities Other than Equity Securities                       |   | 155 |
| *Item 13.*                                            |   | Defaults,  Dividend Arrearages and Delinquencies                              |   | 156 |
| *Item 14.*                                            |   | Material  Modifications to the Rights of Security Holders and Use of Proceeds |   | 156 |
| *Item 15.*                                            |   | Controls  and Procedures                                                      |   | 156 |
| *Item 16A.*                                           |   | Audit  Committee Financial Expert                                             |   | 164 |
| *Item 16B.*                                           |   | Code of Ethics                                                                |   | 165 |
| *Item 16C.*                                           |   | Principal  Accountant Fees and Services                                       |   | 165 |
| *Item 16D.*                                           |   | Exemptions  from the Listing Standards for Audit Committees                   |   | 166 |
| *Item 16E.*                                           |   | Purchases  of Equity Securities by the Issuer and Affiliated Purchasers       |   | 166 |
| *Item 17.*                                            |   | Financial  Statements                                                         |   | 167 |
| *Item 18.*                                            |   | Financial  Statements                                                         |   | 167 |
| *Item 19.*                                            |   | Exhibits                                                                      |   | 167 |
| SIGNATURES                                            |   | 168                                                                           |

 

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Unless the context otherwise requires, references to“Mechel,” “Company,” “us” and “our” refer to Mechel OAO and its subsidiaries.

Our business consists of two segments: mining andsteel. References in this document to segment revenues are to revenues of thesegment excluding intersegment sales, unless otherwise noted.

For purposes of calculating certain market share data,we have included businesses that are currently part of our group that may nothave been part of our group during the period for which such market share datais presented.

In this document, references to “U.S. dollars,” “$” or“cents” are to the currency of the United States, references to “rubles” are tothe currency of the Russian Federation and references to “euro” or “€”are to the currency of the member states of the European Union, or EU,participating in the European Monetary Union.

The term “tonne” as used herein means a metric tonne.A metric tonne is equal to 1,000 kilograms or 2,204.62 pounds.

Certain amounts that appear in this document have beensubject to rounding adjustments; accordingly, figures shown as totals incertain tables or in the text may not be an arithmetic aggregation of thefigures that precede them.

2

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**CAUTIONARY NOTEREGARDING FORWARD-LOOKING STATEMENTS**

Matters discussedin this document may constitute forward-looking statements, as defined inthe safe harbor provisions of the U.S. Private Securities Litigation Reform Actof 1995. We wish to caution you that these statements are only predictions andthat actual events or results may differ materially. Forward-lookingstatements include statements concerning plans, objectives, goals, strategies,future events or performance, and underlying assumptions and other statements,which are other than statements of historical facts. The words “believe,” “expect,”“anticipate,” “intend,” “estimate,” “forecast,” “project,” “will,” “may,” “should”and similar expressions identify forward-looking statements. Forward-lookingstatements appear in a number of places including, without limitation, “Item 3.Key Information—Risk Factors,” “Item 4. Information on the Company” and “Item5. Operating and Financial Review and Prospects,” and include statementsregarding:

·       strategies,outlook and growth prospects;

·       futureplans and potential for future growth;

·       liquidity,capital resources and capital expenditures;

·       growthin demand for our products;

·       economicoutlook and industry trends;

·       developmentsof our markets;

·       theimpact of regulatory initiatives; and

·       thestrength of our competitors.

The forward-looking statements in this documentare based upon various assumptions, many of which are based, in turn, uponfurther assumptions, including without limitation, management’s examination ofhistorical operating trends, data contained in our records and other dataavailable from third parties. Although we believe that these assumptions werereasonable when made, these assumptions are inherently subject to significantuncertainties and contingencies which are difficult or impossible to predictand are beyond our control and we may not achieve or accomplish theseexpectations, beliefs or projections. In addition to these important factorsand matters discussed elsewhere herein, important factors that, in our view,could cause actual results to differ materially from those discussed in theforward-looking statements include the achievement of the anticipatedlevels of profitability, growth, cost and synergy of our recent acquisitions,the timely development and acceptance of new products, the impact ofcompetitive pricing, the ability to obtain necessary regulatory approvals, thecondition of the Russian economy, political stability in Russia, volatility instock markets or in the price of our shares or ADSs, financial risk management,the impact of general business and global economic conditions and otherimportant factors described herein and from time to time in the reports to befiled by us with the Securities and Exchange Commission, or the SEC.

Except to the extentrequired by law, neither we, nor any of our agents, employees or advisorsintend or have any duty or obligation to supplement, amend, update or reviseany of the forward-looking statements contained or incorporated byreference in this document.

3

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**PART I**

***Item1.***                          Identityof Directors, Senior Management and Advisors

Not applicable.

***Item2.***                          OfferStatistics and Expected Timetable

Not applicable.

***Item3.***                          KeyInformation

**Selected FinancialData**

The financial data set forth below as of December 31,2006, 2005, 2004, 2003 and 2002, and for the years then ended, have beenderived from our consolidated financial statements. Our reporting currency isthe U.S. dollar and we prepare our consolidated financial statements in accordancewith U.S. GAAP.(1)

Our results of operations for the periods presentedare significantly affected by acquisitions. Results of operations of theseacquired businesses are included in our consolidated financial statements forthe periods after their respective dates of acquisition. The financial databelow should be read in conjunction with, and are qualified in their entiretyby reference to, our consolidated financial statements and related notesincluded under “Item 18. Financial Statements” and “Item 5. Operating andFinancial Review and Prospects.”

4

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| ** **                                                                                                           | ** ** | **Year ended December 31,**                                                        | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2006**                                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands of U.S. dollars, except per share data)** | ** ** |
| **Consolidated income statement  data:**                                                                             | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue, net                                                                                                         |       | 4,397,811                                                                                         |       | 3,804,995 |   | 3,635,955 |   | 2,028,051 |   | 1,314,149 |   |
| Cost of goods sold                                                                                                   |       | (2,868,564                                                                                        | )          | (2,469,134 | ) | (2,225,088 | ) | (1,422,987 | ) | (947,527 | ) |
| Gross profit                                                                                                         |       | 1,529,247                                                                                         |       | 1,335,861 |   | 1,410,867 |   | 605,064 |   | 366,622 |   |
| Selling, distribution and operating expenses                                                                         |       | (803,549                                                                                          | )          | (820,133 | ) | (660,060 | ) | (407,383 | ) | (277,478 | ) |
| Operating income                                                                                                     |       | 725,698                                                                                           |       | 515,728 |   | 750,807 |   | 197,681 |   | 89,144 |   |
| Other income and expense, net                                                                                        |       | 139,135                                                                                           |       | 10,131 |   | 794,288 |   | (21,555 | ) | (18,083 | ) |
| Income before tax, minority interest, discounted  operations, extraordinary gain and changes in accounting principle |       | 864,833                                                                                           |       | 525,859 |   | 1,545,095 |   | 176,126 |   | 71,061 |   |
| Income tax expense                                                                                                   |       | (230,599                                                                                          | )          | (136,643 | ) | (175,776 | ) | (47,759 | ) | (2,653 | ) |
| Minority interest in loss (income) of subsidiaries                                                                   |       | (31,528                                                                                           | )          | (6,879 | ) | (11,673 | ) | 18,979 |   | 10,433 |   |
| Income from continuing operations                                                                                    |       | 602,706                                                                                           |       | 382,337 |   | 1,357,646 |   | 147,346 |   | 78,841 |   |
| Income (loss) from discontinued operations, net of  tax                                                              |       | 543                                                                                               |       | (1,157 | ) | (15,211 | ) | (5,790 | ) | (1,835 | ) |
| Extraordinary gain, net of tax                                                                                       |       | —                                                                                            |       | — |   | 271 |   | 5,740 |   | 1,388 |   |
| Changes in accounting principle, net of tax                                                                          |       | —                                                                                            |       | — |   | — |   | (3,788 | ) | 10,859 |   |
| Net income                                                                                                           |       | 603,249                                                                                           |       | 381,180 |   | 1,342,706 |   | 143,508 |   | 89,253 |   |
| Currency translation adjustment                                                                                      |       | 148,920                                                                                           |       | (53,822 | )) | 49,116 |   | 46,921 |   | — |   |
| Adjustment of available-for-sale securities                                                                          |       | 11,203                                                                                            |       | 2,181 |   | (2,350 | ) | — |   | — |   |
| Additional minimum pension liability                                                                                 |       | (4,669                                                                                            | )          |   |   |   |   |   |   |   |   |
| Comprehensive income                                                                                                 |       | 758,703                                                                                           |       | 329,539 |   | 1,389,472 |   | 190,429 |   | 89,253 |   |
| Earnings per share from continuing operations                                                                        |       | 1.48                                                                                              |       | 0.95 |   | 3.63 |   | 0.39 |   | 0.24 |   |
| Loss per share effect of discontinued operations                                                                     |       | 0.00                                                                                              |       | 0.00 |   | (0.04 | ) | (0.01 | ) | (0.01 | ) |
| Earnings per share effect of extraordinary gain                                                                      |       | 0.00                                                                                              |       | 0.00 |   | 0.00 |   | 0.02 |   | 0.01 |   |
| Earnings per share effect of changes in accounting  principle                                                        |       | 0.00                                                                                              |       | 0.00 |   | 0.00 |   | (0.01 | ) | 0.03 |   |
| Net income per share                                                                                                 |       | 1.48                                                                                              |       | 0.95 |   | 3.59 |   | 0.39 |   | 0.27 |   |
| Cash dividends per share                                                                                             |       | 0.46                                                                                              |       | 0.48 |   | 0.01 |   | 0.07 |   | 0.04 |   |
| Weighted average number shares outstanding                                                                           |       | 408,979,356                                                                                       |       | 403,118,680 |   | 373,971,312 |   | 366,178,815 |   | 333,243,450 |   |
| **Steel segment income statement  data:**                                                                            | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue, net(2)                                                                                                      |       | 3,085,333                                                                                         |       | 2,766,846 |   | 2,832,189 |   | 1,656,358 |   | 1,050,554 |   |
| Cost of goods sold(2)                                                                                                |       | (2,235,476                                                                                        | )          | (2,146,621 | ) | (2,065,480 | ) | (1,230,314 | ) | (801,481 | ) |
| Gross profit                                                                                                         |       | 849,857                                                                                           |       | 620,225 |   | 766,709 |   | 426,044 |   | 249,073 |   |
| Selling, distribution and operating expenses                                                                         |       | (446,121                                                                                          | )          | (505,749 | ) | (399,955 | ) | (291,814 | ) | (194,341 | ) |
| Operating income                                                                                                     |       | 403,737                                                                                           |       | 114,475 |   | 366,754 |   | 134,230 |   | 54,732 |   |
| **Mining segment income statement  data:**                                                                           | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue, net(2)                                                                                                      |       | 1,712,711                                                                                         |       | 1,431,375 |   | 1,201,409 |   | 599,756 |   | 372,216 |   |
| Cost of goods sold(2)                                                                                                |       | (1,033,321                                                                                        | )          | (715,738 | ) | (557,252 | ) | (420,736 | ) | (254,667 | ) |
| Gross profit                                                                                                         |       | 679,390                                                                                           |       | 715,637 |   | 644,158 |   | 179,020 |   | 117,549 |   |
| Selling, distribution and operating expenses                                                                         |       | (357,428                                                                                          | )          | (314,383 | ) | (260,103 | ) | (115,570 | ) | (83,137 | ) |
| Operating income                                                                                                     |       | 321,962                                                                                           |       | 401,252 |   | 384,055 |   | 63,450 |   | 34,412 |   |
| **Consolidated balance sheet data  (at period end):**                                                                | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total assets                                                                                                         |       | 4,449,058                                                                                         |       | 3,600,083 |   | 3,678,269 |   | 1,834,509 |   | 1,387,378 |   |
| Shareholders’ equity                                                                                            |       | 2,864,963                                                                                         |       | 2,210,474 |   | 2,057,629 |   | 448,826 |   | 278,051 |   |
| Long-term debt, net of current portion                                                                               |       | 322,604                                                                                           |       | 45,615 |   | 216,113 |   | 122,311 |   | 36,496 |   |
| **Consolidated cash flows data:**                                                                                    | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net cash provided by operating activities                                                                            |       | 554,923                                                                                           |       | 620,875 |   | 296,137 |   | 119,858 |   | 81,069 |   |
| Net cash provided by (used in) investing activities                                                                  |       | (552,538                                                                                          | )          | (994,707 | ) | 455,716 |   | (210,317 | ) | (86,633 | ) |
| Net cash provided by (used in) financing activities                                                                  |       | (162,782                                                                                          | )          | (308,870 | ) | 252,269 |   | 103,079 |   | 3,422 |   |
| **Non-U.S. GAAP measures(3):**                                                                                       | ** ** | ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Consolidated EBITDA(4)                                                                                               |       | 1,068,258                                                                                         |       | 726,252 |   | 1,707,711 |   | 341,472 |   | 207,452 |   |
| Steel segment EBITDA(4)                                                                                              |       | 660,119                                                                                           |       | 260,542 |   | 1,249,643 |   | 245,820 |   | 133,448 |   |
| Mining segment  EBITDA                                                                                               |       | 408,139                                                                                           |       | 465,710 |   | 458,068 |   | 95,652 |   | 74,004 |   |

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(1)             The value of property, plant and equipment pertainingto non-controlling shareholders in the accounting for minority interestsresulting from acquisitions of various subsidiaries has been recorded atappraised values rather than at historical cost as required by U.S. GAAP.

5

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(2)             Segment revenues and cost of goods sold includeintersegment sales.

(3)             EBITDA represents net income before interest expense,income taxes and depreciation, depletion and amortization. We present EBITDAbecause we consider it an important supplemental measure of our operatingperformance and believe it is frequently used by securities analysts, investorsand other interested parties in the evaluation of companies in our industry. Wealso present EBITDA by segment because our overall performance is bestexplained with reference to results of each segment.

EBITDA has limitationsas an analytical tool, and you should not consider it in isolation, or as asubstitute for analysis of our operating results as reported under U.S. GAAP.Some of these limitations are as follows:

·        EBITDA does not reflect the impact offinancing costs, which are significant and could further increase if we incurmore debt, on our operating performance.

·        EBITDA does not reflect the impact ofincome taxes on our operating performance.

·        EBITDA does not reflect the impact ofdepreciation, depletion and amortization on our operating performance. Theassets of our businesses which are being depreciated, depleted and/or amortized(including, for example, our mineral reserves) will have to be replaced in thefuture and such depreciation, depletion and amortization expense mayapproximate the cost to replace these assets in the future. By excluding suchexpense from EBITDA, EBITDA does not reflect our future cash requirements forsuch replacements.

·        Other companies in our industry maycalculate EBITDA differently or may use it for different purposes than we do,limiting its usefulness as a comparative measure.

We compensate for these limitations by relyingprimarily on our U.S. GAAP operating results and using EBITDA onlysupplementally. See our consolidated income statements and consolidatedstatements of cash flows included elsewhere in this document.

EBITDA is a measure of our operating performance thatis not required by, or presented in accordance with, U.S. GAAP. EBITDA is not ameasurement of our operating performance under U.S. GAAP and should not beconsidered as an alternative to net income, operating income or any otherperformance measures derived in accordance with U.S. GAAP or as an alternativeto cash flow from operating activities or as a measure of our liquidity. Inparticular, EBITDA should not be considered as a measure of discretionary cashavailable to us to invest in the growth of our business.

Reconciliationof EBITDA to net income is as follows for the periods indicated:

| ** **                                 | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Consolidated EBITDA  reconciliation:**   | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                 |       | 603,249                                    |       | 381,180 |   | 1,342,706 |   | 143,508 |   | 89,253 |   |
| Add:                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation, depletion and amortization   |       | 196,227                                    |       | 167,600 |   | 137,820 |   | 101,689 |   | 78,773 |   |
| Interest expense                           |       | 38,183                                     |       | 40,829 |   | 51,409 |   | 48,516 |   | 36,773 |   |
| Income taxes                               |       | 230,599                                    |       | 136,643 |   | 175,776 |   | 47,759 |   | 2,653 |   |
| Consolidated EBITDA                        |       | 1,068,258                                  |       | 726,252 |   | 1,707,711 |   | 341,472 |   | 207,452 |   |
| **Steel segment EBITDA  reconciliation:**  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                 |       | 406,448                                    |       | 67,444 |   | 1,014,356 |   | 114,011 |   | 57,977 |   |
| Add:                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation, depletion and amortization   |       | 102,112                                    |       | 95,789 |   | 81,052 |   | 67,272 |   | 49,728 |   |
| Interest expense                           |       | 25,722                                     |       | 35,889 |   | 36,058 |   | 38,351 |   | 30,416 |   |
| Income taxes                               |       | 125,837                                    |       | 61,420 |   | 118,177 |   | 26,186 |   | (4,673 | ) |
| Consolidated EBITDA                        |       | 660,119                                    |       | 260,542 |   | 1,249,643 |   | 245,820 |   | 133,448 |   |
| **Mining segment EBITDA  reconciliation:** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                 |       | 196,801                                    |       | 313,736 |   | 328,350 |   | 29,497 |   | 31,274 |   |
| Add:                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation, depletion and amortization   |       | 94,115                                     |       | 71,811 |   | 56,768 |   | 34,417 |   | 29,045 |   |
| Interest expense                           |       | 12,461                                     |       | 4,940 |   | 15,351 |   | 10,165 |   | 6,357 |   |
| Income taxes                               |       | 104,762                                    |       | 75,223 |   | 57,599 |   | 21,573 |   | 7,328 |   |
| Consolidated  EBITDA                       |       | 408,139                                    |       | 465,710 |   | 458,068 |   | 95,652 |   | 74,004 |   |

 

(4)             The 2004 amount includes a gain of$800.0 million from the sale of our stake in Magnitogorsk Iron and SteelWorks, or MMK.

6

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**Exchange Rates**

The following tables show, for the periods indicated,certain information regarding the exchange rate between the ruble and the U.S.dollar, based on data published by the Central Bank of Russia.

Theserates may differ from the actual rates used in preparation of our financialstatements and other financial information provided herein.

| ** **                                 | ** ** | **Rubles per U.S. dollar** | ** ** |
|--------------------------------------------|------------|-------------------------------------------|------------|
| **Year ended December 31,** | ** ** | ** **                                | ** ** | **High** | ** ** | **Low** | ** ** | **Average(1)** | ** ** | **Period End** | ** ** |
| 2006                                       |       | 28.78                                     |       | 26.18 |   |   | 27.19 |   |   |   | 27.33 |   |   |
| 2005                                       |       | 29.00                                     |       | 27.46 |   |   | 28.29 |   |   |   | 28.78 |   |   |
| 2004                                       |       | 29.45                                     |       | 27.75 |   |   | 28.82 |   |   |   | 27.75 |   |   |
| 2003                                       |       | 31.88                                     |       | 29.25 |   |   | 30.61 |   |   |   | 29.45 |   |   |
| 2002                                       |       | 31.86                                     |       | 30.14 |   |   | 31.39 |   |   |   | 31.78 |   |   |
|                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Theaverage of the exchange rates on the last business day of each full monthduring the relevant period.

| ** **         | ** ** | **Rubles per U.S.  dollar** | ** ** |
|--------------------|------------|---------------------------------------|------------|
| ** **         | ** ** | **High**                              | ** ** | **Low** | ** ** |
| May 2007      |       | 25.92                                 |       | 25.73 |   |
| April 2007    |       | 26.01                                 |       | 25.69 |   |
| March 2007    |       | 26.24                                 |       | 25.97 |   |
| February 2007 |       | 26.55                                 |       | 26.16 |   |
| January 2007  |       | 26.58                                 |       | 26.45 |   |
| December 2006 |       | 26,78                                 |       | 26,18 |   |

 

The exchange rate between the ruble and the U.S.dollar on July 2, 2007 was 25.82 rubles per one U.S. dollar.

No representation is madethat the ruble or U.S. dollar amounts in this document could have been or canbe converted into U.S. dollars or rubles, as the case may be, at any particularrate or at all. The ruble is generally not convertible outside Russia. A marketexists within Russia for the conversion of rubles into other currencies, butthe limited availability of other currencies may inflate their values relativeto the ruble.

**Risk Factors**

*An investment inour shares and ADSs involves a high degree of risk. You should carefullyconsider the following information about these risks, together with theinformation contained in this document, before you decide to buy our shares andADSs. If any of the following risks actually occurs, our business, financialcondition, results of operations or prospects could be materially adverselyaffected. In that case, the value of our shares and ADSs could also decline andyou could lose all or part of your investment.*

*We have describedthe risks and uncertainties that our management believes are material, butthese risks and uncertainties may not be the only ones we face. Additionalrisks and uncertainties, including those we currently are not aware of or deemimmaterial, may also result in decreased operating revenues, increasedoperating expenses or other events that could result in a decline in the valueof our shares and ADSs.*

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**Risks Relating toOur Business and Industry**

***We operate in a cyclical industry, and any local or global downturn inthe mining or steel industry may have an adverse effect on our results ofoperations and financial condition.***

Our mining business sells significant amounts of coal,iron ore and nickel to third parties. Cyclical and other uncontrollable changesin world market prices of these commodities could affect the results of ourmining activities. The changes in these prices result from factors, such as demandand transportation costs, which are beyond our control. Prices of thesecommodities have varied significantly in the past and could vary significantlyin the future. Prolonged declines in world market prices for the commodities wesell to third parties would have a material adverse effect on our revenues. Adecline in steel prices could also negatively impact the prices for thesecommodities.

The steel industry also is cyclical in nature becausethe industries in which steel customers operate are cyclical and sensitive tochanges in general economic conditions. The demand for steel products thusgenerally correlates to macroeconomic fluctuations in the economies in whichsteel producers sell products, as well as in the global economy. The prices of steelproducts are influenced by many factors, including demand, worldwide productioncapacity, capacity-utilization rates, raw-material costs, exchange rates,trade barriers and improvements in steel-making processes. Steel priceshave experienced, and in the future may experience, significant fluctuations asa result of these and other factors, many of which are beyond our control.

We derived approximately55% and 46% of our total revenues from sales to customers in Russia in 2006 and2005, respectively. The Russian economy has experienced significantlyfluctuating growth rates over the past 10 years. From 1994 to 1998, theRussian economy contracted in real terms at an average rate of 4.9% per year;after the Russian crisis in 1998, the economy recovered and grew in real termsat an average rate of 6.8% per year from 1999 to 2006. Russian production ofsteel also suffered a substantial decline from over 77 million tonnes in1991 to 44 million tonnes in 1998, but then recovered to 71 million tonnesin 2006. Further, our products in Russia are mainly used in the construction,engineering and automotive industries, which are particularly vulnerable togeneral economic downturns. In addition to Russia, Asia and the Middle East arealso large destinations for our products, and these areas, like Russia, facegreater risks of volatility. Accordingly, any significant decrease in demandfor steel products or decline in the price of these products in Russia or otheremerging market economies could result in significantly reduced revenues,thereby materially adversely affecting our results of operations and financialcondition.

***The steelindustry is highly competitive, and we may not be able to compete successfully.***

We face competition from domestic and foreign steelmanufacturers, many of which have greater resources. A number of our Russiancompetitors are undertaking modernization and expansion plans, which may makethem more efficient or allow them to develop new products.

We also face price-basedcompetition from steel producers in emerging market countries, including, inparticular, Ukraine. Recent consolidation in the steel sector globally has alsoled to the creation of several very large steel producers, each with greaterfinancial resources and more extensive global operations than Mechel. Moreover,the steel industry suffers from production overcapacity. Increased competitioncould result in more competitive pricing and reduced profitability.

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***Successful implementation of our strategy to expandour specialty long product sales depends on our ability to increase our exportsales of these products.***

While we expect continuedgrowth of demand in the Russian market for specialty long products, ourstrategy to expand these sales substantially is dependent on our ability toincrease our exports of these products to other countries, particularly the EUcountries. We face a number of obstacles to this strategy, including tradebarriers and sales and distribution challenges.

***We will require a significant amount of cash tofund our capital improvements program. Our ability to generate cash or obtainfinancing depends on many factors beyond our control.***

The total cost of ourcapital improvements over the next five years is expected to be approximately$2.7 billion. Most of our current borrowings are from Russian and internationalbanks and financial institutions as well as ruble-denominated bonds. In thefuture, we may rely to a greater extent than currently on foreign capitalmarkets and other foreign financing sources for our capital needs. It ispossible that these foreign sources of financing, as well as domestic sources,may not be available in the future in the amounts we require or at anacceptable cost. See “—Risks Relating to the Russian Federation—Emergingmarkets such as Russia are subject to greater risks than more developedmarkets, and financial turmoil in any emerging market could disrupt ourbusiness, as well as cause the price of our securities to suffer” and “—RisksRelating to the Russian Federation—The Russian banking system remainsunderdeveloped, and another banking crisis could place severe liquidityconstraints on our business.”

***Our business strategy foresees additionalacquisitions and continued integration, and we may fail to identify suitabletargets, acquire them on acceptable terms or successfully integrate them.***

Our strategy relies on our status as an integratedmining and steel group, which allows us to benefit from economies of scale,realize synergies, better satisfy the needs of our domestic and internationalmining and steel customers and compete effectively against other mining andsteel producers. We also intend to enhance the profitability of our business byapplying our integration strategy to a larger asset base and, towards that end,we need to identify suitable targets that would fit into our operations,acquire them on acceptable terms and successfully integrate them.

The acquisition andintegration of new companies pose significant risks to our existing operations,including:

·       additionaldemands placed on our senior management, who are also responsible for managingour existing operations;

·       increasedoverall operating complexity of our business, requiring greater personnel andother resources;

·       significant,initial cash expenditures to integrate new acquisitions;

·       incurrenceof debt to finance acquisitions and higher debt service costs related thereto;and

·       strainson our labor force as production may be shifted to new companies or locationsto optimize our overall production.

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Moreover, theintegration of new businesses may be difficult for a variety of reasons,including statutory limitations, differing culture, management styles andsystems and infrastructure and poor records or internal controls. For example,the regional government in Bashkiria has special perpetual rights, or a “goldenshare,” in our subsidiary Beloretsk Metallurgical Plant, giving it the right toveto certain shareholder decisions and appoint a voting representative on theboard of directors of this subsidiary. The shareholder decisions regardingBeloretsk Metallurgical Plant that may be vetoed by the regional government areas follows:

·       approvalof amendments and supplements to the company’s charter or approval of a newversion of the charter;

·       reorganizationof the company;

·       liquidationof the company, appointment of a liquidation committee and approval of interimand final liquidation balances;

·       changesthe amount of the charter capital of the company; and

·       approvalof major and interested party transactions.

In addition, integrating new acquisitions may requiresignificant initial cash investments. Furthermore, even if we are successful inintegrating our existing and new businesses, expected synergies and costsavings may not materialize, resulting in lower than expected profit margins.We cannot assure you that we will be successful in realizing any of theanticipated benefits of the companies that we are now in the process ofintegrating or that we may acquire in the future. If we do not realize thesebenefits, our financial condition, results of operations and prospects could bematerially adversely affected.

We also may acquire orestablish businesses in countries that may represent new operating environmentsfor us and which may be located a great distance from our headquarters inRussia. We may thus have less control over the activities of these companiesand may face more uncertainties with respect to the operational and financialneeds of these businesses, which may hinder our integration efforts.

***We have had material weaknesses in our internalcontrol over financial reporting in the past and cannot assure you thatadditional material weaknesses will not be identified in the future. Ourfailure to implement and maintain effective internal control over financialreporting could result in material misstatements in our financial statementswhich could require us to restate financial statements, cause investors to loseconfidence in our reported financial information and have a negative effect onour stock price.***

Management has identified nine material weaknesses inour internal control over financial reporting as defined in the Public CompanyAccounting Oversight Board’s Auditing Standard No. 2 that affected ourfinancial statements for the year ended December 31, 2006. The materialweaknesses in our internal control over financial reporting for the year ended December 31,2006 are described in “Item 15—Controls and Procedures.”

Notwithstanding the stepswe have taken and continue to take that are designed to remedy each materialweakness identified above, we may not be successful in remediating thesematerial weaknesses in the near or long term and we cannot assure you thatadditional significant deficiencies or material weaknesses in our internalcontrol over financial reporting will not be identified in the future. Anyfailure to maintain or implement required new or improved controls, or anydifficulties we encounter in their implementation, could result in additionalsignificant deficiencies or material weaknesses, cause us to fail to meet ourperiodic reporting obligations or result in material misstatements in ourfinancial statements. Any such failure could also adversely affect the resultsof periodic management evaluations and annual auditor attestation reportsregarding the effectiveness of our internal control over financial reportingrequired under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgatedunder 

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Section 404.The existence of a material weakness could result in errors in our financialstatements that could result in a restatement of financial statements, cause usto fail to meet our reporting obligations and cause investors to loseconfidence in our reported financial information, leading to a decline in ourstock price.

***We depend on key accounting staff for thepreparation of U.S. GAAP financial information. Given the competition for suchpersonnel and the remote locations of our subsidiaries, our key accountingstaff may leave our company, which could disrupt our ability to timely andaccurately report U.S. GAAP financial information.***

Our subsidiaries maintaintheir books and records in local currencies and prepare accounting reports inaccordance with local accounting principles and practices. In particular, eachof our Russian subsidiaries maintains its books in rubles and prepares separateunconsolidated financial statements in accordance with Russian accountingstandards. For every reporting period, we translate, adjust and combine thesestandalone Russian statutory financial statements to prepare consolidated U.S.GAAP financial statements. This is a difficult task requiring U.S.GAAP-experienced accounting personnel at each of our subsidiaries and at ourMoscow corporate offices. Russia has available only a small number of accountingpersonnel with U.S. GAAP expertise. Moreover, there is an increasing demand forsuch personnel as more Russian companies are beginning to prepare financialstatements on the basis of U.S. GAAP or other international standards. Suchcompetition, combined with the remote locations of our subsidiaries which suchpersonnel may not find suitable in comparison to other opportunities, makes itdifficult for us to hire and retain such personnel, and our key accountingstaff may leave our company. Under these circumstances, we may have difficultyin remedying the material weaknesses identified by our independent registeredpublic accounting firm and in the timely and accurate reporting of ourfinancial information in accordance with U.S. GAAP.

***The potential implementation by the Russiangovernment of a law requiring companies to purchase or lease the land on whichthey operate may have a material adverse effect on our financial condition.***

Much of the land occupied by privatized Russiancompanies, including most of our subsidiaries, was not included in theprivatizations of these companies and is still owned by federal, regional ormunicipal governments. The companies use the land pursuant to a special titleof perpetual use whereby they have the right to use the land but do not havethe right to alienate such land.

The Land Code of theRussian Federation, as amended, which was enacted October 25, 2001,requires privatized Russian companies to either purchase or lease the land onwhich they operate. This requirement was scheduled to take effect on January 1,2004, but implementation has been delayed by the Russian legislature until January 1,2008. Currently, there is no procedure for calculating a repurchase price setby law. A draft law scheduled for consideration by the Russian State Duma inthe Spring of 2007 establishes the repurchase price of the land plots in theamount of 2.5% of the cadastral value of such land plots. Companies wishing topurchase the land on which they operate prior to the law’s enactment may do soat a price calculated by multiplying the state cadastral value, land tax rateand repurchase rate set by the laws of the relevant sub-federal politicalunits. Based on the latter calculation, we estimate the cost for us to purchasethe land on which we operate would range from $49.7 million to $194.8 million.This estimate excludes certain land plots on which Beloretsk MetalurgicalPlant, Southern Urals Nickel Plant, Southern Kuzbass Coal Company operate,which were not included in the state cadastral valuation.

***Increasing tariffs and restructuring in the energysector could materially adversely affect our business.***

In 2006, our Russian operations purchasedapproximately 3 billion kWh of electricity, representing 65% of theirneeds, from local subsidiaries of RAO UES, the government-controllednational holding company for the Russian power sector. Domestic electricityprices are regulated by the Russian 

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government. The governmentis currently in the early stages of implementing a restructuring plan for thepower sector aimed at introducing competition, liberalizing the wholesaleelectricity market and moving from regulated pricing to a market-basedsystem by 2008. This reform process could also cause disruptions to the supplyof electricity to us. In addition, while subject to doubt as to whether it willbe implemented as currently written, according to the Russian Energy Strategyapproved by the Russian government in 2003, electricity tariffs for industrialusers are expected to reach 3.2-3.6 cents per kWh by 2007 and 4.0-4.5cents per kWh by 2020. In 2006, our average cost of electricity was 3.3cents per kWh. Assuming a price of 3.6 cents per kWh in 2006, our Russianoperations would have incurred approximately $9 million in additional costs.Further price increases for electricity may also occur in the future as theindustry is restructured and controlled to a greater extent by the privatesector. If we are required to pay higher prices for electricity in the future,our costs will rise and our business and prospects could be materiallyadversely affected.

Our Russian operationsalso purchase significant amounts of natural gas, primarily for the productionof electricity at our own co-generation facilities, from Gazprom. Gazprom is agovernment-controlled company and the dominant producer and monopolytransporter of natural gas within Russia. Domestic natural gas prices areregulated by the government. These prices have been rising over the last fewyears. The average price for industrial consumers was approximately $45 perthousand cubic meters ($1.28 per thousand cubic feet) in 2006, and increased by16% compared with 2005. Further, domestic natural gas prices are significantlybelow Western European levels, which helps to provide us with a cost advantageover our competitors. According to the Russian Ministry of Economic Developmentand Trade forecasts, natural gas prices are expected to reach $108 per thousandcubic meters ($3.06 per thousand cubic feet) by 2010. If we are required to paya higher price for natural gas, our costs will rise and our business andprospects could be materially adversely affected.

***If we are unable to obtain adequate capital, we mayhave to limit our operations substantially, which could have a material adverseeffect on our business, financial condition and results of operations.***

We will need to make significant capital expendituresin our business. We spent $397.8 million during 2006 and expect to spend approximately $500.0million in 2007 for the fulfillment of our capital spending plans. Our abilityto fund planned capital expenditures will depend on our ability to generatecash in the future. This, to a certain extent, is subject to general economic,financial, competitive, legislative, regulatory and other factors that arebeyond our control. To meet our requirements, we may need to attract equity ordebt financing, especially in international capital markets or frominternational lenders. It is possible that these foreign sources of financingmay not be available or may be available only at an unacceptable cost.

Among other things, increased levels of indebtedness,and particularly increases in the level of secured indebtedness, couldpotentially: (1) limit our ability to obtain additional financing; (2) limitour flexibility in planning for, or reacting to, changes in the markets inwhich we compete; (3) place us at a competitive disadvantage relative toour competitors with superior financial resources; (4) lead to a partialor complete loss of control over our key subsidiaries or properties; (5) renderus more vulnerable to general adverse economic and industry conditions, (6) requireus to dedicate all or a substantial part of our cash flow to service our debt;and (7) limit or eliminate our ability to pay dividends. Our ability tomake payments on our indebtedness depends upon our ability to maintain ouroperating performance at a certain level, which is subject to general economicand market conditions and to financial, business and other factors, many ofwhich we cannot control.

In addition, Russian companies are limited in theirability to issue shares in the form of ADSs or other depositary receipts due toRussian securities regulations. We have received permission from the FederalService for the Financial Markets for up to 40% of our shares to be circulatedabroad through depositary receipt programs, which was the maximum volumeallowed at that time. Current Russian securities 

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regulations provide thatno more than 35% of a Russian company’s shares may be circulated abroad throughdepositary receipt programs. Our ADS program currently accounts forapproximately 35% of our shares. Russian securities regulations are unclear asto whether the FSFM’s approval of an amount greater than 35% prior to theestablishment of this limit in the securities regulations will be permitted tostand, or whether the 35% limit established in the regulation trumps prior FSFMpermissions for higher amounts. Until this is clarified, we have instructed ourdepositary not to allow for the conversion of more than 35% of our shares intoADS. We therefore are limited in our ability to raise additional equityfinancing through depositary receipts. Furthermore, in the event thatsecurities regulations are enacted in the future that further reduce the 35%limit, our depositary may be forced to cancel and convert some of our ADS intoa corresponding number of shares. The Russian government or its agencies mayalso impose other restrictions on international financings by Russian issuers.

Any of the foregoing factors may limit the amount ofcapital available to meet our operating requirements. If we cannot obtainadequate funds to satisfy our capital requirements, we may need to limit ouroperations significantly, which could have a material adverse effect on ourbusiness, financial condition and results of operations.

From time to time, we maymerge certain subsidiaries for operational reasons. Under Russian law, suchmergers would be considered a reorganization and the merged subsidiaries wouldbe required to notify their creditors of this reorganization. Russian law alsoprovides that, for a period of 30 days after notice, these creditors wouldhave a right to accelerate the merged subsidiaries’ indebtedness and demandreimbursement for applicable losses. In the event that we decide to undertakeany such merger and all or part of certain of our subsidiaries’ indebtedness isaccelerated, we and such subsidiaries may not have the ability to raise thefunds necessary for repayment and our business and financial condition could bematerially adversely affected.

***The reorganization of the Russian railwaystransportation sector exposes us to uncertainties regarding transportationcosts of raw materials and steel products.***

Railway transportation is our principal means oftransporting raw materials and steel products to our facilities and tocustomers in Russia and abroad. The Russian railways are owned by OAO RussianRailroads, an open joint stock company wholly-owned by the Russiangovernment. Russian Railroads is responsible for the management of all Russianrailroads.

The Russian government,through several government ministries, Russian Railroads, and in cooperationwith large consignors, sets domestic rail tariffs and the terms oftransportation. Factors which have lead and may continue to lead to an increasein domestic rail tariffs include inflation, the poor state of repair of Russia’srolling stock and the cross-subsidization of unprofitable passenger andcheap raw material transportation sectors by increasing tariffs for thetransport of more expensive cargo, including metallurgical products. Failure ofRussian Railroads to upgrade its rolling stock within the next few years couldalso result in a shortage of available working rolling stock and a disruptionin transportation of our materials and products. If these or other factorsresult in continued increases in railway transport costs, our results ofoperations, notwithstanding our efforts to minimize costs and increase therolling stock, could be materially adversely affected.

***We facenumerous protective trade restrictions in the export of our steel products.***

We face numerous protective tariffs, duties and quotaswhich reduce our competitiveness in, and limit our access to, particularmarkets. Several key steel importing countries currently have importrestrictions in place on steel products or intend to introduce them in thefuture. The EU has a quota system in place with respect to Russian steelimports, which affected our exports to ten countries in Central and EasternEurope and the Baltic States that joined the EU in 2004 as well as to Romaniaand Bulgaria, which joined 

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the EU in 2007. Our salesinto the EU constituted approximately 9% of our steel segment revenues in 2006.The export of our steel into the EU is an important part of our growthstrategy. If EU quotas are not increased in line with our sales growthobjectives, our ability to expand our sales in the EU and pursue our growthstrategy could be limited.

The United States has aquota system in place with respect to imports of hot-rolled coil and thicksteel plate. In September 2003, China imposed anti-dumping duties oncold-rolled steel imports from Russia, which were suspended from January 14,2004 for an indefinite period of time. In July 2006, Ukraine imposed anantidumping duty on steel rope imports from Russia at a rate of 32.63% for fourmonths, and we expect Ukraine to extend this duty for an additional five-yearperiod. In 2006, approximately 81% of our steel segment revenues were derivedfrom sales of steel products that were subject to import restrictions. See “Item4. Information on the Company—Steel Business—Trade Restrictions.”

***Webenefit from Russia’s tariffs and duties on imported steel, which may beeliminated in the future.***

Russia has in place import tariffs with respect tocertain imported steel products. These tariffs generally amount to 5% of value,but also step up to 15% of value for certain higher value-added steel products.Russia has in place a 21% countervailing duty on Ukrainian steel bars, whichhas been extended through August 2007. We believe we benefit from thisduty because it prevents subsidized Ukrainian exports to Russia from reducingthe prices we can obtain for these products in our domestic markets. While we havepetitioned for the extension of this duty, we believe there is a lowprobability that the extension will be granted.

From March 20, 2007, an antidumping duty has beenimposed on corrosion-resistant steel originating in the EU at a rate of 840euro per ton. The duty, which we believe will benefit us, will be in force forthree years.

Almost all of our sales of steel products in Russiawere protected by these import tariffs in 2006. These tariffs and duties may bereduced or eliminated in the future, which could materially adversely affectour revenues and results of operations.

According to pressreports, Russia may complete its negotiations and join the WTO in 2007. Russia’sfuture accession to the WTO could negatively affect our business and prospects.In particular, Russia’s entry into the WTO may require gradual lowering orremoving of import tariffs and duties on steel products, causing increasedcompetition in the domestic steel market from foreign producers and exporters.See also “—Increasing tariffs and restructuring in the energy sector couldmaterially adversely affect our business.”

***Inflationcould increase our costs and decrease operating margins.***

The Russian economy hasbeen characterized by high rates of inflation. In 2006, the inflation rate was9.7%, according to Rosstat. The prices for many of our products are denominatedin U.S. dollars. As we tend to experience inflation-driven increases incertain of our ruble-denominated costs, including salaries, rents and energycosts, which are sensitive to rises in the general price level in Russia, ourcosts in U.S. dollar terms will rise. In this situation, due to competitivepressures, we may not be able to raise the prices we charge for our productssufficiently to preserve operating margins. Accordingly, high rates ofinflation in Russia could increase our costs and decrease operating margins.

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***Further appreciation in real terms of the rubleagainst the U.S. dollar may materially adversely affect our results ofoperations.***

Our reporting currency isthe U.S. dollar. Our products are typically priced in rubles for domestic salesand in U.S. dollars (and, to a lesser extent, euros) for export sales, whereasthe majority of our direct costs are incurred in rubles and, to a lesserextent, in other local currencies where our operations are based. Appreciationin real terms of the ruble against the U.S. dollar results in an increase inour costs relative to our revenues, adversely affecting our results ofoperations. In 2006, the ruble appreciated in real terms against the U.S.dollar by 10.7% over 2005 according to the Rosstat, and further realappreciation of the ruble against the U.S. dollar may materially adverselyaffect our results of operations.

***Limitations on the conversion of rubles to foreigncurrencies in Russia could increase our costs when making payments in foreigncurrencies to suppliers and creditors and could cause us to default on ourobligations to them.***

Many of our major capitalexpenditures are denominated and payable in various foreign currencies,including the U.S. dollar and euro. Russian legislation currently permits theconversion of ruble revenues into foreign currency without limitations.However, Russian currency legislation allows for the imposition of certainrestrictions on the conversion of rubles into foreign currencies in the eventof an economic or currency crisis. Should such restrictions be imposed, theremay be delay or other difficulty in converting rubles into a foreign currencyto make a payment or delay in or restriction on the transfer of foreigncurrency. This, in turn, could limit our ability to meet our payment and debtobligations, which could result in the loss of suppliers, acceleration of debtobligations and cross-defaults and, consequently, have a material adverseeffect on our business, financial condition and results of operations.

***Estimatesof our reserves are subject to uncertainties.***

The estimates concerningour reserves contained in this document are subject to considerableuncertainties. These estimates are based on interpretations of geological dataobtained from sampling techniques and projected rates of production in thefuture. Actual production results may differ significantly from reserveestimates. In addition, it may take many years from the initial phase ofdrilling before production is possible. During that time, the economicfeasibility of exploiting a discovery may change as a result of changes in themarket price of coal, iron ore or nickel.

***We aresubject to mining risks.***

Our business operations,like those of other mining companies, are subject to all of the hazards andrisks normally associated with the exploration, development and production ofnatural resources, any of which could result in production shortfalls or damageto persons or property. In particular, hazards associated with our open-pitmining operations include:

·       floodingof the open pit;

·       collapsesof the open-pit wall;

·       accidentsassociated with the operation of large open-pit mining and rock transportationequipment;

·       accidentsassociated with the preparation and ignition of large-scale open-pitblasting operations;

·       deteriorationof production quality due to weather; and

·       hazardsassociated with the disposal of mineralized waste water, such as groundwaterand waterway contamination.

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Hazards associatedwith our underground mining operations include:

·       underground fires andexplosions, including those caused by flammable gas;

·       cave-insor ground falls;

·       dischargesof gases and toxic chemicals;

·       flooding;

·       sinkholeformation and ground subsidence; and

·       otheraccidents and conditions resulting from drilling, blasting and removing andprocessing material from an underground mine.

We are at risk ofexperiencing any and all of these hazards. The occurrence of any of these hazardscould delay production, increase production costs, result in injury to personsand damage to property, as well as liability for us. The liabilities resultingfrom any of these risks may not be adequately covered by insurance, and we mayincur significant costs that could have a material adverse effect upon ourbusiness, results of operations and financial condition.

***More stringent environmental laws and regulationsor more stringent enforcement of existing environmental laws and regulations inthe jurisdictions where we operate may have a significant negative effect onour operating results.***

Our operations and properties are subject toenvironmental, health and safety and other laws and regulations in thejurisdictions in which we operate. For instance, our operations generate largeamounts of pollutants and waste, some of which are hazardous, such asbenzapiren, sulphur oxide, sulphuric acid, nitrogen ammonium, sulphates,nitrites, phenicols and sludges (including sludges containing crome, copper, nickel,mercury and zinc). The discharge, storage and disposal of such hazardous wasteis subject to environmental regulations, including some requiring the clean-upof contamination and reclamation, such as requirements for cleaning up highlyhazardous waste oil and iron slag. In addition, pollution risks and relatedclean-up costs are often impossible to assess unless environmental audits havebeen performed and the extent of liability under environmental laws is clearlydeterminable.

Generally, there is a greater awareness in Russia ofdamage caused to the environment by industry than existed during the Sovietera. At the same time, environmental legislation in the jurisdictions where weoperate is generally weaker and less stringently enforced than in the EU or theUnited States. However, more stringent standards may be introduced in thefuture or enforcement increased in Russia and elsewhere where we conduct ouroperations. Based on the current regulatory environment in these jurisdictions,as of December 31, 2006, we have not created any reserves forenvironmental liabilities and compliance costs, other than an accrual in theamount of $92.4** **million for asset retirementobligations (ARO), consistent with U.S. GAAP requirements. In addition, uponour acquisitions of Mechel Targoviste and Mechel Campia Turzii, as part of thepurchase agreements, we committed to the Romanian government to invest$7.3 million and $4.6 million, respectively, into environmentalprotection and reclamation, which investments we completed as of December 31,2006. Any change in this regulatory environment could result in actual costsand liabilities for which we have not provided.

Also, in the course, or as a result, of anenvironmental investigation, courts can issue orders and decisionsadministratively halting for a 90-day period part or all of theproduction at a facility that has violated environmental standards. In theevent that production at one of our facilities is partially or wholly preventeddue to this type of sanction, our business could suffer and our operatingresults would be negatively affected.

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In addition, we aregenerally not indemnified against environmental liabilities or any requiredland reclamation expenses of our acquired businesses that arise from activitiesthat occurred prior to our acquisition.

***The KyotoProtocol may negatively affect us.***

The Kyoto Protocol to theUnited Nations Framework Convention on Climate Change, which was ratified byRussia on November 4, 2004, and took effect on February 16, 2005,requires the signatory countries to make substantial reductions in “greenhousegas” emissions. Future Russian legislation enacted to implement the KyotoProtocol may result in raised environmental standards for industries includingthe mining and steel industries, which may in turn result in increasedenvironmental costs. Russian industrial technologies may not be able to complywith these raised environmental standards and such non-compliance may become anadditional basis for restricting Russian steel exports to the European market.The amount of EU anti-dumping duty on Russian exports may be increased as aresult of adjustments to the relatively low environmental component ofproduction costs of Russian companies used in the calculation of the EU dumpingmargin. Additionally, Russian companies may not be able to participate incertain mechanisms provided for in the Kyoto Protocol, including trading incarbon emissions, due to a lack of a relevant legislative and regulatoryframework in Russia. This may benefit our competitors from countries that havetimely implemented such a framework.

***Our business couldbe adversely affected if we fail to obtain or renew necessary licenses andpermits or fail to comply with the terms of our licenses and permits.***

Our business depends on the continuing validity ofcertain licenses and the issuance of certain new licenses and our compliancewith the terms thereof, including subsoil licenses for our mining operations.Regulatory authorities exercise considerable discretion in the timing oflicense issuance, renewal and monitoring licensees’ compliance with licenseterms. Requirements imposed by these authorities may be costly andtime-consuming and may result in delays in the commencement or continuation ofexploration or production operations. Further, private individuals and thepublic at large possess rights to comment on and otherwise engage in thelicensing process, including through intervention in courts and politicalpressure. Accordingly, the licenses we need may not be issued or renewed, or ifissued or renewed, may not be issued or renewed in a timely fashion, or mayinvolve requirements which restrict our ability to conduct our operations or todo so profitably.

Our competitors may also seek to deny our rights todevelop certain natural resource deposits by challenging our compliance withtender rules and procedures or compliance with license terms. Politicalfactors can also affect whether non-compliance with licensing regulations andterms of our licenses could lead to suspension or termination of our licensesand permits, and to administrative, civil and criminal liability.

We have a limited history of renewing our subsoillicenses. In 2003, we extended the subsoil license for the Tatianinsk deposit,which was set to expire in 2002, until 2012. In 2006, we extended the licensefor the Olzherasky deposit, which was set to expire in 2007, to 2022. Of ourfifteen coal subsoil licenses, six expire on dates falling in or between 2012through 2014 and nine expire on dates falling in or between 2021 through 2025;our four iron ore subsoil licenses expire on dates falling in or between 2009through 2015; and our two nickel subsoil licenses expire on dates falling in2012 and 2013. See “Item 4. Information on the Company—Mining Business—MineralReserves.”

Accordingly, these factors may seriously affect our abilityto obtain or renew necessary licenses, and if we are unable to obtain or renewnecessary licenses or we are only able to obtain them with newly-introducedmaterial restrictions, we may be unable to realize our reserves and ourbusiness and results of operations could be materially adversely affected.

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In addition, as part oftheir obligations under licensing regulations and the terms of our licenses andpermits, our companies must comply with numerous industrial standards, recruitqualified personnel, maintain necessary equipment and a system of qualitycontrol, monitor our operations, maintain appropriate filings and, uponrequest, submit appropriate information to the controlling authorities, whichare entitled to control and inspect their activities. In the event that thecontrolling authorities discover a material violation by our company, we may berequired to suspend our operations for some period of time or incur substantialcosts in eliminating or remedying such violation, which could have a materialadverse effect on our business or results of operations.

***Deficiencies in thelegal framework relating to subsoil licensing subject our licenses to the riskof governmental challenges and, if our licenses are suspended or terminated, wemay be unable to realize our reserves, which could materially adversely affectour business and results of operations.***

Most of the existing subsoil licenses in Russia datefrom the Soviet era. During the period between the dissolution of the SovietUnion in August 1991 and the enactment of the first post-Soviet subsoillicensing law in the summer of 1992, the status of subsoil licenses andSoviet-era mining operations was unclear, as was the status of the regulatoryauthority governing such operations. The Russian government enacted theProcedure for Subsoil Use Licensing, or Licensing Regulation, on July 15,1992, which came into effect on August 20, 1992. As was common withlegislation of this time, the Licensing Regulation was passed hastily, withoutadequate consideration of transition provisions, and contained numerous gaps.In an effort to address the problems in the Licensing Regulation, the Ministryof Natural Resources issued ministerial acts and instructions that attempted toclarify and, in some cases, modify the Licensing Regulation. Many of these actscontradicted the law and were beyond the scope of the Ministry’s authority, butsubsoil licensees had no option but to deal with the Ministry in relation tosubsoil issues and comply with its ministerial acts and instructions. Thus, itis possible that licenses applied for and/or issued in reliance on the Ministry’sacts and instructions could be challenged by the prosecutor general’s office asbeing invalid. In particular, deficiencies of this nature subject subsoillicensees to selective and arbitrary governmental claims.

Legislation on subsoil rights still remains internallyinconsistent and vague, and the regulators’ acts and instructions are oftenarguably inconsistent with legislation. Subsoil licensees thus continue to facethe situation where both failing to comply with the regulator’s acts andinstructions and choosing to comply with them places them at the risk of beingsubject to arbitrary governmental claims, whether by the regulator or theprosecutor general’s office.

A provision that a license may be suspended orterminated if the licensee does not comply with the “significant” or “material”terms of a license is an example of such a deficiency in the legislation.However, the Ministry of Natural Resources has not issued any interpretiveguidance on the meaning of these terms. Similarly, under Russia’s civil lawsystem, court decisions on the meaning of these terms do not have anyprecedential value for future cases and, in any event, court decisions in thisregard have been inconsistent. These deficiencies result in the regulatoryauthorities, prosecutors and courts having significant discretion overenforcement and interpretation of the law, which may be used to challenge oursubsoil rights selectively and arbitrarily.

Moreover, during the tumultuous period of thetransformation of the Russian planned economy into a free market economy in the1990s, documentation relating to subsoil licenses was not properly maintainedand, in many cases, was lost or destroyed. Initially, during the period betweenthe dissolution of the Soviet Union and the privatizations of the mid-1990s,as state subsidies ceased, many mining operations were forced to shut down orscale back production. In addition, during this time, complete governmentalplanning and oversight ceased, leaving the local management ill-equipped tooperate these businesses, which faced severe liquidity problems. The employees,who were often unpaid for months, had little incentive to look after the businesses.In these circumstances, the maintenance of documentation relating 

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to subsoil licenses, aswell as compliance with the administrative requirements of the legislation ofthis period, was not a priority for management. The situation did notsignificantly improve as these mines were privatized in the mid-1990s,primarily since most Russian businesses during these times continued to facesevere liquidity problems and the management focused on the operation of thesemines. Thus, in many cases, although it may be clearly evident that aparticular enterprise has mined a licensed subsoil area for decades, thehistorical documentation relating to their subsoil licenses may not becomplete.

If, through governmentalor other challenges, our licenses are suspended or terminated we would beunable to realize our reserves, which could materially adversely affect ourbusiness and results of operations.

***Our Romanian operations face certain risks.***

Romania is not self-sufficient in energy resources.Domestic energy prices, which are significantly higher than the prices we payin Russia, have been increasing and may continue to increase in the future,which might hurt the profitability of our operations in Romania. For example,in 2006, the price of natural gas increased by approximately 43% in Romania andis expected to continue to increase through 2007. Shortages in energy supplies,including administrative limitations during peak usage, may limit ourproduction capacity and efficiency and hinder our output. If we are unable toobtain these resources on economic terms, the operations of our Romaniansubsidiaries could be materially adversely affected.

In addition, Romania’sadmission into the EU on January 1, 2007 will result in increasedenvironmental liabilities, labor costs and other expenditures for our Romanianoperations. Entrance into the EU requires the restructuring of Romania’smajor metallurgical entities, including our Romanian subsidiaries MechelTargoviste and Mechel Campia Turzii. As part of this process, individualviability plans must be agreed upon with EU consultants and incorporated intoeach company’s business plans. Evidence of implementation of these plans andachievement of the targets stated therein must be provided to investors undertheir privatization contracts. The viability plans of Mechel Targoviste andMechel Campia Turzii include additional investments into technology andincreased environmental controls. After the restructuring is complete, keybusiness performance indicators must be in line with EU requirements. Inaddition to the costs of complying with these requirements, Romania’s admissionto the EU may also result in trade duties and quotas on the export of steelfinished and semi-finished products into Romania.

***Our controllingshareholder has the ability to take actions that may conflict with those of theholders of our securities.***

Our Chief ExecutiveOfficer, Mr. Igor Zyuzin, directly and indirectly, owns approximately68.3% of our common shares. Except in certain cases as provided by Joint StockCompanies Law, resolutions at a shareholders’ meeting are adopted by a simplemajority in a meeting at which shareholders holding more than half of thevoting shares are present or represented. Accordingly, Mr. Zyuzin has thepower to control the outcome of most matters to be decided by vote at ashareholders’ meeting and can control the appointment of the majority ofdirectors and the removal of all of the elected directors. Thus, thiscontrolling shareholder can take actions that may conflict with the interestsof other shareholders and holders of our ADSs.

***Our competitive position and future prospects dependon our senior managers and other key personnel.***

Our ability to maintain our competitive position andto implement our business strategy is dependent to a large degree on theservices of our senior management team and other key personnel, particularly Mr. Zyuzin,our Chief Executive Officer, who is our controlling shareholder. Mr. Zyuzinhas provided strategic direction and leadership to us. Over the course of 2006,Mr. Vladimir Iorich, who formerly held a 42.2% ownership stake in Mecheland served as Chief Executive Officer from 2004 to 2006, disposed of his 

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stake in Mechel andstepped down as our Chief Executive Officer. On June 29, 2007, Mr. Iorichstepped down as a director of Mechel.

Moreover, competition inRussia, and in the other countries where we operate, for personnel withrelevant expertise is intense due to the small number of qualified individualsand, as a result, we attempt to structure our compensation packages in a mannerconsistent with the evolving standards of the Russian labor market. We are notinsured against the detrimental effects to our business resulting from the lossor dismissal of our key personnel. The loss or decline in the services ofmembers of our senior management team or an inability to attract, retain andmotivate qualified key personnel could have a material adverse effect on ourbusiness, financial condition and results of operations.

***In the event thetitle to any privatized company we acquired is successfully challenged, we risklosing our ownership interest in that company or its assets.***

Almost all of our business consists of privatizedcompanies, and our business strategy will likely involve the acquisition ofadditional privatized companies. The statute of limitations for challengingprivatization transactions was recently reduced from ten years to three years. However,to the extent that privatization legislation is vague, inconsistent or inconflict with other legislation, including conflicts between federal and localprivatization legislation, many privatizations are vulnerable to challenge,including selective challenges. For instance, a series of presidential decreesissued in 1991 and 1992 that granted to the Moscow City government the right toadopt its own privatization procedures were subsequently held to be invalid bythe Constitutional Court of the Russian Federation, which ruled, in part, thatthe presidential decrees addressed issues that were the subject of federal law.While this court ruling, in theory, did not require any implementing actions,the presidential decrees were not officially annulled by another presidentialdecree until 2000. In the event that any title to, or our ownership stakes in,the privatized companies acquired by us, including Chelyabinsk MetallurgicalPlant, Southern Urals Nickel Plant, Southern Kuzbass Coal Company and itssubsidiaries, Beloretsk Metallurgical Plant, Urals Stampings Plant, KorshunovMining Plant, Port Posiet, Port Kambarka, Yakutugol or Izhstal, are subject tochallenge as having been improperly privatized and we are unable to defeat thisclaim, we risk losing our ownership interest in such company or its assets,which could materially affect our business and results of operations.

In addition, under Russianlaw, transactions in shares may be invalidated on many grounds, including asale of shares by a person without the right to dispose of such shares, breachof interested party and/or major transaction rules and failure to registerthe share transfer in the securities register. As a result, defects in earliertransactions in shares of our subsidiaries (where such shares were acquiredfrom third parties) may cause our title to such shares to be subject to challenge.

***If the FederalAntimonopoly Service were to conclude that we acquired or created a new companyin contravention of antimonopoly legislation, it could impose administrativesanctions, seek to invalidate the acquisition, and/or require the divestitureof this company or other assets.***

Our business has grown substantially through theacquisition and founding of companies, many of which required the priorapproval or subsequent notification of the Russian Federal Antimonopoly Serviceor its predecessor agencies. In part, relevant legislation restricts theacquisition or founding of companies by groups of companies or individualsacting in concert without this approval or notification. This legislation isvague in certain parts and subject to varying interpretations. If the FederalAntimonopoly Service were to conclude that an acquisition or the creation of anew company was done in contravention of applicable legislation and thatcompetition has been reduced as a result, it could seek redress, including suingfor the transactions that led to the violation of competition laws to bedeclared invalid, obliging the acquirer to perform activities to restorecompetition, and seeking the dissolution of the company operating 

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in contravention ofantimonopoly legislation. Any of these actions could adversely affect ourbusiness strategy and our results of operations.

Three of oursubsidiaries were included by the Federal Antimonopoly Service into theregister of companies controlling more than 35% on a specific market,including:

·       BeloretskMetallurgical Plant—controls more than 65% of the market for wire nails in theRepublic of Bashkortostan;

·       ChelyabinskMetallurgical Plant—controls more than 35% but less than 65% of the market forforgings made of stainless’ steel ingots in the Russian Federation market; and

·       SouthernUrals Nickel Plant—controls more than 65% of the market for nickel in sulfateand hydroxide in the Russian Federation.

Inclusion of oursubsidiaries in the register of companies controlling more than 35% of aspecific market, as well as the classification of us or our subsidiaries asmonopolists or persons holding a dominant position, does not by itself restrictour current activities or the activities of these subsidiaries. However, in theevent we are deemed to abuse our dominant position, the Federal AntimonopolyService may impose certain restrictions that could restrict and negativelyaffect the operations of these subsidiaries and materially adversely affect ourbusiness and results of operations.

***In the event thatthe minority shareholders of our subsidiaries were to successfully challengepast interested party transactions or do not approve interested partytransactions in the future, we could be limited in our operational flexibility.***

We own less than 100% of the equity interests in someof our subsidiaries. In addition, certain of our wholly-owned subsidiaries havehad other shareholders in the past. We and our subsidiaries in the past havecarried out, and continue to carry out, transactions with us and others whichmay be considered to be “interested party transactions” under Russian law,requiring approval by disinterested directors, disinterested independentdirectors or disinterested shareholders depending on the nature of thetransaction and parties involved. See “Item 10. Additional Information—Charterand Certain Requirements of Russian Legislation—Interested Party Transactions.”The provisions of Russian law defining which transactions must be approved as “interestedparty transactions” are subject to different interpretations, and thesetransactions may not always have been properly approved. We cannot assure youthat our and our subsidiaries’ applications of these concepts will not besubject to challenge by former and current shareholders. Any such challenges,if successful, could result in the invalidation of transactions, which couldhave a material adverse effect on our business, financial condition, results ofoperations or prospects.

In addition, Russian lawrequires a three-quarters majority vote of the holders of voting stockpresent at a shareholders’ meeting to approve certain transactions and othermatters, including, for example, charter amendments, major transactionsinvolving assets in excess of 50% of the assets of the company, repurchase bythe company of shares and certain share issuances. In some cases, minorityshareholders may not approve interested party transactions requiring theirapproval or other matters requiring approval of minority shareholders orsupermajority approval. In the event that these minority shareholders were tochallenge successfully past interested party transactions, or do not approveinterested party transactions or other matters in the future, we could belimited in our operational flexibility and our business, financial condition,results of operations or prospects could be materially adversely affected.

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***In the eventcertain minority shareholder lawsuits are resolved against us, our financialcondition and results of operations could be materially adversely affected.***

Russian law does not protect us and does not allow usto include in our charter protections against greenmail and other similaractions by minority shareholders. For example, minority shareholders holding aslittle as a single share in a company have standing under Russian law to bringclaims against such company. These deficiencies in Russian corporate law areoften abused by minority shareholders, who can bring claims in local courtsseeking injunctions and other relief for which, as a practical matter, we maynot receive notice. Any such actions by minority shareholders could have amaterial adverse effect on our business, results of operations and financialcondition.

For example, in 2006,several claims were brought against us in Russian courts by a group of minorityshareholders. In three of them, minority shareholders are seeking payment by usof damages to our subsidiary Southern Kuzbass Coal Company in the amount of$264.4 million, allegedly caused to the subsidiaries of Southern Kuzbass CoalCompany as a result of losses of such subsidiaries in 2005 through first halfof 2006. In another case, a minority shareholder of Mechel is seeking Mechel’stransfer of 626,913 shares of Southern Kuzbass Coal Company amounting to $18million, which it claims it did not receive as a result of conversion of sharesdue to a merger of Southern Kuzbass Coal Company and one of its subsidiaries,Olzherassky Pit. The aforementioned cases are pending in court. We expectadditional similar claims to be filed against us by the same minorityshareholders. In the event that the foregoing lawsuits are resolved against us,our financial condition and results of operations could be materially adverselyaffected.

***Our existingarrangements with trade unions may not be renewable on terms favorable to us,and our operations could be adversely affected by strikes and lockouts.***

As of December 31,2006, approximately 69% of our employees were represented by trade unions.Although we have not experienced any business interruption at any of ourbusinesses as a result of labor disputes from the dates of their respectiveacquisition by us and we consider our employee relations to be good, largeunion representation subjects our businesses to interruptions through strikes,lockouts or delays in renegotiations of collective bargaining agreements. Ourexisting arrangements with trade unions also may not be renewed on termsfavorable to us. In such events, our business and results of operations couldbe materially adversely affected.

***We do not carry thetypes of insurance coverage customary in more economically developed countriesfor a business of our size and nature, and a significant event could result insubstantial property loss and inability to rebuild in a timely manner or atall.***

The insurance industry isnot yet well developed in Russia, and many forms of insurance protection commonin more economically developed countries are not yet available in Russia oncomparable terms, including coverage for business interruption. At present, ourfacilities are not insured, and we have no coverage for business interruptionor loss of key management personnel or for third-party liability, otherthan customary insurance coverage with respect to our international tradingoperations and sales. In the event that a significant event were to affect oneof our facilities, we could experience substantial property loss andsignificant disruptions in our production capacity, for which we would not becompensated. For example, if substantial production capacity were lost at ourChelyabinsk Metallurgical Plant, which is our primary steel productionfacility, we would not be able to replace a substantial portion of thiscapacity with capacity from our other plants, potentially resulting in the interruptionof the production of a number of our products. Additionally, depending on theseverity of the property damage, we may not be able to rebuild damaged propertyin a timely manner or at all. We do not maintain separate funds or otherwiseset aside reserves for these types of events. Any such loss or third-partyclaim for damages may have a material adverse effect on our business, resultsof operations and financial condition.

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***If transactions ofmembers of the group and their predecessors-in-interest were to be challengedon the basis of non-compliance with applicable legal requirements, the remediesin the event of any successful challenge could include the invalidation of suchtransactions or the imposition of other liabilities on such group members.***

Members of the group, ortheir predecessors-in-interest at different times, took a variety of actionsrelating to share issuances, share disposals and acquisitions, mandatorybuy-out offers, valuation of property, interested party transactions, major transactions,meetings of the group members’ governing bodies, other corporate matters andanti-monopoly issues that, if successfully challenged on the basis ofnon-compliance with applicable legal requirements by competent stateauthorities, counterparties in such transactions or shareholders of therelevant group members or their predecessors-in-interest, could result in theinvalidation of such transactions and our corporate decisions, restrictions onvoting control or the imposition of other liabilities. Because applicableprovisions of Russian law are subject to many different interpretations, we maynot be able to defend successfully any challenge brought against suchtransactions, and the invalidation of any such transactions or imposition ofany such liability may, individually or in the aggregate, have a materialadverse effect on our business, financial condition and results of operations.

***Vaguely draftedRussian transfer pricing rules and lack of reliable pricing informationmay potentially affect our results of operations.***

Russian transfer pricing rules effective since1999 give Russian tax authorities the right to control prices for transactionsbetween related entities and certain other types of transactions betweenunrelated parties, such as foreign trade transactions or transactions withsignificant price fluctuations if the transaction price deviates by more than20% from the market price. Special transfer pricing rules apply tooperations with securities and derivative instruments. The Russian transferpricing rules are vaguely drafted, and are subject of interpretation byRussian tax authorities and courts. Due to the uncertainties in interpretationof transfer pricing legislation, the tax authorities may challenge our pricesand make adjustments which could affect our tax position. In particular, wehave received assessments from the tax authorities for transfer prices-relatedtaxes, interest and penalties owing totaling $12.5 million. If such assessmentsare upheld, our financial condition and results of operations could bematerially adversely affected. In addition, we could face significant lossesassociated with the assessed amount of underpaid prior tax and related interestand penalties. See also “—Legal Risks and Uncertainties—Characteristics of andchanges in the Russian tax system could materially adversely affect ourbusiness, financial condition, results of operations and prospects and thevalue of the shares and ADSs.”

In addition, a number ofdraft amendments to the transfer pricing law have recently been introducedwhich, if implemented, would considerably toughen the existing law. Theproposed changes, among other things, may shift the burden of proving marketprices from the tax authorities to the taxpayer, cancel the existing permitteddeviation threshold and introduce specific documentation requirements forproving market prices.

**Risks Relating toOur Shares and ADSs and the Trading Market**

***Because thedepositary may be considered the beneficial holder of the shares underlying theADSs, these shares may be arrested or seized in legal proceedings in Russiaagainst the depositary.***

Because Russian law may not recognize ADS holders asbeneficial owners of the underlying shares, it is possible that holders of ADSscould lose all their rights to those shares if the depositary’s assets inRussia are seized or arrested. In that case, holders of ADSs would lose all themoney they invested.

Russian law may treat thedepositary as the beneficial owner of the shares underlying the ADSs. This is differentfrom the way other jurisdictions treat ADSs. In the United States, althoughshares may be held in the depositary’s name or to its order, making it a “legal”owner of the shares, the ADS holders are the 

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“beneficial,”or real owners. In U.S. courts, an action against the depositary, would notresult in the beneficial owners losing their shares. Russian law may not makethe same distinction between legal and beneficial ownership, and it may onlyrecognize the rights of the depositary in whose name the shares are held, notthe rights of ADS holders, to the underlying shares. Thus, in proceedingsbrought against a depositary, whether or not related to shares underlying ADSs,Russian courts may treat those underlying shares as the assets of the depositary,open to seizure or arrest. In the past, a lawsuit was filed against adepositary bank other than Deutsche Bank Trust Company Americas seeking theseizure of various Russian companies’ shares represented by ADSs issued by thatdepositary. In the event that this type of suit were to be successful in thefuture against the depositary, and the shares underlying our ADSs were to beseized or arrested, the ADS holders involved would lose their rights to suchunderlying shares.

***Voting rights withrespect to the shares represented by our ADSs are limited by the terms of thedeposit agreement for the ADSs and relevant requirements of Russian law.***

ADS holders will have no direct voting rights withrespect to the shares represented by the ADSs. They will be able to exercisevoting rights with respect to the shares represented by ADSs only in accordancewith the provisions of the deposit agreement relating to the ADSs and relevantrequirements of Russian law. Therefore, there are practical limitations uponthe ability of ADS holders to exercise their voting rights due to theadditional procedural steps involved in communicating with them. For example,the Joint Stock Companies Law and our charter require us to notify shareholdersno less than 30 days prior to the date of any meeting and at least50 days prior to the date of an extraordinary meeting to elect our Boardof Directors upon publication of the notice in the Russian newspaper “RossiiskayaGazeta”. Our ordinary shareholders will receive notice directly from us andwill be able to exercise their voting rights by either attending the meeting inperson or voting by power of attorney.

As an ADS holder, you, by comparison, will not receivenotice directly from us. Rather, in accordance with the deposit agreement, we willprovide the notice to the depositary. The depositary has undertaken in turn, assoon as practicable thereafter, to mail to you notice of such meeting, copiesof voting materials (if and as received by the depositary from us) and astatement as to the manner in which instructions may be given by holders. Toexercise your voting rights, you must then instruct the depositary how to voteits shares. Because of this extra procedural step involving the depositary, theprocess for exercising voting rights may take longer for you than for holdersof shares. ADSs for which the depositary does not receive timely votinginstructions will not be voted at any meeting.

In addition, althoughsecurities regulations expressly permit the depositary to split the votes withrespect to the shares underlying the ADSs in accordance with instructions fromADS holders, there is little court or regulatory guidance on the application ofsuch regulations, and the depositary may choose to refrain from voting at allunless it receives instructions from all ADS holders to vote the shares in thesame manner. You may thus have significant difficulty in exercising votingrights with respect to the shares underlying the ADSs. There can be noassurance that holders and beneficial owners of ADSs will (1) receivenotice of shareholder meetings to enable the timely return of votinginstructions to the depositary, (2) receive notice to enable the timelycancellation of ADSs in respect of shareholder actions or (3) be given thebenefit of dissenting or minority shareholders’ rights in respect of an eventor action in which the holder or beneficial owner has voted against, abstainedfrom voting or not given voting instructions.

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***The price of our shares and ADSs may be highlyvolatile.***

The trading pricesof our shares and ADSs may be subject to wide fluctuations in response to manyfactors, including:

·       variationsin our operating results and those of other domestic and foreign mining andsteel companies;

·       variationsin national and industry growth rates;

·       actualor anticipated announcements of technical innovations or new products orservices by us or our competitors;

·       changesin governmental legislation or regulation;

·       generaleconomic conditions within our business sector or in Russia; or

·       extreme price and volumefluctuations on the Russian or other emerging market stock exchanges and stockexchanges in developed markets.

***You may be unable to repatriate your earnings from ourADSs.***

Dividends that we may payin the future on the shares represented by the ADSs are calculated in Russianrubles and may be declared and paid to the depositary in rubles. Such dividendswill be converted into U.S. dollars by the depositary and distributed toholders of ADSs, net of the depositary’s fees and expenses. The ability toconvert rubles into U.S. dollars is subject to the availability of U.S. dollarsin Russia’s currency markets. Although there is an existing, albeit limited,market within Russia for the conversion of rubles into U.S. dollars, includingthe interbank currency exchange and over-the-counter and currency futuresmarkets, the further development of this market is uncertain. At present, thereis a limited market for the conversion of rubles into foreign currenciesoutside of Russia and only a limited emerging market in which to hedge rubleand ruble-denominated investments.

***ADS holders may not be able to benefit from the UnitedStates-Russia income tax treaty.***

Under Russian law, dividends paid to a non-residentholder of the shares generally will be subject to Russian withholding tax at arate of 15% for legal entities and organizations and at a rate of 30% forindividuals.

Russian tax rules applicable to the holders ofthe ADSs are characterized by significant uncertainties and, until recently, byan absence of interpretive guidance. In 2005 and 2006, the Ministry of Financeof the Russian Federation expressed its opinion in private rulings that holdersof global depositary receipts should be treated as the beneficial owners of thedividends paid on underlying shares for the purposes of double tax treatyprovisions applicable to taxation of dividend income from the underlyingshares, provided that the tax treaty residence of the holders of the globaldepositary receipts is duly confirmed. However, the Russian tax authoritieshave not provided official, generally applicable guidance addressing how an ADSholder should demonstrate its beneficial ownership in underlying shares. In theabsence of any specific provisions in Russian tax legislation with respect tothe concept of beneficial ownership and taxation of income of beneficialowners, it is unclear how the Russian tax authorities will ultimately treat theADS holders in this regard.

Until the Russian taxauthorities clarify whether it is permitted under Russian law to withholdRussian withholding tax in respect of dividends a company pays to theDepositary at a lower rate than the domestic rate applicable to such payments(currently 15%), we intend to withhold Russian withholding tax at the domesticrate applicable to such dividends, regardless of whether the Depositary (thelegal owner of the shares) or an ADS holder would be entitled to reduced ratesof Russian withholding tax under the relevant 

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incometax treaty if it were the beneficial owner of the dividends for purposes ofthat treaty. Although non-resident ADS holders may apply for a refund of aportion of the amount so withheld by us under the relevant income tax treaty,no assurance can be made that the Russian tax authorities will grant any refunds.See “Item 10. Additional Information—Taxation—Russian Income and WithholdingTax Considerations” for additional information.

***Capital gains from the sale of ADSs may be subject toRussian income tax.***

Under Russian tax legislation, gains realized by non-residentlegal entities or organizations from the disposition of Russian shares andsecurities, as well as financial instruments derived from such shares, such asthe ADSs, may be subject to Russian profits tax or withholding income tax ifimmovable property located in Russia constitutes more than 50% of our assets.However, no procedural mechanism currently exists to withhold and remit thistax with respect to sales made to persons other than Russian companies andforeign companies with a registered permanent establishment in Russia. Gainsarising from the disposition at foreign stock exchanges of the foregoing typesof securities listed on these exchanges are not subject to taxation in Russia.

Gains arising from thedisposition of the foregoing types of securities and derivatives outside ofRussia by U.S. holders who are individuals not resident in Russia for taxpurposes will not be considered Russian source income and will not be taxablein Russia. Gains arising from disposition of the foregoing types of securitiesand derivatives in Russia by U.S. holders who are individuals not resident inRussia for tax purposes may be subject to tax either at the source in Russia orbased on an annual tax return, which they may be required to submit with theRussian tax authorities.

***You may havelimited recourse against us and our directors and executive officers because wegenerally conduct our operations outside the United States and all of ourdirectors and executive officers reside outside the United States.***

Our presence outside the United States may limit yourlegal recourse against us. Mechel is incorporated under the laws of the RussianFederation. Most of our directors and executive officers reside outside theUnited States, principally in Russia. All or a substantial portion of ourassets and the assets of most of our directors and executive officers arelocated outside the United States. As a result, you may not be able to affectservice of process within the United States upon us or our directors andexecutive officers or to enforce in a U.S. court judgments obtained against usor our directors and executive officers in jurisdictions outside the UnitedStates, including actions under the civil liability provisions ofU.S. securities laws. In addition, it may be difficult for you to enforce,in original actions brought in courts in jurisdictions outside the UnitedStates, liabilities predicated upon U.S. securities laws.

There is no treaty betweenthe United States and the Russian Federation providing for reciprocalrecognition and enforcement of foreign court judgments in civil and commercialmatters. These limitations may deprive you of effective legal recourse forclaims related to your investment in the ADSs. The deposit agreement providesfor actions brought by any party thereto against us to be settled byarbitration in accordance with the Commercial Arbitration Rules of theAmerican Arbitration Association, provided that any action under the U.S.federal securities laws or the rules or regulations promulgated thereundermay, but need not, be submitted to arbitration. The Russian Federation is aparty to the United Nations (New York) Convention on the Recognition andEnforcement of Foreign Arbitral Awards, but it may be difficult to enforcearbitral awards in the Russian Federation due to a number of factors, includingthe inexperience of Russian courts in international commercial transactions,official and unofficial political resistance to enforcement of awards againstRussian companies in favor of foreign investors, Russian courts’ inability toenforce such orders and corruption.

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**Risks Relating tothe Russian Federation**

***Emerging marketssuch as Russia are subject to greater risks than more developed markets, andfinancial turmoil in any emerging market could disrupt our business, as well ascause the price of our securities to suffer.***

Investors in emergingmarkets such as the Russian Federation should be aware that these markets aresubject to greater risk than more developed markets, including in some cases significantlegal, economic and political risks. Investors should also note that emergingeconomies such as the economy of the Russian Federation are subject to rapidchange and that the information set out herein may become outdated relativelyquickly. Accordingly, investors should exercise particular care in evaluatingthe risks involved and must decide for themselves whether, in light of thoserisks, their investment is appropriate. Generally, investment in emergingmarkets is only suitable for sophisticated investors who fully appreciate thesignificance of the risks involved and investors are urged to consult withtheir own legal and financial advisors before making an investment in theshares and ADSs.

**Economic Risks**

***Economic instability in Russia could adversely affectour business and the value of the shares and ADSs.***

Since thedissolution of the Soviet Union in the early 1990s, the Russian economy hasexperienced at various times:

·       significantdeclines in gross domestic product;

·       hyperinflation;

·       anunstable currency;

·       highgovernment debt relative to gross domestic product;

·       aweak banking system providing limited liquidity to domestic enterprises;

·       highlevels of loss-making enterprises that continued to operate due to the lack ofeffective bankruptcy proceedings;

·       significantuse of barter transactions and illiquid promissory notes to settle commercialtransactions;

·       widespreadtax evasion;

·       growthof a black and gray market economy;

·       pervasivecapital flight;

·       highlevels of corruption and the penetration of organized crime into the economy;

·       significantincreases in unemployment and underemployment; and

·       theimpoverishment of a large portion of the population.

Although Russia has benefited recently from theincrease in global commodity prices, providing an increase in disposable incomeand an increase in consumer spending, the Russian economy has been subject toabrupt downturns in the past. In particular, on August 17, 1998, in theface of a rapidly deteriorating economic situation, the Russian governmentdefaulted on its ruble-denominated securities, the Central Bank of Russiastopped its support of the ruble and a temporary moratorium was imposed oncertain foreign currency payments. These actions resulted in an immediate andsevere devaluation of the ruble and a sharp increase in the rate of inflation;a substantial decline in the prices of Russian debt and equity securities; andan inability of Russian issuers to raise funds in the international capitalmarkets. These problems were aggravated by a major banking crisis in theRussian banking sector after the events of 

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August 17, 1998, asevidenced by the termination of the banking licenses of a number of majorRussian banks. This further impaired the ability of the banking sector to act asa consistent source of liquidity to Russian companies and resulted in thelosses of bank deposits in some cases.

Recently, the Russianeconomy has experienced positive trends, such as the increase in the grossdomestic product, a relatively stable ruble, strong domestic demand, risingreal wages and a reduced rate of inflation; however, these trends may notcontinue or may be abruptly reversed.

***The Russian bankingsystem remains underdeveloped, and another banking crisis could place severeliquidity constraints on our business.***

Russia’s banking and other financial systems are lessdeveloped or regulated in comparison with developed countries, and Russianlegislation relating to banks and bank accounts is subject to varyinginterpretations and inconsistent application. The August 1998 financialcrisis resulted in the bankruptcy and liquidation of many Russian banks andalmost entirely eliminated the developing market for commercial bank loans atthat time. Since that time, the Russian banking sector has steadily developed,as demonstrated by the growing presence of prominent international banks inRussia and emergence of a small number of creditworthy Russian banks. However,many Russian banks currently do not meet international banking standards, andthe transparency of the Russian banking sector in some respects still lags farbehind internationally accepted norms. Aided by inadequate supervision by theregulators, certain banks do not follow existing Central Bank of Russiaregulations with respect to lending criteria, credit quality, loan lossreserves or diversification of exposure. This has resulted in cancellation of anumber of bank licenses in the last few years. Furthermore, in Russia, bankdeposits made by corporate entities generally are not insured.

Recently, there has been a rapid increase in lendingby Russian banks, which many believe has been accompanied by a deterioration inthe credit quality of the borrowers. In addition, a robust domestic corporatedebt market is leading to Russian banks increasingly holding large amounts ofRussian corporate ruble bonds in their portfolios, which is furtherdeteriorating the risk profile of Russian bank assets. In addition, sinceRussian banks generally have a lower capital adequacy, the banking sector couldbe more susceptible to market downturns or economic slowdowns, including due toRussian corporate defaults that may occur during any such market downturn oreconomic slowdown. If a banking crisis were to occur, Russian companies wouldbe subject to severe liquidity constraints due to the limited supply ofdomestic savings and the withdrawal of foreign funding sources that would occurduring such a crisis.

There is currently a limited number of sufficientlycreditworthy Russian banks. We hold the bulk of our excess ruble and foreigncurrency cash in Russian banks, including subsidiaries of foreign banks. Thereare few, if any, safe ruble-denominated instruments in which we mayinvest our excess ruble cash. Another banking crisis or the bankruptcy orinsolvency of the banks from which we receive or with which we hold our fundscould result in the loss of our deposits or affect our ability to completebanking transactions in Russia, which could have a material adverse effect onour business, financial condition and results of operations.

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***The infrastructure in Russia is inadequate, whichcould disrupt normal business activity.***

The infrastructure in Russia largely dates back toSoviet times and has not been adequately funded and maintained over the pastdecade. Particularly affected are the rail and road networks, power generationand transmission systems, communication systems and building stock. InMay 2005, a fire and explosion in one of the Moscow power substationsbuilt in 1963 caused a major power outage in a large section of Moscow and somesurrounding regions. The blackout disrupted the ground electric transport,including the metro system, led to road traffic accidents and massive trafficcongestion, disrupted electricity and water supply in office and residentialbuildings and affected mobile communications. The trading on exchanges and theoperation of many banks, stores and markets were also halted.

The deterioration of theinfrastructure in Russia harms the national economy, disrupts thetransportation of goods and supplies, adds costs to doing business and caninterrupt business operations. The Russian government is actively consideringplans to reorganize the nation’s rail, electricity and communications systems.Any such reorganization may result in increased charges and tariffs whilefailing to generate the anticipated capital investment needed to repair,maintain and improve these systems. These factors could have a material adverseeffect on our business and results of operations.

***Fluctuations in theglobal economy could materially adversely affect the Russian economy and thevalue of the shares and ADSs.***

The Russian economy isvulnerable to market downturns and economic slowdowns elsewhere in the world.As has happened in the past, financial problems or an increase in the perceivedrisks associated with investing in emerging economies could dampen foreigninvestment in Russia and Russian businesses could face severe liquidityconstraints, further materially adversely affecting the Russian economy.Additionally, because Russia produces and exports large amounts of oil, theRussian economy is especially vulnerable to the price of oil on the worldmarket and a decline in the price of oil could slow or disrupt the Russianeconomy or undermine the value of the ruble against foreign currencies.Military conflicts and international terrorist activity also significantlyimpact oil and gas prices, and pose additional risks to the Russian economy.Russia is also a major producer and exporter of metal products and its economyis vulnerable to fluctuations in world commodity prices and the imposition oftariffs and/or anti-dumping measures by the United States, the European Unionor by other principal export markets.

**Political andSocial Risks**

***Political andgovernmental instability could materially adversely affect our business,financial condition, results of operations and prospects and the value of theshares and ADSs.***

Since 1991, Russia has sought to transform itself froma one-party state with a centrally-planned economy to a democracy with amarket economy. As a result of the sweeping nature of the reforms, and thefailure of some of them, the Russian political system remains vulnerable topopular dissatisfaction, including dissatisfaction with the results ofprivatizations in the 1990s, as well as to demands for autonomy from particularregional and ethnic groups.

Current and future changesin the government, major policy shifts or lack of consensus between variousbranches of the government and powerful economic groups could disrupt or reverseeconomic and regulatory reforms. In addition, the Russian presidentialelections scheduled for 2008 could bring more volatility to the market. Anydisruption or reversal of reform policies could lead to political orgovernmental instability or the occurrence of conflicts among powerful economicgroups, which could have a material adverse effect on our business, financialcondition, results of operations and prospects and the value of the shares andADSs.

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***Conflict betweencentral and regional authorities and other conflicts could create an uncertainoperating environment, hindering our long-term planning ability.***

The Russian Federation is a federation of 86sub-federal political units, consisting of republics, territories, regions,cities of federal importance and autonomous regions and districts. Thedelineation of authority and jurisdiction among the members of the RussianFederation and the federal government is, in many instances, unclear andremains contested. Lack of consensus between the federal government and localor regional authorities often results in the enactment of conflictinglegislation at various levels and may lead to further political instability. Inparticular, conflicting laws have been enacted in the areas of privatization,land legislation and licensing. Some of these laws and governmental andadministrative decisions implementing them, as well as certain transactionsconsummated pursuant to them, have in the past been challenged in the courts,and such challenges may occur in the future. This lack of consensus hinders ourlong-term planning efforts and creates uncertainties in our operatingenvironment, both of which may prevent us from effectively and efficientlyimplementing our business strategy.

Additionally, ethnic,religious, historical and other divisions have, on occasion, given rise totensions and, in certain cases, military conflict, such as the continuingconflict in Chechnya. Violence and attacks relating to this conflict havespread to other parts of Russia, and several terrorist attacks have beencarried out by Chechen terrorists in other parts of Russia, including inMoscow. The further intensification of violence, including terrorist attacksand suicide bombings, or its spread to other parts of Russia, could have significantpolitical consequences, including the imposition of a state of emergency insome or all of Russia. Moreover, any terrorist attacks and the resultingheightened security measures are likely to cause disruptions to domesticcommerce and exports from Russia. These factors could materially adverselyaffect our business and the value of the shares and ADSs.

***Crime and corruption and negative publicity coulddisrupt our ability to conduct our business.***

The political and economicchanges in Russia in recent years have resulted in significant dislocations ofauthority. The local and international press have reported that significantorganized criminal activity has arisen, particularly in large metropolitancenters. Property crime in large cities has increased substantially. Inaddition, the local press and international press have reported high levels ofcorruption, including the bribing of officials for the purpose of initiatinginvestigations by government agencies. Press reports have also described instancesin which government officials engaged in selective investigations andprosecutions to further the commercial interests of certain governmentofficials or certain companies or individuals. Additionally, some members ofthe Russian media regularly publish disparaging articles in return for payment.The depredations of organized or other crime, demands of corrupt officials orclaims that we have been involved in official corruption could result innegative publicity, could disrupt our ability to conduct our businesseffectively and could thus materially adversely affect our business, financialcondition and results of operations and the value of the shares and ADSs.

***Social instabilitycould increase support for renewed centralized authority, nationalism or violenceand thus materially adversely affect our business, financial condition, resultsof operations and prospects.***

The failure of thegovernment and many private enterprises to pay full salaries on a regular basisand the failure of salaries and benefits generally to keep pace with therapidly increasing cost of living have led in the past, and could lead in thefuture, to labor and social unrest. Labor and social unrest may have political,social and economic consequences, such as increased support for a renewal ofcentralized authority, increased nationalism, including restrictions on foreigninvolvement in the economy of Russia, and increased violence. An occurrence ofany of the foregoing events could restrict our operations and lead to the lossof operating revenues, materially adversely affecting our business, financialcondition, results of operations and prospects.

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**Legal Risks andUncertainties**

***Weaknesses relatingto the legal system and legislation create an uncertain environment forinvestment and business activity.***

Russia is stilldeveloping the legal framework required to support a market economy. Thefollowing risk factors relating to the Russian legal system createuncertainties with respect to the legal and business decisions that we make,many of which uncertainties do not exist in countries with more developedmarket economies:

·       inconsistenciesbetween and among the Constitution, federal law, presidential decrees andgovernmental, ministerial and local orders, decisions, resolutions and otheracts;

·       conflictinglocal, regional and federal rules and regulations;

·       thelack of judicial and administrative guidance on interpreting legislation;

·       substantialgaps in the regulatory structure due to the delay or absence of implementinglegislation;

·       therelative inexperience of judges and courts in interpreting legislation;

·       thelack of an independent judiciary and corruption within the judiciary;

·       ahigh degree of discretion on the part of governmental authorities, which couldresult in arbitrary actions such as suspension or termination of our licenses;and

·       poorlydeveloped bankruptcy procedures that are subject to abuse.

The recent nature of muchof Russian legislation, the lack of consensus about the scope, content and paceof economic and political reform and the rapid evolution of the Russian legalsystem in ways that may not always coincide with market developments place theenforceability and underlying constitutionality of laws in doubt and results inambiguities, inconsistencies and anomalies. In addition, Russian legislationoften contemplates implementing regulations which have not yet beenpromulgated, leaving substantial gaps in the regulatory infrastructure. All ofthese weaknesses could affect our ability to enforce our rights under ourlicenses and under our contracts, or to defend ourselves against claims byothers. We cannot assure you that regulators, judicial authorities or thirdparties will not challenge our compliance with applicable laws, decrees andregulations.

***Failure to complywith existing laws and regulations or the findings of government inspections,or increased governmental regulation of our operations, could result insubstantial additional compliance costs or various sanctions or court judgmentswhich could materially adversely affect our business, financial condition,results of operations and prospects.***

Our operations and properties are subject toregulation by various government entities and agencies in connection withobtaining and renewing various licenses, permits, approvals and authorizations,as well as with ongoing compliance with existing laws, regulations andstandards. Regulatory authorities exercise considerable discretion in mattersof enforcement and interpretation of applicable laws, regulations and standards,the issuance and renewal of licenses, permits, approvals and authorizations andin monitoring licensees’ compliance with the terms thereof. Russian authoritieshave the right to, and frequently do, conduct periodic inspections of ouroperations and properties throughout the year. Any such future inspections mayconclude that we or our subsidiaries have violated laws, decrees orregulations, and we may be unable to refute such conclusions or remedy theviolations.

Our failure to comply withexisting laws and regulations or the findings of government inspections or toobtain all approvals, authorizations and permits required for our operations,may result in the imposition of fines or penalties or more severe sanctionsincluding the suspension, amendment or 

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terminationof our licenses, permits, approvals and authorizations or in requirements thatwe cease certain of our business activities, or in criminal and administrativepenalties applicable to our officers. Moreover, an agreement made or transactionexecuted in violation of a law may be invalidated and unwound by a courtdecision. Any such decisions, requirements or sanctions, or any increase ingovernmental regulation of our operations, could increase our costs andmaterially adversely affect our business, financial condition, results ofoperations and prospects.

***One or more of oursubsidiaries could be forced into liquidation on the basis of formalnon-compliance with certain requirements of Russian law, which could materiallyadversely affect our business, financial condition, results of operations andprospects.***

Certain provisions of Russian law may allow a court toorder liquidation of a Russian legal entity on the basis of its formalnon-compliance with certain requirements during formation, reorganization orduring its operation. There have been cases in the past in which formaldeficiencies in the establishment process of a Russian legal entity ornon-compliance with provisions of Russian law have been used by Russian courtsas a basis for liquidation of a legal entity. For example, in Russian corporatelaw, negative net assets calculated on the basis of Russian accountingstandards as at the end of the second or any subsequent year of a company’soperation, can serve as a basis for a court to order the liquidation of thecompany, upon a claim by governmental authorities. Many Russian companies havenegative net assets due to very low historical asset values reflected on theirRussian accounting standards balance sheets; however, their solvency, *i.e*., their ability to pay debts as theycome due, is not otherwise adversely affected by such negative net assets.Currently, we have three subsidiaries with negative net assets, Port Kambarka,Vyartsilya Metal Products Plant and Mechel Recycling.

Weaknesses in the Russianlegal system create an uncertain legal environment, which makes the decisionsof a Russian court or a governmental authority difficult, if not impossible, topredict. If involuntary liquidation were to occur, then we may be forced to reorganizethe operations we currently conduct through the affected subsidiaries. Any suchliquidation could lead to additional costs, which could materially adverselyaffect our business, financial condition, results of operations and prospects.

***The judiciary’slack of independence, overall inexperience, occasional abuse of discretion, thedifficulty of enforcing court decisions and governmental discretion inenforcing claims could prevent us or you from obtaining effective redress in acourt proceeding.***

The independence of the judicial system and itsimmunity from economic, political and nationalistic influences in Russia remainlargely untested. The court system in Russia is understaffed and underfunded.Judges and courts are generally inexperienced in the area of business andcorporate law. Judicial precedents generally have no binding effect onsubsequent decisions. Not all Russian legislation and court decisions arereadily available to the public or organized in a manner that facilitatesunderstanding. The Russian judicial system can be slow or unjustifiably swift.Enforcement of court orders can, in practice, be very difficult in Russia.Additionally, court claims are often used in furtherance of political andcommercial aims or infighting. We may be subject to such claims and may not beable to receive a fair hearing. Additionally, court orders are not alwaysenforced or followed by law enforcement agencies, and the government mayattempt to invalidate court decisions by backdating or retroactively applyingrelevant legislative changes. Judicial decisions in Russia can be unpredictableand may not provide effective redress.

These uncertainties alsoextend to property rights. During Russia’s transformation from a centrallyplanned economy to a market economy, legislation has been enacted to protectprivate property against expropriation and nationalization. However, it ispossible that due to the lack of experience in enforcing these provisions anddue to political factors, these protections would not be enforced in the eventof an attempted expropriation or nationalization. Expropriation ornationalization of any of our entities, their 

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assetsor portions thereof, potentially without adequate compensation, would have amaterial adverse effect on our business, financial condition, results ofoperations and prospects.

***Selective orarbitrary government action could have a material adverse effect on ourbusiness, financial condition, results of operations and prospects and thevalue of the shares and ADSs.***

Governmental authorities in Russia have a high degreeof discretion and, at times, act selectively or arbitrarily, without hearing orprior notice, and sometimes in a manner that is inconsistent with legislationor influenced by political or commercial considerations. Selective or arbitrarygovernmental actions have reportedly included the denial or withdrawal oflicenses, sudden and unexpected tax audits and claims, criminal prosecutionsand civil actions. Federal and local government entities have also used ordinarydefects in matters surrounding share issuances and registration as pretexts forcourt claims and other demands to invalidate such issuances and registrationsor to void transactions. Moreover, the government also has the power in certaincircumstances, by regulation or government act, to interfere with theperformance of, nullify or terminate contracts. Standard & Poor’s, aprovider of independent credit ratings, has expressed concerns that “Russiancompanies and their investors can be subjected to government pressure throughselective implementation of regulations and legislation that is eitherpolitically motivated or triggered by competing business groups.” In thisenvironment, our competitors may receive preferential treatment from thegovernment, potentially giving them a competitive advantage over us.

In addition, in recentyears, the Russian tax authorities aggressively have brought tax evasion claimson the basis of certain Russian companies’ use of tax-optimization schemes, andpress reports have speculated that these enforcement actions have beenselective and politically motivated. Selective or arbitrary government action,if directed at us, could have a material adverse effect on our business,financial condition, results of operations and prospects, and the value of theshares and ADSs.

***Lack of developedcorporate and securities laws and regulations in Russia could limit our abilityto attract future investment.***

The regulation andsupervision of the securities market, financial intermediaries and issuers areconsiderably less developed in Russia than in the United States and WesternEurope. Securities laws, including those relating to corporate governance,disclosure and reporting requirements, have only recently been adopted, whereaslaws relating to anti-fraud safeguards, insider trading restrictions andfiduciary duties are rudimentary. In addition, the Russian securities market isregulated by several different authorities, which are often in competition witheach other. These include:

·       theFederal Service for the Financial Markets, or the FSFM;

·       theMinistry of Finance;

·       theRussian Federal Anti-Monopoly Service;

·       theCentral Bank of Russia; and

·       variousprofessional self-regulatory organizations.

The regulations of thesevarious authorities are not always coordinated and may be contradictory. Inaddition, Russian corporate and securities rules and regulations canchange rapidly, which may materially adversely affect our ability to conductsecurities-related transactions. While some important areas are subjectto virtually no oversight, the regulatory requirements imposed on Russianissuers in other areas result in delays in conducting securities offerings andin accessing the capital markets. It is often unclear whether or how regulations,decisions and letters issued by the various regulatory authorities apply to ourgroup. The FSFM has recently introduced a number of regulations relating toofferings of shares in and 

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outsideof Russia, including combined offerings involving closed subscription for newshares and the sale of existing shares, which remain largely untested andsubject to varying interpretations. Any challenges of such regulations ortransactions consummated pursuant to them could have an adverse effect on ourability to effect equity offerings in the future. As a result, we may besubject to fines and/or other enforcement measures despite our best efforts atcompliance, which could have a material adverse effect on our business,financial condition and results of operations.

***Because there islittle minority shareholder protection in Russia, your ability to bring, orrecover in, an action against us will be limited.***

In general, minority shareholder protection underRussian law derives from supermajority shareholder approval requirements forcertain corporate action, as well as from the ability of a shareholder todemand that the company purchase the shares held by that shareholder if thatshareholder voted against or did not participate in voting on certain types ofactions. Companies are also required by Russian law to obtain the approval ofdisinterested shareholders for certain transactions with interested parties.See “Item 10. Additional Information—Charter and Certain Requirements ofRussian Legislation—Description of Capital Stock—Rights Attaching to CommonShares” for a more detailed description of some of these protections. Whilethese protections are similar to the types of protections available to minorityshareholders in U.S. corporations, in practice, corporate governance standardsfor many Russian companies and enforcement of protections have proven to bepoor, and minority shareholders in Russian companies have suffered losses dueto abusive share dilutions, asset transfers and transfer pricing practices.Shareholder meetings of some companies have been irregularly conducted, andshareholder resolutions have not always been respected by management.Shareholders of some companies also suffered as a result of fraudulentbankruptcies initiated by hostile creditors.

The supermajority shareholder approval requirement ismet by a vote of 75% of all voting shares that are present at a shareholders’meeting. Thus, controlling shareholders owning slightly less than 75% ofoutstanding shares of a company may have a 75% or more voting power if certainminority shareholders are not present at the meeting. In situations wherecontrolling shareholders effectively have 75% or more of voting power at ashareholders’ meeting, they are in a position to approve amendments to thecharter of the company or significant transactions including asset transfers,which could be prejudicial to the interests of minority shareholders. It ispossible that our controlling shareholder and our management in the future maynot run us and our subsidiaries for the benefit of minority shareholders, andthis could materially and adversely affect the value of the ADSs. See “—RisksRelating to Our Business and Industry—Our controlling shareholder has theability to take actions that may conflict with those of the holders of oursecurities.”

Disclosure and reporting requirements, as well asanti-fraud legislation, have only recently been enacted in Russia. Most Russiancompanies and managers are not accustomed to restrictions on their activitiesarising from these requirements. The concept of fiduciary duties of managementor directors to their companies and shareholders is also relatively new and isnot well developed. Violations of disclosure and reporting requirements orbreaches of fiduciary duties to us and our subsidiaries or to our shareholderscould have a material adverse effect on the value of the ADSs.

While the Joint StockCompanies Law provides that shareholders owning not less than 1% of thecompany’s stock may bring an action for damages on behalf of the company,Russian courts to date do not have much experience with respect to suchlawsuits. Russian law currently does not contemplate class action litigation.Accordingly, your ability to pursue legal redress against us may be limited,reducing the protections available to you as a holder of ADSs.

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***Shareholderliability under Russian legislation could cause us to become liable for theobligations of our subsidiaries.***

The Civil Code andthe Joint Stock Companies Law generally provide that shareholders in a Russianjoint stock company are not liable for the obligations of the joint stockcompany and bear only the risk of loss of their investment. This may not be thecase, however, when one person is capable of determining decisions made byanother person or entity. The person or entity capable of determining suchdecisions is deemed an “effective parent.” The person whose decisions arecapable of being so determined is deemed an “effective subsidiary.” Under theJoint Stock Companies Law, an effective parent bears joint and severalresponsibility for transactions concluded by the effective subsidiary incarrying out these decisions if:

·       thisdecision-making capability is provided for in the charter of theeffective subsidiary or in a contract between the companies; and

·       theeffective parent gives obligatory directions to the effective subsidiary.

In addition, an effectiveparent is secondarily liable for an effective subsidiary’s debts if aneffective subsidiary becomes insolvent or bankrupt resulting from the action orinaction of an effective parent. This is the case no matter how the effectiveparent’s ability to determine decisions of the effective subsidiary arises. Forexample, this liability could arise through ownership of voting securities orby contract. In these instances, other shareholders of the effective subsidiarymay claim compensation for the effective subsidiary’s losses from the effectiveparent which caused the effective subsidiary to take action or fail to takeaction knowing that such action or failure to take action would result inlosses. Accordingly, we could be liable in some cases for the debts of oursubsidiaries. This liability could have a material adverse effect on ourbusiness, results of operations and financial condition.

***Shareholder rights provisions under Russian law couldresult in significant additional obligations on us.***

Russian lawprovides that shareholders that vote against or abstain from voting on certainmatters have the right to request that the company redeem their shares atmarket value in accordance with Russian law. The decisions that trigger thisright include:

·       decisionswith respect to a reorganization;

·       theapproval by shareholders of a “major transaction,” which, in general terms, isa transaction involving property worth more than 50% of the gross book value ofour assets calculated according to Russian accounting standards, regardless ofwhether the transaction is actually consummated, except for transactionsundertaken in the ordinary course of business; and

·       theamendment of our charter in a manner that limits shareholder rights.

Our (or, as the case maybe, our subsidiaries’) obligation to purchase shares in these circumstances,which is limited to 10% of our or each of our subsidiary’s net assets, asapplicable, calculated in accordance with Russian accounting standards at thetime the matter at issue is voted upon, could have a material adverse effect onour business, financial condition, results of operations and prospects.

***The lack of acentral and rigorously regulated share registration system in Russia may resultin improper record ownership of our shares, including the shares underlyingyour ADSs.***

Ownership of Russian jointstock company shares (or, if the shares are held through a nominee or custodian,then the holding of such nominee or custodian) is determined by entries in ashare register and is evidenced by extracts from that register. Currently,there is no central registration system in Russia. Share registers aremaintained by the companies themselves or, if a company has more than50 shareholders or so elects, by licensed registrars located throughoutRussia. Regulations have been 

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issuedregarding the licensing conditions for such registrars, as well as theprocedures to be followed by both companies maintaining their own registers andlicensed registrars when performing the functions of registrar. In practice,however, these regulations have not been strictly enforced, and registrarsgenerally have relatively low levels of capitalization and inadequate insurancecoverage. Moreover, registrars are not necessarily subject to effectivegovernmental supervision. Due to the lack of a central and rigorously regulatedshare registration system in Russia, transactions in respect of a company’s sharescould be improperly or inaccurately recorded, and share registration could belost through fraud, negligence, official and unofficial governmental actions oroversight by registrars incapable of compensating shareholders for theirmisconduct. This creates risks of loss not normally associated with investmentsin other securities markets. Further, the depositary, under the terms of theagreement governing the deposit of ADSs, will not be liable for theunavailability of shares or for the failure to make any distribution of cash orproperty with respect thereto due to the unavailability of the shares. See“Item 10. Additional Information—Charter and Certain Requirements of RussianLegislation—Description of Capital Stock—Registration and Transfer of Shares.”

***Characteristics ofand changes in the Russian tax system could materially adversely affect ourbusiness, financial condition, results of operations and prospects and thevalue of the shares and ADSs.***

Generally, taxespayable by Russian companies are substantial and numerous. These taxes include,among others:

·       profitstax;

·       value-addedtax, or VAT;

·       unifiedsocial tax;

·       extractiontax; and

·       propertyand land taxes.

Laws related to these taxes have been in force for ashort period relative to tax laws in more developed market economies and fewprecedents with regard to the interpretation of these laws have beenestablished. Global tax reforms commenced in 1999 with the introduction ofPart One of the Tax Code of the Russian Federation, or the Tax Code, whichsets general taxation guidelines. Since then, Russia has been in the process ofreplacing legislation regulating the application of major taxes such ascorporate profits tax, VAT and property tax with new chapters of the Tax Code.

In practice, the Russian tax authorities generallyinterpret the tax laws in ways that rarely favor taxpayers, who often have toresort to court proceedings to defend their position against the taxauthorities. Recent events within the Russian Federation suggest that the taxauthorities may be taking a more assertive position in their interpretations ofthe legislation and assessments. Differing interpretations of tax regulationsexist both among and within government ministries and organizations at thefederal, regional and local levels, creating uncertainties and inconsistentenforcement. Tax declarations, together with related documentation such ascustoms declarations, are subject to review and investigation by a number ofauthorities, each of which may impose severe fines, penalties and interestcharges. Generally, in an audit, taxpayers are subject to inspection withrespect to the three calendar years which immediately preceded the year inwhich the audit is carried out. Previous audits do not completely exclude subsequentclaims relating to the audited period because Russian tax law authorizes upper-leveltax inspectorates to reaudit taxpayers which were audited by subordinate taxinspectorates. In addition, on July 14, 2005, the Russian ConstitutionalCourt issued a decision that allows the statute of limitations for taxliabilities to be extended beyond the three-year term set forth in the tax lawsif a court determines that a taxpayer has obstructed or hindered a tax audit.Because none of the relevant terms is defined, tax authorities may have broaddiscretion to argue that a taxpayer has “obstructed” or “hindered” an audit andultimately seek back 

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taxes and penalties beyondthe three-year term. In some instances, new tax regulations have beengiven retroactive effect.

Moreover, financial results of Russian companiescannot be consolidated for tax purposes. Therefore, each of our Russiansubsidiaries pays its own Russian taxes and may not offset its profit or lossagainst the loss or profit of any of our other subsidiaries. In addition,intercompany dividends are subject to a withholding tax of 9%, if beingdistributed by Russian companies to Russian companies and/or individual Russianresidents, and 15%, if being distributed by foreign companies to Russiancompanies and natural persons (tax residents of the Russian Federation) or byRussian companies to foreign companies. Dividends from foreign companies toRussian companies are subject to a tax of 15%. Taxes paid in foreign countriesby Russian companies may be offset against payment of these taxes in theRussian Federation up to the maximum amount of the Russian tax liability. Inorder to apply the offset, the company is required to confirm the payment of taxes in the foreigncountry. The confirmations must be authorized by the tax authority of theforeign country if taxes were paid by the company itself, and the confirmationmust be authorized a the tax agent if taxes were withheld by the tax agentunder foreign tax law or international tax agreement.

The foregoing conditionscreate tax risks in Russia that are more significant than typically found incountries with more developed tax systems, imposing additional burdens andcosts on our operations, including management resources. In addition to oursubstantial tax burden, these risks and uncertainties complicate our taxplanning and related business decisions, potentially exposing us to significantfines and penalties and enforcement measures despite our best efforts atcompliance. See also “—Risks Relating to the Russian Federation—Legal Risks andUncertainties—Selective or arbitrary government action could have a materialadverse effect on our business, financial condition, results of operations andprospects and the value of the shares and ADSs.”

***Russian currency control regulations could hinder ourability to conduct our business.***

In the past, Russian currency regulations imposedvarious restrictions on operations involving foreign currencies in an attemptto support the ruble. Effective from January 1, 2007, most of theserestrictions have been removed. However, in case of a crisis, the governmentand the Central Bank of the Russian Federation may impose requirements on cashinflows and outflows into and out of Russia or on the use of foreign currencyin Russia in the future. For example, Russian companies currently mustrepatriate proceeds from export sales. Moreover, the foreign currency market inRussia is still developing and we may experience difficulty in convertingrubles into other currencies. Any delay or difficulty in converting rubles intoa foreign currency to make a payment or any practical difficulty in thetransfer of foreign currency could limit our ability to meet our payment anddebt obligations, which could result in the acceleration of debt obligationsand cross defaults, or prevent us from carrying on necessary businesstransactions.

Furthermore, there areonly a limited number of available ruble denominated instruments in which wemay invest our excess cash. Any balances maintained in rubles will give rise tolosses if the ruble devalues against major foreign currencies. Moreover, theserestrictions could prevent or delay any acquisition opportunities outside ofRussia that we might wish to pursue.

***Russian thin capitalization rules could affectour ability to deduct interest on certain borrowings.***

Russian thincapitalization rules limit the amount of interest that can be deducted bya Russian company on debts payable to non-resident shareholders. UntilJanuary 1, 2006, these rules applied only to loans issued to aRussian company by a foreign shareholder owning directly or indirectly morethan 20% of the share capital of the Russian company. However, thincapitalization rules that came into effect on January 1, 2006 extendthe rules’ application to loans issued to a Russian company by another Russiancompany that is affiliated with the foreign shareholder as well as to loanssecured by such foreign 

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shareholderor its affiliated Russian company. Under these rules, a positive difference between the accrued interest andmaximum interest calculated in accordance with the thin capitalizationrules is considered to be dividends and, thus, is not included in thetaxable expenses.

**Other Risks**

***We face similarrisks in other countries of the former Soviet Union and former Soviet-bloccountries in Eastern and Central Europe.***

We currently have two steel mills in Romania and ahardware plant in Lithuania. We may acquire additional operations in thecountries of the former Soviet Union and former Soviet-bloc countries inEastern and Central Europe. Additionally, we owned a pipe mill in Croatia untilAugust 2004, when we transferred its ownership back to the government ofCroatia. As with Russia, these countries are emerging markets subject togreater political, economic, social and legal risks than more developedmarkets. In many respects, the risks inherent in transacting business inthese countries are similar to those in Russia, especially those risks setout above in “—Risks Relating to the Economic Environment in Russia,” “—RisksRelating to the Social Environment in Russia” and “—Risks Relating to RussianLegislation and the Russian Legal System.”

Moreover, these countriesrepresent new operating environments for us, which are located, in manyinstances, a great distance from our Russian operations and across multipleinternational borders. We thus expect to have less control over theiractivities. In addition, we may face more uncertainties with respect to theoperational and financial needs of these businesses. These factors may hurt theprofitability of our current and future operations in these countries.

***We have not independently verified information we havesourced from third parties.***

We have sourced certaininformation contained in this document from third parties, including privatecompanies and Russian government agencies, and we have relied on the accuracyof this information without independent verification. The official datapublished by Russian federal, regional and local governments may be substantiallyless complete or researched than those of Western countries. Officialstatistics may also be produced on different bases than those used in Westerncountries. Any discussion of matters relating to Russia in this document must,therefore, be subject to uncertainty due to concerns about the completeness orreliability of available official and public information. In addition, theveracity of some official data released by the Russian government may bequestionable. In 1998, the Director of the Russian State Committee onStatistics and a number of his subordinates were arrested and subsequentlysentenced by a court in 2004 in connection with their misuse of economic data.

***Item4.  *Information on the Company**

**Overview**

We are a low-cost integrated mining and steel groupwith revenues of $4.4 billion in 2006. Our mining business is focused on miningproducts used in the production of steel, primarily coking coal, iron ore andnickel. We also produce a significant amount of steam coal. We have substantialcoal, iron ore and nickel mining interests in Russia, with the flexibility tosupply our own steel production or sell to third parties depending on pricedifferentials between purchases from local suppliers and sales to foreign anddomestic customers. We are capable of internally sourcing 80% of the cokingcoal, 40% of the iron ore and 67% of the nickel requirements of our steelsegment. We were the third largest producer of coking coal in Russia in 2006,with a 13.8% market share, and Russia’s second largest exporter of coking coaland coal concentrate. We also control 20% of the coking coal washing capacityin Russia.

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Our steel businesscomprises the production and sale of semi-finished steel products, carbon andspecialty long products, carbon and stainless flat products and value-addeddownstream metal products including hardware, stampings and forgings. It alsoproduces significant amounts of coke, both for internal use and for sales tothird parties. We are the largest and most comprehensive producer of specialty steelsand alloys in Russia, producing 39% of total Russian specialty steel output in2006. We are also the third largest producer in Russia of long products. 

Mechel OAO is an openjoint stock company incorporated under the laws of the Russian Federation. Weare a holding company and conduct our business through a number ofsubsidiaries. We are registered with the Ministry of Taxes and Duties of theRussian Federation under the main state registration number 103770301896.Our principal executive offices are located at Krasnoarmeyskaya Street, 1,Moscow 125993, Russian Federation. Our telephone number is +7 495 2218888. Our Internet addresses are www.mechel.com and www.mechel.ru. Informationposted on our website is not a part of this document. We have appointed CTCorporation Systems, 111 Eight Avenue, New York, New York 10011 as ourauthorized agent upon which process may be served for any suit or proceedingarising out of or relating to our shares, ADSs or deposit agreement. 

**Our History andDevelopment**

We trace our beginnings to a small coal tradingoperation in Mezhdurechensk in the southwestern part of Siberia in the early1990s. See “Item 5. Operating and Financial Review and Prospects—TheReorganization.” Since that time, through strategic acquisitions in Russia andabroad, Mechel has developed into a large, integrated mining and steel group,comprising coal, iron ore, nickel and limestone mining, coke production, andsteel production, with operations in Russia, Romania and Lithuania. With eachof our acquisitions, we implement improved operational and managementpractices, and we are generally able to realize significant increases inproduction efficiency and volume with only modest, targeted capitalexpenditures. We also devote the management, technological and logisticalresources necessary to integrate new acquisitions into all aspects of ourbusiness, including the supply of raw materials and steel, productionmethodologies and sales and distribution.

By 2000, we had acquired many of our coal interests,consisting of seven mining operations and related processing plants, alllocated within close proximity to each other in Mezhdurechensk in thesouthwestern part of Siberia. These operations, now consolidated under SouthernKuzbass Coal Company and OAO Tomusinsky Pit, produced 17.0 million tonnesof coal in 2006.

Set forth below areour primary mining and steel acquisitions after 2000:

In 2001, weacquired:

·       ChelyabinskMetallurgical Plant, an integrated blast furnace and BOF/EAF steel mill whichproduced 4.9 million tonnes of raw steel, 4.0 million tonnes of rolled productsand 2.3 million tonnes of coke in 2006 and which is located in Chelyabinsk, inthe southern Urals near the border with Kazakhstan; and

·       SouthernUrals Nickel Plant, consisting of two open-pit nickel mines and a nickelprocessing facility which produced 14,436 tonnes of nickel products in 2006 andwhich is located in Orsk, in the southern Urals.

In 2002, weacquired:

·       VyartsilyaMetal Products Plant, a hardware plant which produced 62,571 tonnes of hardwarein 2006 and which is located in Sortavala, Karelia, in northwest Russia close tothe border with Finland;

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·       BeloretskMetallurgical Plant, a hardware plant which produced a total of 571,563 tonnesof rolled steel products in 2006, including 202,340 tonnes of wire rod and 363,223tonnes of hardware and which is located in Beloretsk, in the southern Urals;

·       Pugachevlimestone quarry, consisting of a quarry and processing facility which produced2.0 milliontonnes of limestone in 2006 and which is located close to Beloretsk, in thesouthern Urals; and

·       MechelTargoviste, a steel mill which produced 465,825 tonnes of raw steel and 385,632tonnes of rolled products in 2006 and which is located in Targoviste, Romania.

In 2003, weacquired:

·       MechelZeljezara, a Croatian steel mill that produced pipes, which we subsequentlyshut down in August 2004 due to its high input costs and a persistentweakness in pipe prices;

·       UralsStampings Plant, a forging and stamping mill which produced 82,978 tonnes ofspecialty steel stampings in 2006 and which is located in Chebarkul, in thesouthern Urals;

·       MechelCampia Turzii, a steel mill which produced 17,940 tonnes of raw steel in 2006prior to closing down its raw steel production in February 2006 formodernization. Mechel Campia Turzii produced 141,708 tonnes of rolled productsand 86,016 tonnes of hardware in 2006 and is located in Campia Turzii, Romania;

·       KorshunovMining Plant, consisting of three iron ore mines and an iron ore concentratorplant which produced 4,975 million tonnes of iron ore concentrate in 2006and which is based in Zheleznogorsk-Ilimskiy, in eastern Siberia;

·       MechelNemunas, a hardware plant which produced 63,835 tonnes of products in 2006 andwhich is located in Kaunas, Lithuania; and

·       MechelCoal Resources, a coal washing plant in Kazakhstan, which we subsequently soldin August 2005 together with our Gorbachev Mine in Kazakhstan inaccordance with our strategy to focus on our Russian operations. Finalsettlement of the sale transaction occurred in November 2006.

In 2004, weacquired:

·       PortPosiet, a port located in Russia’s Far East on the Sea of Japan and which hasapproximately two million tonnes of cargo and 140,000tonnes of warehousing capacity and processed 1,427 tonnes of cargo,mostly coal, in 2006;

·       GorbachevMine, an underground coal mine located in Kazakhstan, which we subsequentlysold in August 2005 together with Mechel Coal Resources;

·       Izhstal,a Russian specialty steel producer located in Izhevsk, Udmurtia, west of theUrals, which produced approximately 586,655 tonnes of raw steel, 366,235 tonnesof rolled products, 42,363 tonnes of hardware and 17,428 tonnes ofstampings and forgings in 2006; and

·       asubsoil license for the Sibirginsky mine area of the Sibirginsky and Tomskycoal deposits, near our Sibirginsk Open Pit Mine.

In 2005, weacquired:

·       ablocking minority stake of 25% plus one share in Yakutugol, located in easternSiberia, which produced 5.4 million tonnes of coking coal and 5.0 milliontonnes of steam coal in 2006 from open and underground mines;

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·       PortKambarka, a river port located in Kama in the Republic of Udmurtia, whichprocessed 543 tonnes of cargo, mostly sand and crushed stone, in 2006;

·       twosubsoil licenses for the Raspadsky open-pit mine area of the Raspadsky coaldeposit and Berezovsky-2 area of the Berezovsky and Olzherassky coal deposits;

·       twosubsoil licenses for the Erunakov-1 and Erunakov-3 coal mines nearKemerovo; and

·       threesubsoil licenses for the Sorokinsky, Razvedochny and Olzherassk coal fields inKemerovo.

In 2006, weacquired:

·       MechelRecycling, a Chelyabinsk-based metal scrap processing company in line with ourpolicy of enhancing the steel segment’s self-sufficiency in raw materials.

·       Moscow Coke Gas Plant, acoking coal producer based in the Moscow Region which produced 1.0 milliontonnes of coke in 2006.

In 2007, weacquired:

·       SouthernKuzbass Power Plant, a powerplant located in Kemerovo Region that was separated from Kuzbassenergoin July 2006. As of January 1, 2007, its installed electric power capacity was554 MWt, and the heat power capacity was 560 Gcal/h. On March 29, 2007, weacquired 93.4% of the voting stock of Southern Kuzbass Power Plant.

**Business Strategy**

Our goal is to expand our mining business, boththrough organic growth as well as acquisitions; to improve our steel segmentmargins through plant modernization, cost cutting and product portfoliooptimization; to maintain our strong position as a producer of carbon andspecialty long steel products in Russia; and to capitalize on the synergiesderiving from our status as an integrated mining and steel group. We alsointend to leverage our core businesses, where appropriate, with acquisitions ofvalue-added downstream businesses.

The key elements ofour strategy include the following:

*Expand our MiningBusiness.**  *Weintend to build on our substantial mining experience by:

·       Developingour existing coal and iron ore reserves, particularly in order to sell morehigh-quality coking coal and iron ore concentrate to third parties. We plan toincrease our coal production from 17 million tonnes in 2006 to 25 milliontonnes in 2010, and maintain our iron ore concentrate production at the levelof 5.0 million tonnes during 2006-2011.

·       Continuingto make selective acquisitions of coal and other mining enterprises, includingnew subsoil licenses, particularly in Russia, as strategic opportunitiespresent themselves.

·       Maintainingour flexibility to internally source raw-material inputs for our steel-makingbusiness, depending on price differentials between purchases from localsuppliers and sales to foreign and domestic customers.

*Improve our Steel SegmentMargins through Plant Modernization, Cost Cutting and Product PortfolioOptimization and Further Enhance our Position as a Low-Cost Producer.*   We intend to further increase our efficiency and reduce ourmanufacturing costs by:

·       Selectivelyinvesting in technology and capital improvements, including expanding use ofcontinuous casters in our steel-making, optimizing our product portfolioand cuttings costs.

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·       Preservingcost advantages in our labor, raw materials and energy inputs.

·       Achievingadditional savings by fully integrating recent acquisitions into ouroperations.

*Maintain our Position as aLeading Producer of Carbon Long Products in Russia.**  *We have already built a solidpresence in this sector, including the second largest market share for fittings.We are also a market leader in rod production and have a strong presence in thestructural steel production market. We intend to maintain these positions,including through the addition of new production capacity achieved by targeted,cost-effective capital expenditures. We plan to increase our rolled productsoutput from 4.3 million tonnes as of the end of 2006 to 4.5 million tonnesas of the end of 2009, primarily at our Chelyabinsk Metallurgical Plant.Additionally, we seek to benefit from the following factors in Russia: 

·       Ifthe economy continues to expand, the demand for long products, particularly inthe construction industry, should increase, providing us with additional salesopportunities.

·       Substantialinfrastructure repairs and industrial upgrade needs should also drive demandfor our products. 

*Develop our Position as aHigh-Quality, Low-Cost Producer of Specialty Long Products.**   We are one of Russia’s primaryproducers of specialty long products. We believe that this higher marginbusiness provides us with substantial opportunities to increase our revenuesand profitability for the following reasons:*

·       Ourlow-cost production provides us with a competitive base for expanding ourmarket share in Europe, Asia and the CIS countries.

·       TheRussian market for specialty long products has considerable room for growth ifdemand from domestic engineering and manufacturing sectors recovers from historicpost-Soviet lows in the past few years. 

*FurtherCapitalize upon Synergies between our Core Businesses.**  *In addition to synergies derivingfrom our status as an integrated group, we believe that additional cost savingsand opportunities will arise as we benefit from economies of scale and continueto integrate recent acquisitions, in particular by implementing improvements inworking practices and operational methods. We regularly evaluate the manner inwhich our subsidiaries source their raw material needs and transfer productswithin the group in order to operate in the most efficient way, and we expectto identify and take advantage of further synergies between our corebusinesses.

*Selectively Expand ourDownstream Capacity.**  *Weintend to continue to selectively acquire value-added downstreambusinesses such as hardware, stampings and forgings producers to help us reachour customer base, including in new markets. This downstream integration:

·       Isa logical extension of our specialty and low-carbon long product lines,representing a higher margin, next value-added step for products that wealready manufacture.

·       Isin a market less cyclical than the upstream market, reducing our exposure tomarket downturns.

·       Movesus closer to our final customers, enabling us to better understand customerneeds, influence buyer behavior and respond quickly to change.

*SelectivelyExpand our Internal Logistics Capabilities.**  *We intend to selectively expand ourinternal logistics capabilities, currently centered on our railway freight andforwarding company, and enhanced by our acquisitions of Port Posiet, located onthe Sea of Japan, and Port Kambarka to help us optimize our transportationexpenses.

*MaintainStrong Export Sales.**  *Weintend to maintain our strong relationships with our significant exportcustomers. Although we are focused on maintaining our market position withinRussia, export sales, 

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which constituted 38% ofour total sales in 2006, allow us to diversify our sales and reduce ourreliance on the Russian market in the event that it were to experience adownturn.

Implementation of thesestrategies is subject to a number of risks. See “Item 3. Key Information—Risk Factors”for a description of these risks.

**CompetitiveStrengths**

Our main competitive strengths are the following:

*Low-Cost Producer.**  *Our base of operations in Russiaand integrated status allow us to take advantage of a number of cost advantagesvis-à-vis foreign producers. 

·       *Low-Cost Raw Materials.  *We arecapable of internally sourcing 80% of the coking coal, 40% of the iron ore and 67%of the nickel requirements of our steel segment. Our mines, processingfacilities and steel production facilities have long and established operatinghistories, and we continue to find additional cost savings through internallysourcing these raw materials. Having the ability to internally source alsogives us a better bargaining position with our outside suppliers and allows usto control our raw material costs.

·       *Inexpensive Energy.  *We internallysatisfy about 31% of our electricity needs from our own co-generationfacilities, and purchase most of the remainder at low, regulated prices. Wealso purchase natural gas from Gazprom at low, regulated prices for ourelectrical and other production needs. See “Item 3. Key Information—RiskFactors—Risks Relating to Our Business and Industry—Increasing tariffs andrestructuring in the energy sector could materially adversely affect ourbusiness.”

·       *Low Labor Costs.  *Russia has very lowlabor costs, including few pension obligations, as compared to the UnitedStates, Western Europe, Japan and South Korea.

·       *Cost Management.  *We view strict costmanagement and increases in productivity as fundamental aspects of ourday-to-day operations, and continually reassess and improve the efficiency ofour mining and steel-making operations. With our acquisition andsuccessful integration of Chelyabinsk Metallurgical Plant, BeloretskMetallurgical Plant, Southern Urals Nickel Plant, Urals Stampings Plant, Izhstaland Korshunov Mining Plant in the past few years, we have established a trackrecord of turning around underperforming facilities by implementing improvedoperational and management practices, leading to reductions in production costsand improved product quality.

*Abilityto Internally Source Significant Amounts of Raw Materials.**  *We are capable of internallysourcing 80% of the coking coal, 40% of the iron ore and 67% of the nickelrequirements of our steel segment. We are also currently expanding our iron oreprocessing capability so that we will be able to internally process more of ouriron ore concentrate into sinter. While other steel producers have certaincaptive raw-materials suppliers, we are the only steel manufacturer in theworld with its own nickel production facilities. We believe that our captivesupply of coking coal, iron ore and nickel provides us significant advantagesover other steel producers, such as higher stability of operations, bettercontrol of quality of end products, reduced production costs, improvedflexibility and planning latitude in the production of our steel and value-addedsteel products and the ability to respond quickly to market demands and cycles.Moreover, in recent years, the supply of iron ore and coal, the two primary rawmaterials inputs into the steel-making process, has been increasinglyconcentrated among fewer companies, resulting in weaker bargaining positionsfor steel makers. Our integration strategy has allowed us to minimize theadverse effect of such concentration and maintain a consistent supply of rawmaterials. In addition, our ability to source raw materials internally andwithin Russia means that we are not exposed to any shortages in worldwideshipping capacity.

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*Abilityto Improve Cost Efficiency with Relatively Modest Capital Expenditures.**  *We believe that relatively modestcapital improvements will allow us to decrease our production costs and improveour margins. For example, we expect the further introduction of continuouscasting at our plants to result in substantial improvements in our costefficiency.

*Abilityto Increase Current Production Cost Effectively.**  *We believe that we have asignificant competitive advantage over our competitors in our ability toincrease our production capacity relatively cost effectively because oursubstantial existing infrastructure can accommodate new facilities andproduction lines through brownfield development. Moreover, due to ourintegration, experience and location in Russia, which has some of the largestreserves of coal and iron in the world, we are better positioned than ourEuropean competitors to secure raw materials for any increases in steelproduction. For example, we plan to increase Chelyabinsk Metallurgical Plant’srolled steel production capacity from 4.1 million tonnes as of the end of 2006to 4.3 million tonnes in 2009. 

*SignificantDomestic Market Shares in Specialty Steel and Carbon Long Products.**  *Russia is our most important marketand we have significant domestic market shares in all our key specialty steeland carbon long products. We believe we have established a strong reputationand brand image for Mechel within Russia and certain of our key export markets.

*EstablishedExport Market Presence.**  *We export a substantial portion of our productsthrough our sales and distribution network in seven countries and agents in 12additional countries. These export sales, which constituted 38% and 45% of ourtotal sales in 2006 and 2005, respectively, allow us to diversify our sales,provide us with additional growth opportunities and reduce our reliance on theRussian market in the event that it were to experience a downturn.

*Well-Situatedfor Construction Market.**  *The location of our primary steel manufacturingfacility, Chelyabinsk Metallurgical Plant, in the southern Urals makes itbetter situated, compared to our primary competitor in this market, to servethe Russian construction market. Our share of the Russian reinforcing bars marketin 2006 was approximately 20%.

*Value-AddedProduct Line.**  *Weproduce long products for a broad range of end uses, as well as forgings andstampings, wire rod for metal cord production and a wide range of hardware(wires, nails, nets, ropes and rope products). Downstream production providesus with higher margin opportunities.

*TrackRecord of Successful Acquisitions.**  *Building upon our success inturning around the coal operations of Southern Kuzbass Coal Company in the late1990s and following our acquisition and revitalization of ChelyabinskMetallurgical Plant, a steel manufacturer that was one of our primary customersof coking coal, in the last few years we have acquired other metal finishingand hardware manufacturing operations that we can supply with our steel. Witheach of our acquisitions, we implement improved operational and managementpractices, and we are generally able to realize significant increases inproduction efficiency and volume with only modest, targeted capital expenditures.We also devote the management, technological and logistical resources necessaryto integrate new acquisitions into all aspects of our business, including thesupply of raw materials and steel, production methodologies and sales anddistribution. We have a good track record of using existing workforces andmaintaining excellent relations with the local communities where we operate.

*IncreasingControl over Logistics.**  *Our increasing internal logistics capabilities,currently centered on our railway freight and forwarding company, and enhancedby our acquisitions of Port Posiet, located on the Sea of Japan, and PortKambarka, a river port, help us to optimize our transportation expenses.

*Strong and FocusedManagement Team.**  *Ourcurrent management team has significant experience in all aspects of ourbusinesses and has successfully transformed us from a small coal tradingoperation to a large, integrated coal and steel producer. Mr. Zyuzin, our controllingshareholder, is our Chief Executive Officer. Our Chief Operating Officer,Alexey Ivanushkin, has significant experience from his previous 

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positions atGlencore International and as chief executive officer at Chelyabinsk MetallurgicalPlant. Many of our directors and officers began their careers in floor jobs orin mines and moved up into management positions over the course of theircareers.

**Mining Business**

Our main products comprise coking and steam coalconcentrate, steam coal, iron ore concentrate and ferronickel. Among the keyadvantages of our mining business is the high quality of our coking coal, thelow level of volatile matters in our steam coal and our modern coal washingfacilities, primarily built during the 1970s and 1980s, including facilitiesbuilt as recently as 2001-2002.

**Sales of miningproducts**

Thefollowing table sets forth third-party sales of our mining products (byvolume) for the periods indicated.

| **Product**              | ** ** | ** **                                  | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **               | ** ** | **(in thousands of tonnes)** | ** ** |
| Coking coal  concentrate |       | 6,603                                       |       | 5,013    |       | 5,247    |       |
| Steam coal               |       | 6,728                                       |       | 5,876    |       | 5,539    |       |
| Iron ore  concentrate    |       | 2,885                                       |       | 2,876    |       | 2,438    |       |
| Nickel                   |       | 12                                          |       | 11       |       | 9        |       |

 

Thefollowing table sets forth revenues by product, as further divided betweendomestic sales and exports (including as a percentage of total mining segmentrevenues) for the periods indicated:

| ** **               | ** ** | **2006**                                                                                     | ** ** | **2005**   | ** ** | **2004**                    | ** ** |
|--------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|
| **Revenues**             | ** ** | ** **                                                                                   | ** ** | **Amount** | ** ** | **% of revenues** | ** ** | **Amount** | ** ** | **% of revenues** | ** ** | **Amount** | ** ** | **% of revenues** | ** ** |
| ** **               | ** ** | **(in millions of U.S. dollars, except for percentages)** | ** ** |
| Coking coal  concentrate |       | 518.3                                                                                        |       |       | 39         | %                           |       | 463.0 |   |   | 42 | % |   |   | 402.1 |   |   |   | 46 | % |   |
| Domestic Sales (%)       |       | 74                                                                                           | %          |       |       |                        |       | 64 | % |   |   |   |   |   | 40 | % |   |   |   |   |   |
| Export (%)               |       | 26                                                                                           | %          |       |       |                        |       | 36 | % |   |   |   |   |   | 60 | % |   |   |   |   |   |
| Steam Coal               |       | 311.1                                                                                        |       |       | 23         | %                           |       | 273.5 |   |   | 25 | % |   |   | 211.7 |   |   |   | 24 | % |   |
| Domestic Sales (%)       |       | 21                                                                                           | %          |       |       |                        |       | 12 | % |   |   |   |   |   | 13 | % |   |   |   |   |   |
| Export (%)               |       | 79                                                                                           | %          |       |       |                        |       | 88 | % |   |   |   |   |   | 87 | % |   |   |   |   |   |
| Iron ore concentrate     |       | 168.2                                                                                        |       |       | 13         | %                           |       | 167.1 |   |   | 15 | % |   |   | 113.8 |   |   |   | 13 | % |   |
| Domestic Sales (%)       |       | 98                                                                                           | %          |       |       |                        |       | 69 | % |   |   |   |   |   | 52 | % |   |   |   |   |   |
| Export (%)               |       | 2                                                                                            | %          |       |       |                        |       | 31 | % |   |   |   |   |   | 48 | % |   |   |   |   |   |
| Nickel                   |       | 258.7                                                                                        |       |       | 19         | %                           |       | 150.5 |   |   | 14 | % |   |   | 108.0 |   |   |   | 12 | % |   |
| Domestic Sales (%)       |       | 0                                                                                            | %          |       |       |                        |       | — |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Export (%)               |       | 100                                                                                          | %          |       |       |                        |       | 100 | % |   |   |   |   |   | 100 | % |   |   |   |   |   |
| Other(1)                 |       | 79.8                                                                                         |       |       | 6          | %                           |       | 40.7 |   |   | 4 | % |   |   | 42.8 |   |   |   | 3 | % |   |
| Total                    |       | 1,336.1                                                                                      |       |       | 100        | %                           |       | 1,094.8 |   |   | 100 | % |   |   | 878.4 |   |   |   | 100 | % |   |
| Domestic Sales (%)       |       | 51                                                                                           | %          |       |       |                        |       | 44 | % |   |   |   |   |   | 33 | % |   |   |   |   |   |
| Export (%)               |       | 49                                                                                           | %          |       |       |                        |       | 56 | % |   |   |   |   |   | 67 | % |   |   |   |   |   |
|                          |            |                                                                                              |            |            |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includes revenues fromtransportation, distribution, construction and other miscellaneous servicesprovided to local customers.

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**Marketing anddistribution**

Ourmining products are marketed domestically primarily through Mechel TradingHouse and internationally through Mechel Trading AG’s branch in Liechtenstein.The following table sets forth by percentage of sales the regions in which ourmining segment products were sold for the periods indicated:

| **Region(1)** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Russia        |       | 51.4       | %          | 44.3     | %          | 32.0     | %          |
| Other CIS     |       | 10.1       | %          | 13.0     | %          | 16.4     | %          |
| Europe        |       | 31.6       | %          | 31.5     | %          | 31.3     | %          |
| Asia          |       | 4.3        | %          | 9.3      | %          | 14.3     | %          |
| Middle East   |       | 2.6        | %          | 1.9      | %          | 6.0      | %          |
| Other         |       | —     |       | —   |       | —   |       |
|          |       | 100.0      | %          | 100.0    | %          | 100.0    | %          |

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(1)          The regional breakdownof sales is based on the geographic location of our customers, and not on thelocation of the end users of our products, as our distributor customers reselland, in some cases, further export our products.

In 2006, the five largestcustomers of our mining products were Glencore International (nickel, steamcoal), MMK (coking coal), ZapSib (iron ore), Evrazresurs (coking coal) and NLMK(coking coal), which together accounted for 59% of our mining segment sales.

***Domestic sales***

We generally do not involve intermediaries in thedomestic distribution of our mining products. Our domestic coking and steamcoal and iron ore customers are generally located in large industrial areas andhave had long-standing relationships with us. We do not sell our nickelproducts within Russia.

We ship our coking coal concentrate from our coalwashing facilities, located near our coal mines and pits, by railway directlyto key customers, including steel producers. Our largest domestic customer forour coking coal concentrate is MMK, accounting for 30% of our total coking coalconcentrate sales and 12% of our total mining segment sales in 2006. Wegenerally conclude sales contracts with domestic customers on an annual basis,and set our prices and volumes on a monthly basis by open tender.

Our internal consumption of steam coal is negligible,and we sell substantially all of our steam coal to third parties. KashirskayaGRES 4, an electric utility, is our largest domestic customer of steam coal,accounting for 6% of our total steam coal sales and 1% of our total miningsegment sales in 2006. We ship our steam coal from our warehouses by railwaydirectly to key customers, which are predominantly electric power stations.Sales contracts for steam coal are generally concluded with customers on anannual basis.

Iron ore concentrate is shipped via railway directlyfrom Korshunov Mining Plant to customers. Our largest domestic customer,ZapSib, accounted for 96% of our total iron ore concentrate sales and 12% ofour total mining segment sales in 2006. Prices are set monthly.

Since 2002, Mechel TradingHouse has operated its wholly-owned subsidiary, Mecheltrans, a railwayfreight and forwarding company. Mecheltrans owns its own rolling stock,consisting of 293 open cars, 259 pellet cars, rents 1,210 open cars and 20pellet cars, and leases 1,600 open cars. The company transported domesticallyapproximately 36 million tonnes of our cargo in 2006, approximately 80% ofwhich was comprised of coal and iron ore.

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***Export sales***

We export coking coal, steam coal concentrate, lowbituminous and anthracite steam coal, iron ore concentrate and ferronickel.

In the year ended December 31, 2006, our largestmining segment customer was Glencore International, accounting for 22% of ourtotal mining segment sales. Glencore International’s purchases consisted ofnickel (88%) and steam coal (12%). It was also our largest customer in theyears ended December 31, 2005 and 2004, accounting for 13.9% and 5.0%,respectively, of the total mining segment sales in those periods.

We are Russia’s second largest exporter of coking coalconcentrate after Yakutugol. We export our coking coal concentrate primarily toUkraine, Slovakia and Bulgaria. In 2006, Greenway Trading was our largestforeign customer of coking coal concentrate, accounting for 9% of our totalcoking coal concentrate sales and 4%****of our totalmining segment sales. Shipments are made by railway and by ship.

Our exports of steam coal are primarily toSwitzerland, Japan, Turkey and Spain, which together accounted for 52% of ourtotal steam coal sales and 12% of our total mining segment sales in 2006. Therewere two international trading companies among our largest customers, bothregistered in Switzerland: Mechel Energy, in which we have a 50%stake, and Glencore International. Steam coal is shipped to customersfrom our warehouses by railway and, in some cases, by ship from Russian andUkrainian ports.

In February 2004, we acquired Port Posiet, located inRussia’s Far East on the Sea of Japan. The port has approximately two milliontonnes of cargo handling capacity and 140,000 tonnes of warehousing capacityand processed 1.4 million tonnes of cargo, mostly coal in 2006. We shipprimarily our steam coal and coking coal concentrate to Japan from this port.

We also exported iron ore concentrate to China during2006, accounting for 2% of our total iron ore concentrate sales and 0.3% of ourtotal mining segment sales in 2006. We ship iron ore concentrate to China byrail and by sea.

In 2006, we sold all ofour ferronickel that we did not use internally to Glencore International basedon the London Metal Exchange, or LME, nickel prices. In 2007, we began sellingour ferronickel that we do not use internally to Stratton Metals in addition toGlencore International. The proportion of our sales to Stratton Metals comparedto Glencore International is 10:4. In each case, the ferronickel is deliveredby railway to the port of St. Petersburg and it is then forwarded by thepurchasers to their end users.

**Market share andcompetition**

***Coal***

As a result of mergers and acquisitions undertakenprimarily by steel producers, the number of domestic coal producers hasdecreased from 250 in the mid-1990s to less than 60 in 2006. Over thelast few years, domestic coal mining companies have generally enjoyed arelatively stable customer base.

47

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We arethe third largest coking coal producer in Russia, with a 13.8% market share,and we have a 5.5% market share with respect to overall Russian coalproduction. We also control 20.0% of the coking coal washing capacity inRussia. The following table lists the principal Russian coking coal producersin 2006 and their respective shares of total coking coal production, total coalproduction, location and controlling shareholders. 

| ** **                     | ** ** | **Coking coal  production**        | ** ** | **Share of total  coking coal  production** | ** ** | **Total coal  production**         | ** ** | **Share of  total coal  production** | ** ** | **Location** | ** ** | **Controlling  shareholder** | ** ** |
|--------------------------------|------------|-----------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------------|------------|--------------|------------|------------------------------|------------|
| ** **                     | ** ** | **(in thousands  of tonnes)** | ** ** | ** **                                                 | ** ** | **(in thousands  of tonnes)** | ** ** | ** **                                     | ** ** | ** **   | ** ** | ** **                   | ** ** |
| Yuzhkuzbassugol                |       |                                    | 10,735.1   |                                                       |       |                                    | 15.3       | %                                              |       |         | 16,137.4   |                         |       |   | 5.2 | % |   | Kuzbass |   | EvrazGroup(1) |   |
| Southern Kuzbass  Coal Company |       |                                    | 9,697.0    |                                                       |       |                                    | 13.8       | %                                              |       |         | 17,013.1   |                         |       |   | 5.5 | % |   | Kuzbass |   | Mechel |   |
| Raspadskaya Mine               |       |                                    | 9,471.7    |                                                       |       |                                    | 13.5       | %                                              |       |         | 9,471.7    |                         |       |   | 3.1 | % |   | Kuzbass |   | EvrazGroup(1) |   |
| Kuzbassrazrezugol              |       |                                    | 4,112.0    |                                                       |       |                                    | 5.9        | %                                              |       |         | 41,359.5   |                         |       |   | 13.4 | % |   | Kuzbass |   | Ural  Mining-Metallurgical Company |   |
| Prokopievskugol                |       |                                    | 3,437.8    |                                                       |       |                                    | 4.9        | %                                              |       |         | 4,721.3    |                         |       |   | 1.5 | % |   | Kuzbass |   | NLMK |   |
| Kuzbassugol                    |       |                                    | 2,099.4    |                                                       |       |                                    | 3.0        | %                                              |       |         | 2,534.8    |                         |       |   | 0.8 | % |   | Kuzbass |   | Severstal |   |
| Mezhdurechye(2)                |       |                                    | 2,665.8    |                                                       |       |                                    | 3.8        | %                                              |       |         | 6,016.6    |                         |       |   | 1.9 | % |   | Kuzbass |   | Sibuglemet,  Bagomes |   |
| Yakutugol(3)                   |       |                                    | 5,364.1    |                                                       |       |                                    | 7.6        | %                                              |       |         | 9,542.3    |                         |       |   | 3.0 | % |   | Yakutiya |   | Yakut  Government |   |
| Other                          |       |                                    | 22,683.0   |                                                       |       |                                    | 32.3       | %                                              |       |         | 201,991.2  |                         |       |   | 65.5 | % |   |   |   |   |   |
| Total                          |       |                                    | 70,265.9   |                                                       |       |                                    | 100.0      | %                                              |       |         | 308,787.9  |                         |       |   | 100.0 | % |   |   |   |   |   |

----

Source: CDU TEK

(1)          Accounted for byEvrazGroup on an equity basis.

(2)          We own 16.1% ofMezhdurechye.

(3)          We own 25% + 1 share inYakutugol.

In the domestic coalmarket, we compete primarily on the basis of price, as well as on the basis ofthe quality of coal, which depends upon the quality of our production assetsand the quality of our mineral reserves. Competition in the steam coal marketis also affected by the fact that most steam power stations were built nearspecific steam coal sources and had their equipment customized to utilize theparticular type of coal produced at the relevant local source. Outside ofRussia, competition in the steam coal market is largely driven by coal quality,including volatile matters and calorie content.

***Iron ore***

The Russian iron ore market is generally characterizedby high demand and limited sources of supply, with product quality as the mainfactor driving prices. The market is dominated by relatively few producers,with the top three producers representing 49.7% of total production of iron oreconcentrate.

48

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Thefollowing table lists the main Russian iron ore concentrate producers in 2006and their respective shares of total production, location and controllingshareholders. 

| ** **              | ** ** | **Iron ore  concentrate  production** | ** ** | **Share of  total  production** | ** ** | **Location** | ** ** | **Controlling  shareholder** | ** ** |
|-------------------------|------------|--------------------------------------------|------------|--------------------------------------|------------|--------------|------------|------------------------------|------------|
| ** **              | ** ** | **(in thousands  of tonnes)**    | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                   | ** ** |
| Lebedinsky GOK          |       |                                       | 21,012.4   |                                 |       |         | 21.1       | %                            |       | Belgorod  Region |   | Metalloinvest |   |
| Mikhailovsky GOK        |       |                                       | 17,106.1   |                                 |       |         | 17.2       | %                            |       | Kursk  Region |   | Metalloinvest |   |
| Stoylensky GOK          |       |                                       | 11,305.0   |                                 |       |         | 11.4       | %                            |       | Belgorod  Region |   | NLMK |   |
| Karelsky Okatysh        |       |                                       | 9,964.2    |                                 |       |         | 10.0       | %                            |       | North-West  Region |   | Severstal-Resurs |   |
| Kachkanarsky GOK        |       |                                       | 9,430.7    |                                 |       |         | 9.5        | %                            |       | Urals  Region |   | EvrazGroup |   |
| Kovdorsky GOK           |       |                                       | 5,613.2    |                                 |       |         | 5.6        | %                            |       | North-West  Region |   | EvroChim |   |
| Korshunov Mining  Plant |       |                                       | 4,975.8    |                                 |       |         | 5.0        | %                            |       | Siberia |   | Mechel |   |
| Olenegorsky GOK         |       |                                       | 4,471.8    |                                 |       |         | 4.5        | %                            |       | North-West  Region |   | Severstal-Resurs |   |
| KMAruda                 |       |                                       | 1,850.9    |                                 |       |         | 1.9        | %                            |       | Belgorod  Region |   | Industrial  Metallurgical Holding |   |
| Sheregeshkoe RU         |       |                                       | 1,797.2    |                                 |       |         | 1.8        | %                            |       | Siberia |   | EvrazGroup |   |
| Vysokogorsky GOK        |       |                                       | 1,666.3    |                                 |       |         | 1.7        | %                            |       | Urals  Region |   | EvrazGroup |   |
| Irbinskoe RU            |       |                                       | 1,350.4    |                                 |       |         | 1.4        | %                            |       | Siberia |   | EvrazGroup |   |
| Bogoslovskoe RU         |       |                                       | 1,331.3    |                                 |       |         | 1.3        | %                            |       | Urals  Region |   | Ural  Mining-Metallurgical Company |   |
| Other                   |       |                                       | 7,633.6    |                                 |       |         | 7.7        | %                            |       |   |   |   |   |
| Total                   |       |                                       | 99,508.9   |                                 |       |         | 100.0      | %                            |       |   |   |   |   |

----

Source: Rudprom

In addition, Sokolovsko-Sarbayskoye MiningAmalgamation, which is located in Kazakhstan with a capacity of 16.7 milliontonnes of iron ore concentrate and 8.7 million tonnes of pellets per annum, hasbeen a major supplier to MMK since April 2006.

Nickel prices and demandsare driven by international markets.

**Coal production**

Southern Kuzbass Coal Company, through its branchesand one subsidiary (Tomusinsk Pit), operate five active coal mines centeredaround the city of Mezhdurechensk in the southwestern part of Siberia. Themines are located in the Kuznetsky Basin, Russia’s largest coal producingregion. This basin trends for approximately 300 kilometers in anorthwest-southeast direction and averages about 120 kilometers in width. Thereare four surface mines, Krasnogorsk, Tomusinsk, Olzherassk and Sibirginsk, aswell as three underground mines, Lenin, Sibirginsk and New-Olzherassk.Production started at Lenin in 1953, at Krasnogorsk in 1954, at Tomusinsk in1959, at Sibirginsk in 1973 (open-pit) and 2002 (underground) and at Olzherasskin 1980. We primarily lease or have a right of perpetual use of the land onwhich our coal mines and processing facilities are located.

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Thetable below sets forth the subsoil licenses used by our coal mines and theexpiration dates thereof.

| **No** | ** ** | ** **      | ** ** | **Mine / Pit**            | ** ** | **License Area**             | ** ** | **License Holder** | ** ** | **Expiry Date**  | ** ** | **Status** | ** ** | **Area  (sq. km)** | ** ** |
|--------|------------|-----------------|------------|-------------------------------------|------------|-----------------------------------|------------|-------------------------|------------|-----------------------|------------|------------|------------|-------------------------|------------|
| 1      |       | Krasnogorsk Pit |       | Tomsk,  Sibirginsk                  |       | Krasnogorsk Pit(1)                |       | December 2013      |       | In  production        |       |       | 22.4       |                    |       |
| 2      |       | Krasnogorsk Pit |       | Sorokinsky,  Tomsk, Sibirginsk      |       | Southern  Kuzbass Coal Company    |       | November 2025      |       | In  production        |       |       | 2.8        |                    |       |
| 3      |       | Lenin Mine      |       | Olzherassk                          |       | Lenin  Mine(1)                    |       | November 2013      |       | In  production        |       |       | 10.0       |                    |       |
| 4      |       | Lenin Mine      |       | Olzherassk                          |       | Lenin  Mine(1)                    |       | December 2014      |       | In  production        |       |       | 2.9        |                    |       |
| 5      |       | Olzherassk Pit  |       | Raspadsk,  Berezovsk, Olzherassk    |       | Olzherassk  Pit(1)                |       | January 2014       |       | In  production        |       |       | 10.1       |                    |       |
| 6      |       | Olzherassk Pit  |       | Raspadsk                            |       | Southern  Kuzbass Coal Company    |       | December 2024      |       | In  production        |       |       | 3.5        |                    |       |
| 7      |       | Olzherassk Pit  |       | Berezovsk-2,  Berezovsk, Olzherassk |       | Southern  Kuzbass Coal Company    |       | December 2024      |       | In  production        |       |       | 8.6        |                    |       |
| 8      |       | Olzherassk Pit  |       | Raspadsk                            |       | Olzherassk  Pit(1)                |       | December 2021      |       | In  production        |       |       | 10.1       |                    |       |
| 9      |       | Olzherassk Pit  |       | Razvedochny,  Raspadsk              |       | Southern  Kuzbass Coal Company(3) |       | November 2025      |       | Feasibility  study(3) |       |       | 14.6       |                    |       |
| 10     |       | Sibirginsk Mine |       | Sibirginsk,  Tomsk                  |       | Southern  Kuzbass Coal Company    |       | December 2024      |       | In  production        |       |       | 5.9        |                    |       |
| 11     |       | Sibirginsk Pit  |       | Sibirginsk,  Kureinsk, Uregoisk     |       | Southern  Kuzbass Coal Company(1) |       | January 2014       |       | In  production        |       |       | 17.7       |                    |       |
| 12     |       | Tomusinsk Pit   |       | Tomsk                               |       | Tomusinsk  Pit                    |       | December 2013      |       | In  production        |       |       | 6.7        |                    |       |
| 13     |       | Erunakovsk-1    |       | Erunakovsk-1,  Erunakovsk           |       | Southern  Kuzbass Coal Company(2) |       | July 2025          |       | Feasibility  study(2) |       |       | 8.4        |                    |       |
| 14     |       | Erunakovsk-3    |       | Erunakovsk-3,  Erunakovsk           |       | Southern  Kuzbass Coal Company(2) |       | July 2025          |       | Feasibility  study(2) |       |       | 7.1        |                    |       |
| 15     |       | Lenin Mine      |       | Olzherassk                          |       | Southern Kuzbass Coal  Company(2) |       | November 2025      |       | Feasibility study(2)  |       |       | 19.2       |                    |       |

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(1)                In process of re-registration due to merger of previouslicense holder into this company.

(2)                Not included in our mineral reserves.

(3)                Deposits of Olzherassk Pit are partially included in our reserves, asinternational standards for reserves appraisal only include reserves that canbe extracted with economic benefits during the license period. Thus, under theRussian standard, these deposits amounted to 159.9 million tonnes, and underthe international standard (which we use), these deposits amounted to 25.5million tonnes.

Coal is mined using open-pit or underground miningmethods. Following a drilling and blasting stage, a combination of shovels anddraglines is used for moving coal and waste at our surface mines. Production atthe underground mines is predominantly from longwall mining. After mining,depending upon the amount of impurities in the coal, the coal is processed in awash plant, where it is crushed and impurities are removed. Coking coalconcentrate is then transported to steel plants for conversion to coke for usein steel-making. Steam coal is shipped to utilities which use it in furnacesfor steam generation to produce electricity.

The coal produced by our mines is predominatelylow-sulfur (0.3%) bituminous. Heating values for the coking coal range from6,861 to 8,488 kcal/kg on a moisture- and ash-free basis. Heating values forthe steam coal range from 6,627 to 8,286 kcal/kilogram on a moisture- andash-free basis.

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Thetable below summarizes our coal production by mine and type of coal for theperiods indicated.

| ** **                       | ** ** | **2006**                               | ** ** | **2005**                  | ** ** | **2004**   | ** ** |
|----------------------------------|------------|----------------------------------------|------------|---------------------------|------------|------------|------------|
| ** **                       | ** ** | **Tonnes**                             | ** ** | **% of  production** | ** ** | **Tonnes** | ** ** | **% of  production** | ** ** | **Tonnes** | ** ** | **% of  production** | ** ** |
| ** **                       | ** ** | **(tonnes in thousands)(1)** | ** ** |
| **Coking Coal**                  | ** ** | ** **                             | ** ** |                      | ** ** | ** ** |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Sibirginsk (Pit & Mine) |       | 1,759                                  |       |                      | 18.1       | %          |       | 2,822 |   |   | 32.9 | % |   | 3,000 |   |   | 32.2 | % |   |
| Tomusinsk Pit                    |       | 2,477                                  |       |                      | 25.6       | %          |       | 2,607 |   |   | 30.4 | % |   | 2,660 |   |   | 28.6 | % |   |
| Olzherassk Pit                   |       | 1,613                                  |       |                      | 16.6       | %          |       | 1,581 |   |   | 18.4 | % |   | 1,413 |   |   | 15.2 | % |   |
| Lenin Mine                       |       | 1,880                                  |       |                      | 19.4       | %          |       | 1,573 |   |   | 18.3 | % |   | 2,236 |   |   | 24.0 | % |   |
| Sibirginsk Mine                  |       | 1,386                                  |       |                      | 14.3       | %          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Olzherassk Mine                  |       | 582                                    |       |                      | 6.0        | %          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Coking Coal                |       | 9,697                                  |       |                      | 100.0      | %          |       | 8,583 |   |   | 100.0 | % |   | 9,309 |   |   | 100.0 | % |   |
| **Steam Coal**                   | ** ** | ** **                             | ** ** |                      | ** ** | ** ** |       | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Krasnogorsk Pit                  |       | 5,587                                  |       |                      | 76.4       | %          |       | 5,278 |   |   | 74.7 | % |   | 4,726 |   |   | 74.6 | % |   |
| Sibirginsk (Pit & Mine) |       | 1,703                                  |       |                      | 23.3       | %          |       | 1,649 |   |   | 23.3 | % |   | 1,473 |   |   | 23.3 | % |   |
| Olzherassk Pit                   |       | 26                                     |       |                      | 0.3        | %          |       | 135 |   |   | 1.9 | % |   | 136 |   |   | 2.1 | % |   |
| Total Steam Coal                 |       | 7,316                                  |       |                      | 100.0      | %          |       | 7,063 |   |   | 100.0 | % |   | 6,335 |   |   | 100.0 | % |   |
| Total Coal                       |       | 17,013                                 |       |                      |       |       |       | 15,646 |   |   |   |   |   | 15,644 |   |   |   |   |   |
| % Coking Coal                    |       |                                   |       |                      | 57.0       | %          |       |   |   |   | 54.9 | % |   |   |   |   | 59.5 | % |   |
| % Steam Coal                     |       |                                   |       |                      | 43.0       | %          |       |   |   |   | 45.1 | % |   |   |   |   | 40.5 | % |   |

----

(1)          Tonnagesare reported on a wet basis.

***Coal washing plants***

We operate four coalwashing plants located near our coal mines in Southern Kuzbass. Of the totalcoal feed enriched by our washing plants in 2006, about 86.6% (14.9 milliontonnes) was supplied by our own mining operations, and 13.3% (2.3 milliontonnes) from the nearby Raspadsk and Prokopyevsk mines on a tolling basis. In2006, the capacity of our washing plants in Russia accounted for approximately15.5% of the total domestic coking coal washing capacity in Russia.

***Investments in coal companies***

We own 25.0% plus one share of Yakutugol, a coalproducer located in eastern Siberia. Yakutugol extracts predominantly cokingcoal, as well as steam coal, in open and underground mines. Yakutugol’s annualoutput in 2006 was 9.5 million tonnes of coal consisting of 5.4 milliontonnes of coking coal and 4.2 million tonnes of steam coal, and it sells mostof its output to the Asian Pacific region, primarily Japan, South Korea andTaiwan, mostly under long-term contracts.

Current subsoil licenses of Yakutugol expire in 2013, but based on theprovisions of Russian legislation we believe that their extension through theend of the estimated proven and probable reserve depletion period is reasonablyassured. We also believe that since the Government of Republic Sakha (Yakutia) owns a majority stake in Yakutugol,the renewal of its subsoil licenses upon their expiration in 2013 is virtuallyautomatic. Consequently, in our consolidated financial statements, we amortizeYakutugol’s subsoil licenses using the units-of-production method through the end of theestimated proven and probable reserve depletion period (2031).

We also own 16.1% ofMezhdurechye, a Russian coal producer which accounted for 3.8% of Russiancoking coal and 1.9% of Russian total coal output in 2006.

51

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**Iron ore andconcentrate production**

Korshunov Mining Plant operates three iron ore mines,Korshunovsk, Rudnogorsk and Tatianinsk, as well as a concentrating plantlocated outside of the town of Zheleznogorsk-Ilimsky, 120 kilometers eastof the city of Bratsk in eastern Siberia.

The Korshunovsk mine is located near the concentratingplant, and started production in 1965. The Rudnogorsk mine is located about 85kilometers to the northwest of the concentrating plant, and started productionin 1982. The Tatianinsk mine is located about 10 kilometers to the north of theconcentrating plant, and started production in 1986. All three mines produce amagnetite ore (Fe3O4). We have a right of perpetualuse of the land on which Korshunov Mining Plant’s facilities and mines arelocated.

Thetable below sets forth the subsoil licenses used by our iron ore mines and theexpiration dates thereof.

| **License area** | ** ** | ** **             | ** ** | **License Holder** | ** ** | **Expiry Date** | ** ** | **Status** | ** ** | **Area  (sq. km)** | ** ** |
|-----------------------|------------|------------------------|------------|-------------------------|------------|----------------------|------------|------------|------------|-------------------------|------------|
| Korshunovsk           |       | Korshunov  Mining Plan |       | June 2009          |       | In  production       |       |       | 4.3        |                    |       |
| Tatyaninsk            |       | Korshunov  Mining Plan |       | June 2012          |       | In  production       |       |       | 1.3        |                    |       |
| Rudnogorsk            |       | Korshunov  Mining Plan |       | June 2014          |       | In  production       |       |       | 5.1        |                    |       |
| Krasnoyarsk           |       | Korshunov Mining Plan  |       | July 2015          |       | Feasibility study(1) |       |       | 3.0        |                    |       |

----

(1)          Not included in ourmineral reserves and deposits.

All three mines are conventional open-pit operations.Following a drilling and blasting stage, ore is hauled via a combination oftruck and/or rail to the concentrator plant. At the concentrator, the ore iscrushed and ground to a fine particle size, then separated into an ironconcentrate slurry and a waste stream using wet magnetic separators. The ironore is upgraded from approximately 29.8% Fe to a concentrate that containsabout 62.9% Fe. Tailings are pumped to a tailings dam facility located adjacentto the concentrating plant. The concentrate is sent to disk filters whichremove the water to a moist filter cake, and then to a concentrate storage facility.The filter cake is then shipped to customers via rail during warmer months, butin colder periods the filter must be dried further to prevent freezing in therail cars. Korshunov Mining Plant has its own drying facility.

Thetable below summarizes our iron ore and iron ore concentrate production for theperiods indicated.

| ** **                       | ** ** | **2006**                               | ** ** | **2005**               | ** ** | **2004**   | ** ** |
|----------------------------------|------------|----------------------------------------|------------|------------------------|------------|------------|------------|
| ** **                       | ** ** | **Tonnes**                             | ** ** | **Grade  (% Fe)** | ** ** | **Tonnes** | ** ** | **Grade  (% Fe)** | ** ** | **Tonnes** | ** ** | **Grade  (% Fe)** | ** ** |
| ** **                       | ** ** | **(tonnes in thousands)(1)** | ** ** |
| Korshunovsk ore  production      |       | 6,193                                  |       |                   | 27.6       | %          |       | 6,522 |   |   | 26.7 | % |   | 6,263 |   |   | 26.4 | % |   |
| Rudnogorsk ore  production       |       | 5,224                                  |       |                   | 37.1       | %          |       | 4,104 |   |   | 35.3 | % |   | 3,576 |   |   | 35.5 | % |   |
| Tatianinsk ore  production       |       | 222                                    |       |                   | 32.2       | %          |       | 707 |   |   | 30.2 | % |   | 364 |   |   | 32.5 | % |   |
| Total ore  production            |       | 11,639                                 |       |                   | 32.0       | %          |       | 11,333 |   |   | 30.0 | % |   | 10,203 |   |   | 29.8 | % |   |
| Iron ore concentrate  production |       | 4,976                                  |       |                   | 62.6       | %          |       | 4,522 |   |   | 62.6 | % |   | 3,876 |   |   | n/a |   |   |

----

(1)          Tonnagesare reported on a wet basis.

52

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**Nickel ore andnickel production**

Southern Urals Nickel Plant operates two open-pitnickel ore mines, Sakhara and Buruktal, and a nickel production plant in Orsk.The Sakhara mine is located east of the Ural Mountains in the ChelyabinskRegion. It lies 10 to 15 kilometers south of the town of Subutak, which islocated on a main-line railroad 20 kilometers east of the city of Magnitogorsk,an industrial center in the Chelyabinsk Region. Stripping of overburden atSakhara started in 1983, and stripping of the main pit started in 1986.Shipments to Southern Urals Nickel Plant in Orsk (about 375 kilometers south ofSakhara) started in 1994 when Southern Urals Nickel Plant stopped receiving orefrom the Kempirsay deposit in Kazakhstan. Production at Sakhara has beencontinuous since 1994. The Buruktal mine is located east of the south tip ofthe Ural Mountains, in the Orenburg Region, close to the border withKazakhstan. It lies near the town of Svetly, which is located 230 kilometerseast of Orsk, at the end of a rail line. Mining at Buruktal began in 1968, andhas been continuous since then. We generally have a right of perpetual use ofthe land on which Southern Urals Nickel Plant’s facilities and mines arelocated, although we lease some of the area on which the Buruktal mine islocated.

Thetable below sets forth the subsoil licenses used by our nickel mines and theexpiration dates thereof.

| **License area** | ** ** | ** **                   | ** ** | **License Holder** | ** ** | **Expiry Date** | ** ** | **Status** | ** ** | **Area  (sq. km)** | ** ** |
|-----------------------|------------|------------------------------|------------|-------------------------|------------|----------------------|------------|------------|------------|-------------------------|------------|
| Buruktalsk            |       | Southern  Urals Nickel Plant |       | December 2012      |       | In  production       |       |       | 5.2        |                    |       |
| Sakharinsk            |       | Southern Urals Nickel  Plant |       | April 2013         |       | In production        |       |       | 2.2        |                    |       |

 

Both the Sakhara and Buruktal mining operations aretypical of Russian open-pit mines of their size. The weathered lateritic oresand overburden can be directly loaded by electric shovel and dragline into haultrucks, without any drilling or blasting. The ore is stockpiled and then loadedinto railcars for shipment to Southern Urals Nickel Plant. Overburden waste ishauled to dumping locations inside the mined-out pits whenever possible orplaced in dumps adjacent to the pit.

Nickel ore from both mines is transported by rail toour nickel production plant in the city of Orsk, which also lies east of thesouth tip of the Ural Mountains, close to the border with Kazakhstan. At thisplant, nickel ore is processed into sinter, which is smelted (with the additionof coke and limestone) in shaft furnaces and then put through oxygen convertersto produce converter matte and tailings. Converter matte is then processed intoferronickel. Ferronickel is shipped via rail from Orsk to our ChelyabinskMetallurgical Plant and to St. Petersburg or Kaliningrad for export.

Thefollowing table summarizes our nickel ore and nickel products production forthe periods indicated:

| ** **               | ** ** | **2006**                               | ** ** | **2005**               | ** ** | **2004**   | ** ** |
|--------------------------|------------|----------------------------------------|------------|------------------------|------------|------------|------------|
| ** **               | ** ** | **Tonnes**                             | ** ** | **Grade  (% Ni)** | ** ** | **Tonnes** | ** ** | **Grade  (% Ni)** | ** ** | **Tonnes** | ** ** | **Grade  (% Ni)** | ** ** |
| ** **               | ** ** | **(tonnes in thousands)(1)** | ** ** |
| Sakhara ore  production  |       | 1,118.3                                |       |                   | 1.10       | %          |       | 1,113.7 |   |   | 1.14 | % |   | 1,358.4 |   |   | 1.08 | % |   |
| Buruktal ore  production |       | 1,240.3                                |       |                   | 1.05       | %          |       | 901.6 |   |   | 1.06 | % |   | 1,243.6 |   |   | 1.02 | % |   |
| Total ore  production    |       | 2,358.6                                |       |                   | 1.07       | %          |       | 2,015.3 |   |   | 1.1 | % |   | 2,602.0 |   |   | 1.05 | % |   |
| Nickel production        |       | 14.4                                   |       |                   | 89.75      | %          |       | 12.6 |   |   | n/a |   |   | 12.7 |   |   | n/a |   |   |

----

(1)          Tonnagesare reported on a wet basis.

53

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**Limestoneproduction**

The Pugachev limestone quarry is an open-pit minelocated approximately 12 kilometers southeast of the city of Beloretsk in theUral Mountains. The mine is connected to the Beloretsk railway system via a 3-kilometerrail spur. A road system also connects the mine to regional customers ofaggregate limestone produced by the mine. The quarry was developed in 1952 tosupport Beloretsk Metallurgical Plant’s steel-making facilities, whichare currently closed. The Pugachev limestone quarry is owned by our BeloretskMetallurgical Plant. The current subsoil license is valid untilJanuary 2014.

Pugachev uses conventional mining technology. Ore isdrilled and blasted, then loaded with electric shovels into haultrucks.Relatively minor amounts of waste are hauled to external dumps. The ore is hauledto stockpiles located adjacent to the crushing and screening plant. Ore iscrushed, screened and segregated by size fraction. Product is separated intothree categories for sale: 0-20 millimeters product, 20-40millimeters product and 40-80 millimeters product.

The quarry produces both high-grade flux limestone foruse in steel making and nickel smelting and aggregate limestone for use in roadconstruction. The flux limestone and aggregate limestone are the same grade oflimestone, but they are produced in different fraction sizes, which determinestheir suitability for particular use. In 2006, approximately 71.6% of thelimestone produced at Pugachev was used internally, with 51.3% shipped toChelyabinsk Metallurgical Plant, 16.2% shipped to Southern Urals Nickel Plant,and 2.8% to Izhstal, 1.4% used auxiliary and the remaining 8.0% was sold tothird parties. This breakdown does not include normal losses of 2.6% of thetotal limestone production, which are losses ordinarily sustained during theproduction process, as well as our stock of 20.4% of the total limestoneproduction, which is limestone produced but neither sold nor consumed. We arecapable of internally sourcing 100% of the limestone requirements of our steeloperations.

Thetable below summarizes our limestone production for the periods indicated.

| ** **            | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|
| ** **            | ** ** | **(in thousands of tonnes)** | ** ** |
| Limestone  production |       | 2,013.7                                     |       | 2,054.0  |       | 509.0    |       |

 

Following the recentcommissioning****of our new crushing and screeningplant in December 2004, our total production capacity has increased to 2.0million tonnes of crushed limestone per year.

**Mineral reserves**

Our mineral reserves are based on exploration drillingand geological data, and are that part of a mineral deposit which could beeconomically and legally extracted or produced at the time of the reservedetermination. Each year we update our reserve calculations based on actualproduction and other factors, including economic viability and any newexploration data. Our reserves, consisting of proven and probable reserves,meet the standards set by the SEC in its Industry Guide 7 and have beenappraised by Marston & Marston, independent mining engineers, as ofJanuary 1, 2007.

Russian subsoil licenses are issued for definedboundaries and specific periods, generally about 20 years. Our declaredreserves are contained within the current license boundary. Additionally, tomeet the legally viable requirement of the SEC, only material that is scheduledto be mined during the license period of existing subsoil licenses based onplanned production was included in reserves.

Our subsoil licenses expire on dates falling in 2009through 2025. These subsoil licenses, however, may be terminated prior to, ornot be extended at, the time of their expiration. See “Item 3. Key Information—RiskFactors—Risks Relating to Our Business and Industry—Our business could beadversely affected if we fail to obtain or renew necessary licenses and permitsor fail to comply with the terms of our licenses and permits;” “Item 3. Key Information—RiskFactors—Risks Relating to Our Business and

54

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Industry—Deficiencies inthe legal framework relating to subsoil licensing subject our licenses to therisk of governmental challenges and, if our licenses are suspended orterminated, we may be unable to realize our reserves, which could materiallyadversely affect our business and results of operations;” and “—RegulatoryMatters—Subsoil Licensing.”

In addition to our mineral reserves, we have mineraldeposits. Our mineral deposits are similar to our mineral reserves in allrespects, except that the deposit is either (1) contained within thelicense boundary but is scheduled to be extracted beyond the license period or(2) is adjacent but not contained within the license boundary. In bothsuch cases, we expect to be able to obtain the legal right to extract suchdeposit in the future, but we have a limited history of license renewals andthe Russian legal system provides regulatory authorities with discretion inmatters of license renewal. See “Item 3. Key Information—Risk Factors—RisksRelating to Our Business and Industry—Our business could be adversely affectedif we fail to obtain or renew necessary licenses and permits or fail to complywith the terms of our licenses and permits” and “Item 3. Key Information—RiskFactors—Risks Relating to the Russian Federation—Legal Risks and Uncertainties—Weaknessesrelating to the legal system and legislation create an uncertain environmentfor investment and business activity.”

Thetable below summarizes our reserves as of January 1, 2007. 

| ** **  | ** ** | **Coal**                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------|------------|------------------------------------------------------------|------------|------------|------------|------------|------------|-------------------|------------|
| **Summary** | ** ** | ** **                                                 | ** ** | **Coking** | ** ** | **Steam**  | ** ** | **Iron Ore** | ** ** | **Nickel Ore** | ** ** | **Limestone** | ** ** |
| ** **  | ** ** | **(quantities in millions of tonnes)** | ** ** |
| Reserves    |       |                                                       | 126.3      |       |       | 155.5      |       |              | 61.4       |   |   |   | 12.9 |   |   |   | 23.9 |   |   |
| Grade(%)    |       |                                                       | 44.8       | %(1)       |       | 55.2       | %(1)       |              | 27.4       | % |   |   | 1.0 | % |   |   | 55.2 | % |   |
| Deposits    |       |                                                       | 56.2       |       |       | 135.4      |       |              | 111.8      |   |   |   | 63.4 |   |   |   | 40.5 |   |   |
| Grade(%)    |       |                                                       | 29.3       | %(1)       |       | 70.7       | %(1)       |              | 27.9       | % |   |   | 1.0 | % |   |   | 55.2 | % |   |
|             |            |                                                            |            |            |            |            |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Showspercent of the type of coal.

***Coal***

As ofJanuary 1, 2007, we had coal reserves (proven and probable) totaling 281.8 milliontonnes, of which approximately 44.8% was coking coal. The table below summarizescoal reserves by mine. 

| **Coal Reserves** | ** ** | ** **                                                    | ** ** | **Coking Coal** | ** ** | **Steam Coal** | ** ** | **Heating  Value(1)** | ** ** | **% Sulfur** | ** ** |
|------------------------|------------|---------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|-----------------------|------------|-------------------|------------|
| ** **             | ** ** | **(quantities in millions of tonnes)(2)** | ** ** |
| Krasnogorsk            |       |                                                          | —     |                 |       |                | 117.5      |                  |       |              | 5,700      |   |   |   | 0.35 | % |   |
| Tomusinsk              |       |                                                          | 12.6       |                 |       |                | —     |                  |       |              | 8,355      |   |   |   | 0.22 | % |   |
| Olzherassk Pit         |       |                                                          | 37.8       |                 |       |                | —     |                  |       |              | 8,250      |   |   |   | 0.30 | % |   |
| Olzherassk Mine        |       |                                                          | —     |                 |       |                | 25.5       |                  |       |              | 7,900      |   |   |   | 0.30 | % |   |
| Sibirginsk Pit         |       |                                                          | 19.6       |                 |       |                | 12.6       |                  |       |              | 8,446      |   |   |   | 0.30 | % |   |
| Sibirginsk Mine        |       |                                                          | 41.1       |                 |       |                | —     |                  |       |              | 8,510      |   |   |   | 0.30 | % |   |
| Lenin                  |       |                                                          | 15.3       |                 |       |                | —     |                  |       |              | 8,451      |   |   |   | 0.30 | % |   |
| Total                  |       |                                                          | 126.4      |                 |       |                | 155.6      |                  |       |              |       |   |   |   |   |   |   |
| % of Total             |       |                                                          | 44.8       | %                    |       |                | 55.2       | %                     |       |              |       |   |   |   |   |   |   |

----

(1)          Heating values (inkcal/kg) are reported on a moisture- and ash-free basis.

(2)          Tonnages are reported ona wet in-place basis.

55

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As ofJanuary 1, 2007, we had coal deposits totaling 191.6 milliontonnes, of which approximately 29.3% was coking coal. The table below summarizescoal deposits by mine. 

| **Coal Deposits** | ** ** | ** **                                                    | ** ** | **Coking Coal** | ** ** | **Steam Coal** | ** ** | **Heating  Value(1)** | ** ** | **% Sulfur** | ** ** |
|------------------------|------------|---------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|-----------------------|------------|-------------------|------------|
| ** **             | ** ** | **(quantities in millions of tonnes)(2)** | ** ** |
| Krasnogorsk            |       |                                                          | —     |                 |       |                | 110.5      |                  |       |              | 5,783      |   |   |   | 0.35 | % |   |
| Tomusinsk              |       |                                                          | 8.9        |                 |       |                | —     |                  |       |              | 8,355      |   |   |   | 0.22 | % |   |
| Olzherask              |       |                                                          | 14.4       |                 |       |                | —     |                  |       |              | 8,250      |   |   |   | 0.30 | % |   |
| Sibirginsk Pit         |       |                                                          | 12.1       |                 |       |                | 24.9       |                  |       |              | 8,466      |   |   |   | 0.30 | % |   |
| Sibirginsk Mine        |       |                                                          | 6.0        |                 |       |                | —     |                  |       |              | 8,533      |   |   |   | 0.30 | % |   |
| Lenin                  |       |                                                          | 14.7       |                 |       |                | —     |                  |       |              | 8,450      |   |   |   | 0.30 | % |   |
| Total                  |       |                                                          | 56.1       |                 |       |                | 135.4      |                  |       |              |       |   |   |   |   |   |   |
| % of Total             |       |                                                          | 29.3       | %                    |       |                | 70.7       | %                     |       |              |       |   |   |   |   |   |   |

----

(1)          Heating values (inkcal/kg) are reported on a moisture- and ash-free basis.

(2)          Tonnages are reported ona wet in-place basis.

Coal reserves and depositswere estimated using assumed base prices of $30.84per tonne for coking coal and $22.28 per tonne for steam coal. These priceswere for the saleable product so the actual prices in the cash flow werereduced to account for process recoveries, which varied by mine. All presentand future operating and capital costs were converted into U.S. dollars usingan exchange rate of 26.50 rubles per U.S. dollar.

***Iron ore***

As ofJanuary 1, 2007, we had iron ore reserves (proven and probable) totaling61.4 million tonnes at an average iron grade of 27.4%. The table belowsummarizes iron ore reserves by mine. 

| **Iron Ore Reserves(1)** | ** ** | ** **                         | ** ** | **Tonnes(2)** | ** ** | **Grade  (% Fe)(3)** | ** ** |
|------------------------------------|------------|------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                         | ** ** | **(tonnes in millions)** | ** ** |
| Korshunovsk                        |       |                               | 15.0       |          |       |                      | 25.0       | % |   |
| Rudnogorsk                         |       |                               | 42.2       |          |       |                      | 30.5       | % |   |
| Tatianinsk                         |       |                               | 4.2        |          |       |                      | 26.6       | % |   |
| Total                              |       |                               | 61.4       |          |       |                      | 27.4       | % |   |

----

(1)          Includes adjustments fordilution and mine recovery, based on historical records.

(2)          Tonnages are reported ona wet basis.

(3)          Metallurgical recoveryis projected to be 70.2%.

As ofJanuary 1, 2007, we had iron ore deposits totaling 111.8 milliontonnes at an average iron grade of 27.8%. The table below summarizes iron oredeposits by mine. 

| **Iron Ore Deposits(1)** | ** ** | ** **                         | ** ** | **Tonnes(2)** | ** ** | **Grade  (% Fe)(3)** | ** ** |
|------------------------------------|------------|------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                         | ** ** | **(tonnes in millions)** | ** ** |
| Korshunovsk                        |       |                               | 48.2       |          |       |                      | 25.0       | % |   |
| Rudnogorsk                         |       |                               | 63.6       |          |       |                      | 30.5       | % |   |
| Tatianinsk                         |       |                               | 0.0        |          |       |                      | 0.0        | % |   |
| Total                              |       |                               | 111.8      |          |       |                      | 27.8       | % |   |

----

(1)          Includes adjustments fordilution and mine recovery, based on historical records.

56

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(2)          Tonnages are reported ona wet basis.

(3)          Metallurgical recoveryis projected to be 70.2%.

Iron ore reserves anddeposits were estimated using an assumed iron ore concentrate price of $37.47 pertonne for 2007-2014. All present and future operating and capital costswere converted into U.S. dollars using an exchange rate of 26.50 rubles per U.S.dollar.

***Nickel ore***

As ofJanuary 1, 2007, we had nickel ore reserves (proven and probable) totaling13.0 million tonnes at an average nickel grade of 1.0%. The table belowsummarizes nickel ore reserves by mine. 

| **Nickel Ore Reserves(1)** | ** ** | ** **                         | ** ** | **Tonnes(2)** | ** ** | **Grade  (% Ni)(3)** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                           | ** ** | **(tonnes in millions)** | ** ** |
| Sakhara                              |       |                               | 5.8        |          |       |                      | 1.1        | % |   |
| Buruktal                             |       |                               | 7.2        |          |       |                      | 1.0        | % |   |
| Total                                |       |                               | 13.0       |          |       |                      | 1.0        | % |   |

----

(1)          Includes adjustments fordilution and mine recovery, based on historical records.

(2)          Tonnages are reported ona dry basis.

(3)          Metallurgical recoveryis projected to be 73.8%.

As ofJanuary 1, 2007, we had nickel ore deposits totaling 63.4 milliontonnes at an average nickel grade of 1.0%. The table below summarizes nickelore deposits. 

| **Nickel Ore Deposits(1)** | ** ** | ** **                         | ** ** | **Tonnes(2)** | ** ** | **Grade  (% Ni)(3)** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                           | ** ** | **(tonnes in millions)** | ** ** |
| Sakhara                              |       |                               | 0.0        |          |       |                      | 0.0        | % |   |
| Buruktal                             |       |                               | 63.4       |          |       |                      | 1.0        | % |   |
| Total                                |       |                               | 63.4       |          |       |                      | 1.0        | % |   |

----

(1)          Includes adjustments fordilution and mine recovery, based on historical records.

(2)          Tonnages are reported ona dry basis.

(3)          Metallurgical recoveryis projected to be 73.8%.

Nickel ore reserves anddeposits were estimated using an assumed nickel price of $8.05 per pound forthe period 2007-2042.****All presentand future operating and capital costs were converted into U.S. dollars usingan exchange rate of 26.50 rubles per U.S. dollar.

***Limestone***

As ofJanuary 1, 2007, we had limestone reserves (proven and probable) totaling 23.9 milliontonnes at 55.2% CaO. 

| **Limestone Reserves(1)** | ** ** | ** **                         | ** ** | **Tonnes** | ** ** | **Grade  (% CaO)** | ** ** |
|--------------------------------|------------|------------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                     | ** ** | **(tonnes in millions)** | ** ** |
| Pugachev                       |       |                               | 23.9       |       |       |                    | 55.2       | % |   |
|                                |            |                                    |            |            |            |                         |            |  |  |  |  |

----

(1)          Includes adjustments fordilution and mine recovery, based on historical records.

57

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As ofJanuary 1, 2007, we had limestone deposits totaling 40.5 million tonnes at55.2% CaO.

| **Limestone Deposits(1)** | ** ** | ** **                         | ** ** | **Tonnes** | ** ** | **Grade  (% CaO)** | ** ** |
|--------------------------------|------------|------------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                     | ** ** | **(tonnes in millions)** | ** ** |
| Pugachev                       |       |                               | 40.5       |       |       |                    | 55.2       | % |   |
|                                |            |                                    |            |            |            |                         |            |  |  |  |  |

----

(1)          Includesadjustments for dilution and mine recovery, based on historical records.

Limestone reserves anddeposits were estimated using an assumed aggregate limestone price of $5.03 pertonne.****All present and future operating andcapital costs were converted into U.S. dollars using an exchange rate of 26.50 rublesper U.S. dollar.

**Steel Business**

Our steel businesscomprises production and sale of semi-finished steel products, carbon andspecialty long products, carbon and stainless flat products, and value-addeddownstream metal products including hardware, stampings and forgings. Withinthese product groups, we are further able to tailor steel grades to meetspecific end-user requirements. Our steel business is supported by our miningbusiness, which includes coal (steam and coking coal), iron ore, nickel andlimestone.

Thefollowing table sets out our production volumes by primary steel productcategories and main products within these categories.

| ** **                                     | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                     | ** ** | **(in thousands of tonnes)** | ** ** |
| Coke                                           |       | 2,570                                       |       | 2,589    |       | 2,942    |       |
| Coking Products                                |       | 49                                          |       | 85       |       | 120      |       |
| Pig Iron                                       |       | 3,631                                       |       | 3,349    |       | 3,880    |       |
| Semi-Finished  Steel Products, including:      |       | 1,785                                       |       | 1,777    |       | 1,623    |       |
| Carbon and Low-Alloyed  Semi-Finished Products |       | 1,716                                       |       | 1,755    |       | 1,601    |       |
| Long Steel Products,(1) including:        |       | 2,529                                       |       | 2,510    |       | 2,902    |       |
| Stainless Long Products                        |       | 15                                          |       | 12       |       | 18       |       |
| Alloyed Long Products                          |       | 79                                          |       | 123      |       | 139      |       |
| Rebar                                          |       | 1,358                                       |       | 1,349    |       | 1,229    |       |
| Wire-Rod                                       |       | 367                                         |       | 349      |       | 640      |       |
| Low-Alloyed  Engineering Steel                 |       | 712                                         |       | 676      |       | 877      |       |
| Flat Steel Products,  including:               |       | 400                                         |       | 313      |       | 331      |       |
| Stainless Flat Products                        |       | 39                                          |       | 14       |       | 40       |       |
| Carbon and Low-Alloyed  Flat Products          |       | 361                                         |       | 299      |       | 291      |       |
| Forgings, including:                           |       | 75                                          |       | 79       |       | 99       |       |
| Stainless Forgings                             |       | 3                                           |       | 3        |       | 4        |       |
| Alloyed Forgings                               |       | 24                                          |       | 14       |       | 18       |       |
| Carbon and Low-Alloyed  Forgings               |       | 48                                          |       | 62       |       | 76       |       |
| Forged Alloys                                  |       | 1                                           |       | 1        |       | 1        |       |
| Stampings                                      |       | 101                                         |       | 104      |       | 78       |       |
| Hardware,(2) including:                   |       | 611                                         |       | 558      |       | 560      |       |
| Wire                                           |       | 466                                         |       | 394      |       | 395      |       |
| Ropes                                          |       | 55                                          |       | 55       |       | 53       |       |

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(1)          Includes calibratedrolled products of Mechel Targoviste.

(2)          Excludes calibratedrolled products of Mechel Targoviste.

58

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With the exception of ourforeign subsidiaries, we manufacture almost all of our steel products usinginternally sourced coke, pig iron, raw steel and semi-finished steel products.When economically justified, we sometimes purchase small quantities of semi-finishedsteel products from local steel producers. In 2006, we did not purchase anysemi-finished steel products from third parties. 

**Sales of steelproducts**

Thefollowing table sets forth our revenues by primary steel segment productcategories and our main products within these categories (including as apercentage of total steel segment revenues) for the periods indicated. Steelsegment sales data presented in “Steel Business” does not include intercompanysales to the mining segment.

| ** **                                        | ** ** | **2006**                                                                                     | ** ** | **2005**   | ** ** | **2004**                | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|
| **Revenues**                                      | ** ** | ** **                                                                                   | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** |
| ** **                                        | ** ** | **(in millions of U.S. dollars, except for percentages)** | ** ** |
| Coke                                              |       | 38.7                                                                                         |       |       | 1          | %                       |       | 49.2 |   |   | 2 | % |   | 39.0 |   |   | 1 | % |   |
| Coking Products                                   |       | 10.3                                                                                         |       |       | 0          | %                       |       | 17.6 |   |   | 1 | % |   | 18.3 |   |   | 1 | % |   |
| Pig Iron                                          |       | 14.1                                                                                         |       |       | 0          | %                       |       | 16.7 |   |   | 1 | % |   | 37.3 |   |   | 1 | % |   |
| Semi-Finished Products,including:                 |       | 397.5                                                                                        |       |       | 13         | %                       |       | 465.0 |   |   | 17 | % |   | 452.9 |   |   | 16 | % |   |
| Carbon and Low-Alloyed Semi-Finished  Products(1) |       | 299.3                                                                                        |       |       | 10         | %                       |       | 282.1 |   |   | 10 | % |   | 306.6 |   |   | 11 | % |   |
| Long Steel Products, including:                   |       | 1,436.3                                                                                      |       |       | 47         | %                       |       | 1,311.1 |   |   | 48 | % |   | 1,302.7 |   |   | 47 | % |   |
| Stainless Long Products                           |       | 35.2                                                                                         |       |       | 1          | %                       |       | 44.4 |   |   | 2 | % |   | 26.3 |   |   | 1 | % |   |
| Alloyed Long Products                             |       | 131.1                                                                                        |       |       | 4          | %                       |       | 118.3 |   |   | 4 | % |   | 89.1 |   |   | 3 | % |   |
| Rebar                                             |       | 753.0                                                                                        |       |       | 25         | %                       |       | 616.8 |   |   | 23 | % |   | 605.5 |   |   | 22 | % |   |
| Wire-Rod                                          |       | 202.3                                                                                        |       |       | 7          | %                       |       | 184.6 |   |   | 7 | % |   | 304.9 |   |   | 11 | % |   |
| Carbon and Low-Alloyed Engineering Steel     |       | 314.7                                                                                        |       |       | 10         | %                       |       | 347.0 |   |   | 13 | % |   | 177.0 |   |   | 6 | % |   |
| Flat Steel Products, including:                   |       | 304.2                                                                                        |       |       | 10         | %                       |       | 219.5 |   |   | 8 | % |   | 233.3 |   |   | 8 | % |   |
| Stainless Flat Products                           |       | 125.2                                                                                        |       |       | 4          | %                       |       | 45.9 |   |   | 2 | % |   | 94.3 |   |   | 3 | % |   |
| Carbon and Low-Alloyed Flat  Products             |       | 178.9                                                                                        |       |       | 6          | %                       |       | 173.6 |   |   | 6 | % |   | 139.1 |   |   | 5 | % |   |
| Forgings, including:                              |       | 81.2                                                                                         |       |       | 3          | %                       |       | 93.5 |   |   | 3 | % |   | 71.6 |   |   | 3 | % |   |
| Stainless Forgings                                |       | 9.8                                                                                          |       |       | 0          | %                       |       | 11.0 |   |   | 0 | % |   | 11.2 |   |   | 0 | % |   |
| Alloyed Forgings                                  |       | 11.9                                                                                         |       |       | 0          | %                       |       | 29.8 |   |   | 1 | % |   | 19.5 |   |   | 1 | % |   |
| Carbon and Low-Alloyed Forgings                   |       | 49.1                                                                                         |       |       | 2          | %                       |       | 45.8 |   |   | 2 | % |   | 28.9 |   |   | 1 | % |   |
| Forged Alloys                                     |       | 10.3                                                                                         |       |       | 0          | %                       |       | 6.9 |   |   | 0 | % |   | 12.0 |   |   | 0 | % |   |
| Stampings                                         |       | 151.7                                                                                        |       |       | 5          | %                       |       | 121.8 |   |   | 4 | % |   | 83.1 |   |   | 3 | % |   |
| Hardware, including:                              |       | 458.0                                                                                        |       |       | 15         | %                       |       | 373.8 |   |   | 14 | % |   | 326.2 |   |   | 12 | % |   |
| Wire                                              |       | 303.3                                                                                        |       |       | 10         | %                       |       | 253.9 |   |   | 9 | % |   | 213.0 |   |   | 8 | % |   |
| Ropes                                             |       | 60.6                                                                                         |       |       | 2          | %                       |       | 55.7 |   |   | 2 | % |   | 52.4 |   |   | 2 | % |   |
| Other                                             |       | 169.7                                                                                        |       |       | 6          | %                       |       | 42.3 |   |   | 2 | % |   | 193.0 |   |   | 7 | % |   |
| Total                                             |       | 3,061.7                                                                                      |       |       | 100        | %                       |       | 2,710.2 |   |   | 100 | % |   | 2,757.5 |   |   | 100 | % |   |
|                                                   |            |                                                                                              |            |            |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          We deducted the revenuesfrom slab sales in 2004-2006 from sales of “carbon and low-alloyedsemi-finished products.”

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Thefollowing table sets forth by percentage of sales the regions in which oursteel segment products were sold for the periods indicated.

| **Region(1)** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Russia        |       | 57.1       | %          | 48.0     | %          | 41.3     | %          |
| Other CIS     |       | 5.6        | %          | 5.0      | %          | 2.9      | %          |
| Europe        |       | 28.5       | %          | 29.9     | %          | 36.3     | %          |
| Asia          |       | 1.3        | %          | 8.6      | %          | 15.3     | %          |
| Middle East   |       | 5.5        | %          | 4.7      | %          | 2.3      | %          |
| United States |       | 1.7        | %          | 2.1      | %          | 1.2      | %          |
| Other         |       | 0.3        | %          | 1.7      | %          | 0.6      | %          |

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(1)          The regional breakdownof sales is based on the geographic location of our customers, and not on thelocation of the end users of our products, as our distributor customers reselland, in some cases, further export our products.

In 2006, our steel segment sales outside of Russiawere principally to Europe and CIS. Sales in Europe accounted for 28.5% of ourtotal steel segment sales. European sales during 2006 were largely to Romania(9.9%) and Switzerland (6.8%), followed by Germany (2.4%), Poland (1.2%), andFrance (0.8%). Sales to Switzerland primarily consisted of sales to GlencoreInternational (see below). Sales in Asia accounted for 1.3% of our total steelsegment sales, consisting of Indonesia (0.6%), followed by Vietnam (0.3%), andthe Philippines (0.2%). Middle East sales in 2006 accounted for 5.5% of ourtotal steel segment sales. The three largest markets were Iran (3.1%), UnitedArab Emirates (0.6%) and Turkey (0.5%).

In 2006, the five largest customers of our steelsegment products were Glencore International (carbon and low alloyed semifinished products, wire rods), Metallokomplekt-M (reinforcing bars and wirerods), MetallService (carbon and low-alloyed flat products, stainlessflat products, carbon and low-alloyed engineering steel ),Sibpromsnab (carbon and low-alloyed flat products, stainless flatproducts and reinforcing bars) and Dipos (reinforcing bars, wire rods, carbonand low-alloyed engineering steel ), which together accounted for16% of our steel segment sales.

Sales of our steel products to Glencore Internationalcomprised 9.2%, 8.0% and 10.9% of our total steel segment sales in 2006, 2005and 2004, respectively, which we record as European sales. GlencoreInternational resells these steel products primarily to customers in the MiddleEast and Asia. In 2006 and 2005, customers in the Middle East accounted for51.6% and 42.0%, respectively, of these sales, with most of these sales beingto Iran, and customers in Asia accounted for 27.0% and 43.0%, respectively, ofthese sales. See “—Marketing and Distribution—Export Sales” below for a furtherdescription of our steel product sales to Glencore International.

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Thefollowing table sets forth information on our domestic and export sales of ourprimary steel product categories for the periods indicated. We define exportsales as sales by our Russian and foreign subsidiaries to customers locatedoutside their respective countries. We define domestic sales as sales by ourRussian and foreign subsidiaries to customers located within their respectivecountries.

| **Products**                 | ** ** | ** **                                                                               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **                   | ** ** | **(in millions of U.S. dollars,  except for percentages)** | ** ** |
| Coke                         |       | 38.7                                                                                     |       | 49.2     |       | 39.0     |       |
| Domestic (%)                 |       | 95                                                                                       | %          | 100      | %          | 100      | %          |
| Export (%)                   |       | 5                                                                                        | %          | —   |       | —   |       |
| Coking Products              |       | 10.3                                                                                     |       | 17.6     |       | 18.3     |       |
| Domestic (%)                 |       | 99                                                                                       | %          | 89       | %          | 92       | %          |
| Export (%)                   |       | 1                                                                                        | %          | 11       | %          | 8        |       |
| Pig Iron                     |       | 14.1                                                                                     |       | 16.7     |       | 37.3     |       |
| Domestic (%)                 |       | 100                                                                                      | %          | 11       | %          | 29       | %          |
| Export (%)                   |       | 0                                                                                        | %          | 89       | %          | 71       | %          |
| Semi-Finished Steel Products |       | 397.5                                                                                    |       | 465.0    |       | 452.9    |       |
| Domestic (%)                 |       | 11                                                                                       | %          | 7        | %          | 8        | %          |
| Export (%)                   |       | 89                                                                                       | %          | 93       | %          | 92       | %          |
| Long Steel Products          |       | 1,436.3                                                                                  |       | 1,311.1  |       | 1,302.7  |       |
| Domestic (%)                 |       | 76                                                                                       | %          | 63       | %          | 55       | %          |
| Export (%)                   |       | 24                                                                                       | %          | 37       | %          | 45       | %          |
| Flat Steel Products          |       | 304.2                                                                                    |       | 219.5    |       | 233.3    |       |
| Domestic (%)                 |       | 79                                                                                       | %          | 57       | %          | 56       | %          |
| Export (%)                   |       | 21                                                                                       | %          | 43       | %          | 44       | %          |
| Forgings                     |       | 81.2                                                                                     |       | 93.5     |       | 71.6     |       |
| Domestic (%)                 |       | 48                                                                                       | %          | 48       | %          | 64       | %          |
| Export (%)                   |       | 52                                                                                       | %          | 52       | %          | 36       | %          |
| Stampings                    |       | 151.7                                                                                    |       | 121.8    |       | 83.1     |       |
| Domestic (%)                 |       | 82                                                                                       | %          | 84       | %          | 89       | %          |
| Export (%)                   |       | 18                                                                                       | %          | 16       | %          | 11       | %          |
| Hardware                     |       | 458.0                                                                                    |       | 373.8    |       | 326.2    |       |
| Domestic (%)                 |       | 76                                                                                       | %          | 72       | %          | 67       | %          |
| Export (%)                   |       | 24                                                                                       | %          | 28       | %          | 33       | %          |
| Other                        |       | 169.7                                                                                    |       | 42.3     |       | 193.0    |       |
| Domestic (%)                 |       | 70                                                                                       | %          | 64       | %          | 31       | %          |
| Export (%)                   |       | 30                                                                                       | %          | 36       | %          | 69       | %          |
| Total                        |       | 3,061.7                                                                                  |       | 2,710.2  |       | 2,757.5  |       |
| Domestic (%)                 |       | 68                                                                                       | %          | 55       | %          | 49       | %          |
| Export (%)                   |       | 32                                                                                       | %          | 45       | %          | 51       | %          |

 

The end users of our steel products vary. Our rebarsare principally used in the construction industry. The main end users of ourwire rods are small wire-drawing operations. Our carbon sheet is used inconstruction (covers, floor plates), the automotive industry (spare parts) andpipe manufacturing and shipbuilding (non-critical applications). Ourhigh-quality round bars are used in various moving parts manufactured by theautomotive industry (spare parts, gear boxes), the machinery industry(hydraulic 

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devices, drill bits), theshipbuilding industry (forged parts), the basic materials industry (molds,balls for crushing) and other industries. Our forgings and stampings areprimarily used in the automotive, aerospace, petrochemical, textile and foodand consumer goods sectors.

Thefollowing table sets forth by percentage a breakdown of our shipment volumes ofall products produced in Russia by industry sector within the Russian market in2006. 

| **Use by Industry**      | ** ** | ** ** | ** ** | **Metal Works,  Hardware  Plants** | ** ** | **Pipe  Factories** | ** ** | **Construction** | ** ** | **Engineering** | ** ** | **Railway  Construction,  Repair** | ** ** | **Power  Generation** | ** ** | **Other  Industries(1)** | ** ** |
|------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------|------------|------------------|------------|-----------------|------------|------------------------------------|------------|-----------------------|------------|--------------------------|------------|
| Semi-Finished  Steel Products |       |       | 95         | %                                       |       |                | 1          | %                |       |            | 0          | %                                  |       |                  | 3          | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 1 | % |   |
| Long Steel  Products               |       |       | 4          | %                                       |       |                | 1          | %                |       |            | 73         | %                                  |       |                  | 17         | %                        |       |   | 1 | % |   |   | 0 | % |   |   | 4 | % |   |
| Flat Steel  Products               |       |       | 1          | %                                       |       |                | 11         | %                |       |            | 67         | %                                  |       |                  | 20         | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 1 | % |   |
| Forgings                           |       |       | 16         | %                                       |       |                | 50         | %                |       |            | 0          | %                                  |       |                  | 32         | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 1 | % |   |
| Stampings                          |       |       | 2          | %                                       |       |                | 0          | %                |       |            | 4          | %                                  |       |                  | 54         | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 40 | % |   |
| Hardware                           |       |       | 8          | %                                       |       |                | 0          | %                |       |            | 19         | %                                  |       |                  | 20         | %                        |       |   | 10 | % |   |   | 2 | % |   |   | 41 | % |   |

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(1)          Includingthe defense, aerospace, petrochemical, textile, food and consumer goodssectors.

**Marketing andDistribution**

We use flexible sales strategies that are tailored toour customers and the markets we serve. Mechel Trading House, headquartered inMoscow, coordinates our Russian sales and has four sales branch offices. MechelTrading AG, based in Zug, Switzerland, coordinates export sales of our steelproducts through its branch in Schaan, Liechtenstein.

Our overall sales strategyis to develop long-term, close partnerships with the end users of our products.As part of our end-user strategy, we research sales to distributors to identifythe end user and directly market our steel capabilities and products to thesecustomers. With respect to our largest end-user customers, we have establishedworking committees, composed of our manufacturing engineers and customerpersonnel. These committees meet quarterly to monitor the performance of ourproducts and ensure that our customers’ specifications and quality requirementsare consistently met. These committees also provide customers the opportunityto discuss their future needs with us. Our sales force also regularly followsup with these and many of our other customers. We attend industry conferencesand advertise in industry periodicals to market our products and capabilities.Through these efforts, we have established a strong reputation for Mechelthroughout Russia and other countries of the CIS, Central and Eastern Europe,Southeast Asia and the Middle East.

***Domestic sales***

The Moscow headquarters of Mechel Trading House servesas the central domestic sales office for all our products. Our Moscow officeprovides additional customer service for, and collects feedback from, ourlargest and most important customers, and the information gathered is directlyprovided to senior management. The Moscow office, by virtue of its location, isalso well suited to develop new customers by approaching large Russianmanufacturers headquartered in Moscow or those companies that have centralizedpurchasing offices in Moscow. The Moscow office is also involved in respondingto tenders or requests for proposals, which is the most common method by whichRussian companies procure the supply of raw materials.

In January 2006, we established Mechel Hardware,which will sell products produced at Beloretsk Metallurgical Plant, VyartsilyaMetal Products Plant and Mechel Nemunas to the Russian and internationalmarkets.

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Our domestic steel production facilities are locatedin large industrial areas and have long-standing relationships dating fromSoviet times with local end-user customers. Mechel Trading House has fourbranches in Moscow, Chelyabinsk, Chebarkul and Izhevsk; and Mechel-Service hasseventeen warehouses in Chelyabinsk, Omsk, Tyumen, Ufa, Kazan, NizhniyNovgorod, Samara, Saratov, Tolyaty, Ekaterinburg, Perm, Novosibirsk, Rostov,Krasnodar, Sochi, Moscow and St. Petersburg. These branches develop and serviceour long-standing customer relationships by virtue of their proximity to bothproduction and customers and thereby allow our local sales forces to providehighly specialized and technical sales and service support to our Russiancustomers.

Mechel Trading House hasapproximately 300 employees. Mechel-Service has approximately 320 employees.Mechel Hardware has approximately 60 employees.

***Export sales***

Mostof our international steel sales are made to independent distributors, whichthen sell our products in smaller quantities to end users. Our subsidiaryMechel International Holdings has sales offices in the following sevencountries: 

| **Asia**    | ** ** | **Europe** |
|-------------|------------|------------|
| Philippines |       | Vietnam    |   | Austria |   | Belgium |
|        |       |       |   | Liechtenstein |   | Romania |
|        |       |       |   | Switzerland |   |   |
|             |            |            |  |  |  |  |  |  |

 

We also work with agents in 12 additional countries.We have an internationally oriented sales force which facilitatescommunications between our production facilities and the end users of ourproducts, keeping in mind local and international customs in business dealings,including language requirements. Our use of a centralized international salesorganization offers comprehensive and coordinated logistical and financialservices to our international customers.

Our Romanian sales are carried out by our Romaniansubsidiaries Mechel Campia Turzii and Mechel Targoviste.

Most of our distributor customers are based in onelocation close to end users. We service these customer relationships employinglocal sales forces and maintaining local sales offices, which makes us familiarwith the markets in which end users of our products are located.

Glencore International is the largest customer of ourexported steel segment products. During 2006, 2005, and 2004, we sold $282.6million, $217.3 million and $299.5 million in steel products to GlencoreInternational, respectively, comprising 9.2%, 8.0% and 10.9% of our total steelsegment sales, respectively, during these periods. Starting inNovember 2004, steel sales to Glencore International were made pursuant toa framework contract providing for the sale of a minimum of 180,000 tonnes ofcommodity carbon steel products per quarter at market-based prices. Thisframework contract extends through December 2007. The products purchasedby Glencore International consist of wire rod, rebar, billets, hot-rolled sheetand coil, which are then resold by Glencore International abroad, principallyto purchasers in Asia and the Middle East.

We also sell steel products to wholesalers on awalk-in basis through large open and covered warehouse areas in the Port ofAntwerp, Belgium. At this port, we primarily stock both rolled and forged bars,and intend to expand the product offering to cover other products such as wirerods and nails.

Mechel InternationalHoldings and its subsidiaries, branches and representative offices haveapproximately 92 employees.

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***Distribution***

Rail transportation isused for nearly all shipments from our production facilities and warehouses toour end customers, wholesale warehouses or sea ports.

**Market share andcompetition**

In our core international markets, we primarilycompete with Russian and Ukrainian producers, as the leading global steelmanufacturers focus more on value-added and higher-priced products.The principal competitive factors include price, distribution, product qualityand customer service.

In the Russian market, we compete on the basis ofprice and quality of steel products, their added value, product range andservice, technological innovation and proximity to customers. The Russian steelindustry is characterized by relatively high concentration of production, withthe six largest integrated steel producers, including us, accounting for 80% ofoverall domestic steel output in 2006.

Following is abrief description of Russia’s other four largest steel producers:

·       *EvrazGroup*, which consists of Nizhny TagilMetallurgical Plant, Zapadno-Sibirsky Metallurgical Plant (ZapSib), andKuznetsky Metallurgical Plant, is effectively the largest producer in Russia ona consolidated basis, accounting for 22% of Russia’s total rolled productsoutput (including production of long products, semi-finished products, forgingsand stampings) in 2006. Like us, EvrazGroup focuses on the production of longproducts including rebars, wire rods and profiled rolled products (such asrails, beams and channels). EvrazGroup also controls iron ore producers KachkanarskyGOK and Vysokogorsky GOK and coking coal producer Yuzhkuzbassugol, and has anequity investment in Raspaskaya Mine, which produces coking coal.

·       *Severstal* had a 17% market share ofRussian rolled steel production in 2006. The company specializes in flatproducts which constitute a significant part of its production. Severstal isthe second-leading producer of flat products and controls 24% of Russia’s totalproduction output. Domestic sales accounted for 68% of Severstal’s output in2006, with the oil and gas industry and automotive sector as its leadingcustomers. Severstal also controls UAZ, a domestic off-road car-maker,VorkutaUgol and Kuzbassugol, which completely satisfy Severstal’s coking coalrequirements, and iron ore producers Karelsky Okatysh and Olenegorsky GOK.

·       *MMK* accounted for 20% of Russian rolledsteel production in 2006. MMK’s product mix is comprised mostly of flatproducts, representing 85% of its commercial steel products output (includingproduction of slabs). Domestically, MMK controls a significant portion of thesupplies to the oil and gas and automotive sectors. MMK exported 52% of itsoutput in 2006 and also produces its own iron ore. Its production facilitiesare located in Magnitogorsk in the southern Urals.

·       *NLMK* had a 14% market share of Russianrolled steel production in 2006. The company produces primarily flat products(hot-rolled and cold-rolled), including galvanized products. NLMK exported 66%of its products in 2006. Domestically, NLMK’s largest customers are in theconstruction and oil and gas industries, followed by companies in theautomotive sector. NLMK also controls iron ore producer Stoilensky GOK. Thecompany’s steel facilities are located in Lipetsk, to the southeast of Moscow.

·       Metalloinvest, which consists of OEMK and Ural Steel,had a 9% market share of Russian rolled steel production. OEMK produces onlylong products, and Ural Steel produces both long and flat products.Metalloinvest exported 37% of its rolled steel production in 2006. The company’sproduction facilities are located in the Central and Ural Regions of Russia.The main shareholder of Metalloinvest also controls Russia’s largest iron oreand pellets production facilities, Lebedinskii and Mikhailovskii GOK.

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These six companies, including us, can be divided intotwo groups by product type. MMK, Severstal and NLMK focus mainly on flatproducts, while we, EvrazGroup and Metalloinvest produce primarily longproducts. According to Metall-Expert, Mechel is the leading and mostcomprehensive producer of specialty steel and alloys in Russia, and controlled39% of total Russian specialty steel output in 2006. We are also the thirdlargest producer in Russia of long products, with significant market shares inboth carbon and specialty steel long products, according to Metall-Expert.

In the Russiancarbon long market segment, our primary products and our market positions areas follows, according to Metall-Expert:

·       *Reinforcement bar*—In rebar, we compete inthe 6-40 millimeters range. In 2006, the rebar market was dominated byMechel (20%) and EvrazGroup (25%)(excluding imported rebars from the CIS). Atpresent, the Russian domestic market for rebar is protected from Ukrainianimports by a 21% import tariff, which was extended through August 2007.

·       *Wire rod*—There were five major producersof wire rod in Russia in 2006: Mechel (30%), EvrazGroup (21%), Severstal (24%),Nizhneserginsky MZ (12%) and MMK (11%). We produce some of the highest qualityand widest ranges of wire rod (5-10 millimeters) among Russian producers.

We were one of the leadingproducers in Russia of specialty steel long products (bearing, tool, high-speedand stainless steel) in 2006, producing 39% of the total Russian output. We hadsignificant market shares in stainless long products (45%), tool steel (39%)and high-speed steel (40%) in 2006. OEMK, an integrated steel mill specializingin long carbon and specialty steel products and our nearest specialty steelcompetitor, is located in the southwest of Russia and serves customers in thepipe, engineering and ball-bearing industries. Other Russian specialty steelproducers, like Electrostal, lag significantly behind us in terms of overallspecialty steel production. We were also Russia’s largest producer of stainlessflat products, with an 84% share of domestic production in 2006. We were thesecond largest producer of hardware in Russia in 2006 with a 23% market share,following Severstal (35%) and followed by MMK (15%). For products in which wespecialize, however, our share was substantially higher. For example, we had a54% share of the spring wire market and a 47% share of the high-endurance wiremarket during 2006. The preceding market share data was, in each case,according to the Association of Specialty Steel and Metall-Expert.

**Raw materials**

The principal raw materials we use in the making ofsteel are coke (produced from coking coal), iron ore, nickel, ferrous scrap andlimestone. We are 80% self-sufficient in our requirements of coking coal, withSouthern Kuzbass Coal Company having supplied 2.3 million tonnes of cokingcoal concentrate to Chelyabinsk Metallurgical Plant in 2006. We process cokingcoal concentrate into coke at Chelyabinsk Metallurgical Plant. Coke is used inboth steel-making operations at Chelyabinsk Metallurgical Plant and ournickel-smelting operations at Southern Urals Nickel Plant. In 2006, weproduced and internally used 0.3 million tonnes of coke in our productionfacilities and produced and sold another 2.2 million tonnes of coke to thirdparties. Our internal steam coal requirements are not material.

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Our steel-makingoperations use iron ore in the form of pellets, sinter, concentrate and sinterore. The ultimate form of the iron ore feed into the steel making process,however, consists of pellets and sinter only. In 2006, our steel-makingoperations used 5.7 million tonnes of iron ore feed, approximately 40% inthe form of pellets and 60% in the form of sinter, and we internally sourced40% of our total iron ore feed requirements during this period. Our KorshunovMining Plant supplied us with 2.3 million tonnes of iron ore concentrate in2006, which accounted for 100% of our total iron ore concentrate needs in thisperiod. Iron ore concentrate is converted into sinter at ChelyabinskMetallurgical Plant. We purchase most of the remaining part of our iron orefeed, mainly in the form of pellets, from Russian domestic suppliers such asKostomukshinsky GOK, Lebedinsky GOK and Karelsky Okatysh under annual contractson market terms.

In 2006, we usedapproximately 5,000 tonnes of nickel in the production of stainless and otherspecialty steels. We sourced approximately 67% of our nickel requirements in2006 from our nickel mining and smelting operations at Southern Urals NickelPlant. We source other nickel grades from Norilsk Nickel, Ufaleinikel and othersmaller nickel producers.

Our steel makingtechnology is primarily based on the basic oxygen furnaces, accounting for overhalf of our raw steel production. Ferrous scrap represents approximately 38% offeedstock, and we are approximately 41% self-sufficient in this raw material,sourcing the balance from various scrap traders. Electric arc furnaces are theprimary method of steel-making at Mechel Targoviste.

In March 2006, weacquired Mechel Recycling, a Chelyabinsk-based metal scrap processing company,in line with our policy of ensuring the steel segment’s self sufficiency in rawmaterials.

We internally source allof our limestone requirements from our Pugachev quarry. In 2006, we usedapproximately 1.1 million tonnes of limestone in the production of steel.

Steel making requiressignificant amounts of electricity to power electric arc furnaces and rollingmills and to convert coal to coke. In 2006, our operations consumedapproximately 3.5 billion kWh of electricity, of which 2.5 billion kWh was usedat Chelyabinsk Metallurgical Plant, 0.5 billion kWh was used at other Russianfacilities and 0.5 billion kWh was used at our Eastern European plants.Chelyabinsk Metallurgical Plant and Urals Stamping Plant have cogenerationpower facilities, which produced 1.7 billion kWh of electricity for internalconsumption in 2006, yielding 68% self-sufficiency at these plants and 31%self-sufficiency overall for the group, including mining operations. Thebalance was purchased from local utilities. Substantially all of our power-generatingfacilities work on blast furnace and coke gas, which are by-products of oursteel-making operations, and natural gas, which we purchase from Gazprom.In 2006, we consumed 5.0 billion cubic meters of blast furnace gas, 0.8 billioncubic meters of coke gas and 2.0 billion cubic meters of natural gas.

Large amounts of water arealso required in the production of steel. Water is used to cool the steel, tocarry away waste, to help produce and distribute heat and power and to diluteliquids. One of the principal sources of water is rivers, and many of ourfacilities recirculate a portion of water used for their production needs. Forexample, Chelyabinsk Metallurgical Plant sources 10% of its water needs from alocal river and the rest from recycled water. Each of Vyartsilya Metal ProductsPlant and Urals Stamping Plant sources 100% of its water needs from a localriver. Southern Urals Nickel Plant sources 88% of its water needs throughrecycling and the rest from a local river. Mechel Targoviste sources 100% ofits production water needs through recycling and the rest is sourced from alocal river.

Transportation costs are asignificant component of our production costs and a factor in our price-competitivenessin the export markets. Rail transportation is our principal means oftransporting raw materials from our mines to processing facilities and productsto domestic customers and to ports for shipment overseas. For a description ofour railway freight and forwarding subsidiary, see “—Steel Business—Marketingand Distribution—Distribution” above.

For a description of howseasonal factors impact our use and reserve levels of raw materials see “Item 5.Operating and Financial Review and Prospects—Trend Information—Seasonality”below.

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**Steel production facilities**

We generally own, lease orhave a right of perpetual use of the properties on which our steel productionfacilities are located. Most of the land on which Chelyabinsk MetallurgicalPlant, Beloretsk Metallurgical Plant, Urals Stampings Plant and Izhstal arelocated is used pursuant to a right of perpetual use. The land on whichVyartsilya Metal Products Plant and Mechel Nemunas are located is leased. Theland on which Mechel Targoviste and Mechel Campia Turzii are located is owned.

The main manufacturingprocesses at Chelyabinsk Metallurgical Plant, Beloretsk Metallurgical Plant,Urals Stampings Plant, Izhstal, Mechel Campia Turzii (with the exception ofwire-drawing workshop No. 3, as described below) and Mechel Targoviste areISO 9001:2000 certified through 2009. Wire-drawing workshop No. 3 ofMechel Campia Turzii is ISO 14001 certified through 2008.

***ChelyabinskMetallurgical Plant***

Our raw steel productionin Russia takes place at Chelyabinsk Metallurgical Plant. ChelyabinskMetallurgical Plant is an integrated coke and gas, sintering production, blastfurnace and BOF/EAF steel mill. It produces coke for sale, semi-finished steelproducts, carbon and specialty steel products and forgings. Its customer baseis largely comprised of steel producers and tube manufacturers, and customersfrom the construction, engineering and ball-bearing industries. The plantsources all of its coking coal needs from our Southern Kuzbass Coal Company andmost of its iron ore needs from our Korshunov Mining Plant and a majority ofits nickel needs from our Southern Urals Nickel Plant, respectively. In 2006,coke production and specialty steel production were separated from ChelyabinskMetallurgical Plant into separate entities called Mechel Coke and SpecialtySteel, respectively. Mechel Coke produces and sells coke, and Specially Steelproduces and sells specialty steel. Both Mechel Coke and Specialty Steel arewholly owned subsidiaries of Chelyabinsk Metallurgical Plant.

Chelyabinsk MetallurgicalPlant’s (including  Specialty Steel’s)principal steel and hire production lines include a BOF workshop equipped withthree converters; three EAF workshops equipped with electric arc ovens,including two large ovens of 100 and 125 tonnes, respectively; small capacityof constant and alternating-current furnaces, vacuum induction and plasmicfurnaces; vacuum arc and electroslag remelting furnaces; five comprehensivesteel treatment machines; two steel vacuum-degassed machines, an argon-oxygenrefining machine; four continuous billet-casters; blooming withcontinuous rolling mill for 200-320 millimeters and 80-180 millimeterssquare billets; six long product mills for 8-190 millimeters diameterround bar and 75-156 millimeters square bar, 6.5-10 millimeterswire rod, rebar steel, bands and shaped beams; a hot-rolled flat productworkshop with a thick sheet continuous rolling mill for hot-rolled sheets of upto 1,800 millimeters wide and up to 20 millimeters thick; a semi-continuousrolling mill for up to 1,500 millimeters wide and up to 6 millimetersthick hot-rolled coils; a cold-rolled product workshop for 0.3-4 millimeterscold-rolled stainless sheet; a forged piece hammer workshop and a forging andpressing workshop equipped with five presses and forging machines of 1,250-2,000tonnes, as well as eight coking batteries, seven sintering machines and threeblast furnaces. The following table sets forth the capacity, the capacityutilization rate and the planned increase in capacity for each of ChelyabinskMetallurgical Plant’s principal production areas.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Sintering                 |       | 5,100,000                                                  |       |                       | 74.0       | %                                                 |       |                               | 700,000    |   |   |
| Pig Iron                  |       | 3,800,000                                                  |       |                       | 95.6       | %                                                 |       |                               | —     |   |   |
| Steel-making              |       | 5,100,000                                                  |       |                       | 95.1       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 4,130,000                                                  |       |                       | 97.2       | %                                                 |       |                               | 195,400    |   |   |
| Forging and pressing      |       | 73,000                                                     |       |                       | 99.2       | %                                                 |       |                               | 16,440     |   |   |
| Coking                    |       | 3,100,000                                                  |       |                       | 74.0       | %                                                 |       |                               | —     |   |   |

 

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In 2005 we commissionedthe first part of a new sinter plant at Chelyabinsk Metallurgical Plant. Currentlyfour sintering machines are operational, and a new sintering plant provides atotal capacity of 4.5 million tonnes of sinter per annum.

***Izhstal***

Izhstal is a Russian specialty steel producer locatedin the city of Izhevsk, Udmurtia, west of the Urals. Its customer base islargely comprised of companies from the aircraft, defense, automotive,agricultural, power, engineering, oil and gas and construction industries.

Izhstal’sprincipal production lines include five EAF of 30 tonnes each; aggregate “ladlestove” and ladle vacuum machine with oxygen decarburization; three openhearth furnaces of 130-135 tonnes each; blooming machine for 100-220millimeters square billets; three medium-sized long products rollingmills for 30-120 millimeters round bars, 30-90 millimeters squarebars, bands and hexagonal bars; and one continuous small long products wiremill for 5.5-29 millimeters round, 12-28 millimeters square and 12-27millimeters hexagonal light sections, reinforced steel and bands. It also has ahardware workshop, equipped with various drawing mills, a pickling line and aforging workshop, equipped with a number of sledge hammers and press-cutters.The following table sets forth the capacity and the capacity utilization ratefor each of Izhstal’s principal production areas.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Steel-making              |       | 700,000                                                    |       |                       | 83.8       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 1,000,000                                                  |       |                       | 36.6       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 98,000                                                     |       |                       | 43.2       | %                                                 |       |                               | —     |   |   |
| Forging and stamping      |       | 60,000                                                     |       |                       | 29.0       | %                                                 |       |                               | —     |   |   |

 

Izhstal experienced lowcapacity utilization rates due to high production costs and the resultinguncompetitive products. Upon acquisition of Izhstal we took a strategicdecision to lower Izhstal production costs in steel-making and rollingactivities by supplying Izhstal with our semi-finished products, pig iron andnickel that resulted in increase of Izhstal steel-making and rolling capacityutilization from 71% and 36% in 2004 to 84% and 37% in 2006. Hardware andforging and stamping low capacity utilization rates are explained by low demandfor these products on Russian market.

***BeloretskMetallurgical Plant***

BeloretskMetallurgical Plant is a hardware plant that produces wire rod and a broadrange of hardware from semi-finished steel products supplied by ChelyabinskMetallurgical Plant. Its customers are largely from the construction andengineering industries. Beloretsk Metallurgical Plant’s principal productionlines include a steel-rolling workshop equipped with a wire mill forproduction of wire rod of 5.5-12 millimeters diameter and a number ofhardware workshops equipped with drawing, winding, unwinding, rewinding,polishing and rope machines and thermal treatment ovens. The following tablesets forth the capacity, the capacity utilization rate and the planned increasein capacity for each of Beloretsk Metallurgical Plant’s principal productionareas.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Rolling                   |       | 553,000                                                    |       |                       | 36.6       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 411,000                                                    |       |                       | 89.8       | %                                                 |       |                               | 43,000     |   |   |

 

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***Vyartsilya MetalProducts Plant***

VyartsilyaMetal Products Plant is a hardware plant that produces low carbon, welding andstructural wire, zinc-plated nails, and steel and polymeric-coated nets,from wire rod supplied by Chelyabinsk Metallurgical Plant and BeloretskMetallurgical Plant. The plant’s customers are largely from the construction,automotive and furniture industries. Vyartsilya Metal Products Plant’sprincipal production facilities include drawbenches and nail-making andmesh-weaving machines. The following table sets forth the capacity, thecapacity utilization rate and the planned increase in capacity for VyartsilyaMetal Products Plant’s principal production area.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Hardware                  |       |                                                       | 68,000     |                       |       |                                              | 92.0       | %                                  |       |   | — |   |   |
|                           |            |                                                            |            |                            |            |                                                   |            |                                    |            |  |  |  |  |  |  |

 

***Urals StampingsPlant***

Urals Stampings Plant isRussia’s largest producer of stampings from specialty steels and heat-proof andtitanium alloys for the aerospace, oil and gas, heavy engineering, railwaytransportation, power and other industries. Urals Stampings Plant sources its specialtysteel needs from Chelyabinsk Metallurgical Plant. Urals Stampings Plant’sprincipal production facilities include 1.5-25 tonne swages, hydraulicpresses and inker machines. The following table sets forth the capacity, thecapacity utilization rate and the planned increase in capacity for UralsStampings Plant’s principal production area.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Stamping                  |       | 100,000                                                    |       |                       | 83.0       | %                                                 |       |                               | —     |   |   |
|                           |            |                                                            |            |                            |            |                                                   |            |                                    |            |  |  |  |  |

 

***Mechel Targoviste***

Mechel Targoviste is a major Romanian EAF steel millthat produces specialty and carbon long products, forgings, and hardware.Mechel Targoviste is the largest producer of long products in Romania and thesecond largest producer of raw steel in Romania, according to Metal InvestConsulting. The plant’s customers are largely from the engineering, automotive,tool, ball-bearing, tube, hardware and construction industries.

MechelTargoviste’s principal production lines include an EAF workshop equipped withone modernized electric arc oven of 75 tonne capacity; steel vacuum processingand treatment machines; a continuous billets caster; a blooming machine for 80-400 millimeterssquare and 90-145 millimeters round billets; and two continuous longproducts rolling mills for 20-80 millimeters round bars, 24-57 millimetershexagonal bars, 60-70 millimeters square bars, 6-12 millimetersthick and 60-120 millimeters wide bands, 12-26 millimetersbundle rod and reinforcing steel. The following table sets forth the capacity,the capacity utilization rate and the planned increase in capacity for each ofMechel Targoviste’s principal production areas.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Steel-making              |       | 527,000                                                    |       |                       | 88.4       | %                                                 |       |                               | 73,000     |   |   |
| Forging and  pressing     |       | 37,400                                                     |       |                       | 12.4       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 780,000                                                    |       |                       | 47.5       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 6,700                                                      |       |                       | 22.6       | %                                                 |       |                               | —     |   |   |

 

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Mechel Targovisteexperienced low capacity utilization rates due to high production costs anduncompetitive product quality.

***Mechel CampiaTurzii***

Mechel Campia Turzii is a leading Romanian domestichardware plant that produces long steel products, including carbon and alloyedwire rod, rebar and hardware, including various types of wire, ropes, nets,electric cables and nails, as well as carbon and low-alloyed billets. Theplant’s customers are largely from the construction and engineering industries.

MechelCampia Turzii’s principal production lines include several hardware workshopsequipped with drawing, nail-making and zinc-plating machines. The followingtable sets forth the capacity, the capacity utilization rate and the plannedincrease in capacity for each of Mechel Campia Turzii’s principal productionareas.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2009)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Steel-making              |       | 363,000                                                    |       |                       | 0.5        | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 330,000                                                    |       |                       | 42.5       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 100,000                                                    |       |                       | 86.0       | %                                                 |       |                               | 35,500     |   |   |

 

Mechel Campia Turziiexperienced low capacity utilization rates in rolling workshops due to highproduction costs of production of semi-finished low-alloyed products andresulting uncompetitive products. In February 2006, as part of a restructuringof the production process at the Mechel Campia Turzii, one EAF steel-makingworkshop and two rolling mills were discontinued.

***Mechel Nemunas***

MechelNemunas is a Lithuanian hardware plant that produces wire, calibrated steelproducts, nails, rods and nets. Its customers are primarily from theconstruction, engineering and furniture industries. Mechel Nemunas’s principalproduction facilities include drawing mills, and nail-making, threading,net-weaving, net-wicking and contact-welding machines. The followingtable sets forth the capacity, the capacity utilization rate and the plannedincrease in capacity for Mechel Nemunas’s principal production area.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2006** | ** ** | **Capacity  Utilization  Rate in 2006** | ** ** | **Planned  Increase  (2007-2010)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Hardware                  |       |                                                       | 90,000     |                       |       |                                              | 70.9       | %                                  |       |   | — |   |   |
|                           |            |                                                            |            |                            |            |                                                   |            |                                    |            |  |  |  |  |  |  |

 

**Trade restrictions**

Trade restrictions in the form of tariffs, duties andquotas are widespread in the steel industry. However, we are less exposed thanmost other Russian steel producers since restrictions on Russian exports havemainly been directed against flat products, whereas most of our exports consistof long products, such as wire rods and rebars. In addition, the abolition bythe Russian government of steel export duties in 2002 has also effectivelyimproved the Russian steel export market.

In 2006, approximately 81%of our steel segment revenues were derived from sales of steel products thatwere subject to import restrictions. We describe below the main applicable traderestrictions in our key markets.

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***European Union***

Our steel sales to the EU constituted approximately 9%of our total steel segment revenues in 2006. The Russian government and theEuropean Community have an export quota system in place whereby Russian exportsto the EU are limited to certain stipulated quantities for each productcategory. The quota by product category is distributed between the Russianproducers based on a procedure jointly developed by the Ministry of EconomicDevelopment and Trade of the Russian Federation and the Ministry of Industryand Energy of the Russian Federation. The procedure provides that for eachproduct category, a company’s export quota allocation is calculated on thebasis of shipments by the company of the particular product over the past threeyears to the EU market (which is given a 70% weighting), and on the company’smarket share in domestic production of the particular product (which is given a30% weighting). After the quotas are calculated, the Russian Ministry of Industryand Energy then confirms quota allocations, and the Russian Ministry ofEconomic Development and Trade issues export licenses for these quotas. In2006, the quota covered approximately 43.7% of our steel segment productsexported to the EU.

In 2006, the total EU quota for Russian steel was 2.3million tonnes, and we received 268,668 tonnes of the total quota. As quotasare granted by product category, usage of our individual quotas varied. Forexample, usage of our 2006 quota for long products other than rebar and wirerod was 98%, while usage for our wire rod quota was 83%. The EU-Russia SteelAgreement for 2007 provides for the total Russian quota to be 2.9 milliontonnes. Our quota is set at approximately 290,000 tonnes, which includes 19,000tonnes for flat products and 271,000 tonnes for long products. Our supply ofwire rod to Mechel Nemunas, our hardware plant in Lithuania, is also subject tothe EU export quota system, and our quota for that plant is 61,500 tonnes for2007. We also expect to receive an additional quota in 2007 for supplying wirerod to our Romanian subsidiary Mechel Campia Turzii equal to 27,000 tones. See “Item 3.Key Information—Risk Factors—Risks Relating to Our Business and Industry—Weface numerous protective trade restrictions in the export of our steelproducts.”

In addition, an anti-dumping duty in the amount of50.7% was applicable for export to the EU of steel ropes and cablesmanufactured by our Beloretsk Metallurgical Plant until August 2006. Thisduty is under review at the EU, and we expect that it will be extended for fivemore years, but at a lower rate.

Finally, an anti-dumpinginvestigation against imports of steel wire ropes originating in Russia wasinitiated in Ukraine in January 2006. The investigation did not have amaterial effect on our sales, as we increased our sales in the Russian market.

***United States***

The United States has aquota system in place with respect to imports of hot rolled flat-rolled carbonquality steel and thick steel plate. The intergovernmental quota agreementsprovide for quotas and reference prices on Russian exports of these products tothe United States. A distribution of quotas between specific Russian producersand the execution of export licenses is carried out in accordance with the sameprocedure that applies to exports to the EU market. There are no traderestrictions applicable to the export of our Romanian or Lithuanian products tothe United States.

**CapitalImprovements Program**

We plan to spend $2.7 billion for our capital expendituresprogram for the five-year period of 2007 – 2011. It is targeted atexpansion of the mining segment and increasing the efficiency of the steelsegment. The split is approximately $1.2 billion in mining andapproximately $1.5 billion in steel.

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In the mining segment, in line with our target toproduce 25 million tonnes of coal in 2010, we will direct approximately $150million to the development of the Erunakovskaya deposit, which is expected toproduce approximately three million tonnes of coking coal annually; and $100million will be directed to the development of brownfield license areascovering approximately one billion tonnes of predominantly coking coal. Othermajor mining projects are also aimed at improving quality, and include the constructionof Sibirginskaya coal washing plant for approximately $65 million. In theiron ore business, we will invest approximately $90 million in KorshunovMining Plant.

Steel segment projects are targeted at improvingefficiency while maintaining existing output, and will be mainly directed toChelyabinsk Metallurgical Plant, our core steel-producing facility. Wecompleted construction of an additional continuous caster for approximately$145 million in line with our target to raise the proportion of steel producedthrough continuous casting from the current 37% to 50% in 2007. Other projectsinclude a new coking battery and reconstruction of rolling facilities.

The following table setsout by segment and facility the major items of our capital expenditures currentlyin progress or expected to be commenced in 2007-2008. 

| **Project**                                                           | ** ** | ** **                                                                                                                                                        | ** ** | **Estimated Production Increase   and/or Other Improvements** | ** ** | **Total Planned   Expenditures*** | ** ** | **Year of   Project   Start** | ** ** | **Estimated Year of   Commissioning/   completion** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------|------------|----------------------------------------|------------|------------------------------------|------------|---------------------------------------------------------------|------------|
|                                                                  | ** ** | ** **                                                                                                                                                        | ** ** | **(in millions of  U.S. dollars)**                                 | ** ** | ** **                             | ** ** | ** **                         | ** ** |
| **MINING BUSINESS**                                                   | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| **Southern Kuzbass Coal Company**                                     | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| Construction of Erunakovskaya-1 Mine                                  |       | Increase in coking coal output to 4.0 million   tonnes per annum                                                                                                  |       |                                                                              | $          | 150.0                                  | ** ** |                               |       | 2006                                                          | ** ** |   |   | 2012 | ** ** |   |
| Construction of mine in Olzherasskaya-Glubokaya field                 |       | Increase in coking coal output to 1.5 million   tonnes per annum                                                                                                  |       |                                                                              | $          | 75.0                                   | ** ** |                               |       | 2007                                                          | ** ** |   |   | 2011 | ** ** |   |
| Construction of Sibirginsk Mine                                       |       | Increase in coal output  from 1.7 to 3.2 million   tonnes per annum                                                                                               |       |                                                                              | $          | 80.0                                   | ** ** |                               |       | 2006                                                          | ** ** |   |   | 2010 | ** ** |   |
| Construction of Sibirginsk Washing plant                         |       | Increase of coal washing capacity by 4.0 million  tonnes of coking coal per annum                                                                                 |       |                                                                              | $          | 65.0                                   | ** ** |                               |       | 2007                                                          | ** ** |   |   | 2009 | ** ** |   |
| Development of  load-haul-dump system                                 |       | Increase of admission ability to transport  the   obtained coal by railway                                                                                   |       |                                                                              | $          | 85.0                                   | ** ** |                               |       | 2007                                                          | ** ** |   |   | 2009 | ** ** |   |
| Maintenance  current coal  capacity                                   |       | Modernization and renewal of mountain and   transport equipment                                                                                                   |       |                                                                              | $          | 265.0                                  | ** ** |                               |       | 2007                                                          | ** ** |   |   | 2011 | ** ** |   |
| **Korshunov Mining Plant**                                            | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| Development of Concentrate Production Facilities                      |       | Maintenance of iron-ore concentrates at the level   of 5 million tonnes per annum. Decrease mining   and enrichment costs                                         |       |                                                                              | $          | 90.0                                   | ** ** |                               |       | 2007                                                          | ** ** |   |   | 2010 | ** ** |   |
| **Port Posiet**                                                       | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| Reconstruction of Port                                                |       | Construction of modern  port with the aim to   increase export. As a result, port will be able to   handle water crafts with the capacity of  60 thousand tonnes. |       |                                                                              | $          | 70.0                                   | ** ** |                               |       | 2007                                                          | ** ** |   |   | 2009 | ** ** |   |
| **Southern Urals Nickel Plant**                                       | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| Conversion to up-to-date technology of production of iron nickel |       | Increase iron nickel production, decrease   production costs and improve ecological indexes.                                                                      |       |                                                                              | $          | 300.0                                  | ** ** |                               |       | 2009                                                          | ** ** |   |   | 2012 | ** ** |   |
| **STEEL BUSINESS**                                                    | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| **Chelyabinsk Metallurgical Plant**                                   | ** ** | ** **                                                                                                                                                        | ** ** |                                                                              | ** ** | ** **                             |       |                               | ** ** | ** **                                                    |       |   | ** ** | ** ** |   |
| Agglofactory 2                                                        |       | Increase of agglomerate  capacity to 6.5 million   tonnes per annum                                                                                               |       |                                                                              | $          | 85.0                                   | ** ** |                               |       | 2009                                                          | ** ** |   |   | 2012 | ** ** |   |

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| Construction of blast furnace                                                                                    |       | Capacity of 1.7 million tonnes per annum.   Increase of cast iron production to 4.5 million   tonnes per annum. Stopping of out of date   equipment.                                   |       |   | $          | 200.0      | ** ** |   |       | 2008       | ** ** |   |       | 2010           | ** ** |   |
|------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------|------------|------------|------------|--------|------------|------------|------------|--------|------------|----------------|------------|--------|
| Reconstruction of basic oxygen shop                                                                              |       | Replacement of two converters.Increase of steel   production by 270 thousand tonnes per annum                                                                                          |       |   | $          | 90.0       | ** ** |   |       | 2007       | ** ** |   |       | 2008/2009      | ** ** |   |
| Modernization of mill 250-2                                                                                      |       | Increase in production  capacity by 300 thousand   tonnes per annum. Production familiarization of   new sort of profiled iron and rod with diameter   from 5.5 to 40 millimeter. |       |   | $          | 120.0      | ** ** |   |       | 2007       | ** ** |   |       | 2009           | ** ** |   |
| Construction of bloom machine with complex of steel processing outside  stove in oxygen-converter shop |       | Increase in continuous casting block production   capacity by 1.0 million tonnes per annum                                                                                        |       |   | $          | 145.0      | ** ** |   |       | 2007       | ** ** |   |       | 2009           | ** ** |   |
| Construction of complex of outside steel processing                                                         |       | Capacity of 0.6 million tonnes  per annum                                                                                                                                              |       |   | $          | 90.0       | ** ** |   |       | 2008       | ** ** |   |       | 2010           | ** ** |   |
| Construction of rolled facilities in the blooming building                                                       |       | Production of new types of rolling for   construction usage. Capacity of 1 million tonnes   per annum                                                                                  |       |   | $          | 310.0      | ** ** |   |       | 2008       | ** ** |   |       | 2010           | ** ** |   |
| Modernization of slab machine of continuous steel pouring                                                        |       | Increase in production capacity to 1.2 million   tonnes per annum with increase of non-corrosive   steel production                                                                    |       |   | $          | 70.0       | ** ** |   |       | 2007       | ** ** |   |       | 2008           | ** ** |   |
| Reconstruction of sheet-rolling  mill 2300/1700                                                                  |       | Increase production capacity to 1.1million tonnes   and increase in thick sheet production capacity   by 400 thousand tonnes per annum.Production  of non-corrosive steel         |       |   | $          | 145.0      | ** ** |   |       | 2007       | ** ** |   |       | 2008/2009      | ** ** |   |
| Reconstruction of cool sheet-rolling mill                                                                        |       | Modernization of cool sheet-rolling shop in order   to increase non-corrosive rolling production                                                                                       |       |   | $          | 35.0       | ** ** |   |       | 2008       | ** ** |   |       | 2009           | ** ** |   |
| **Izhstal**                                                                                                      |       |                                                                                                                                                                                   |       |   |       | ** ** |       |   |       | ** ** |       |   |       | ** **     |       |
| Modernization of electro steel melting  production                                                               |       | Increase of steel melting capacity to  480 thousand tonnes per annum and steel quality   improvements. Close of open-hearth furnace                                                    |       |   | $          | 110.0      | ** ** |   |       | 2007       | ** ** |   |       | 2009           | ** ** |   |
| Reconstruction of mill 250                                                                                       |       | Increase in capacity to  300 thousand tonnes   per annum and increase of quality                                                                                                  |       |   | $          | 30.0       | ** ** |   |       | 2007       | ** ** |   |       | 2009           | ** ** |   |
| **Mechel Targoviste**                                                                                            | ** ** | ** **                                                                                                                                                                             | ** ** |   | ** ** | ** ** |       |   | ** ** | ** ** |       |   | ** ** | ** **     |       |
| Modernization of medium-grade and small-grade rolling mill complex                                               |       | Increase of profiled rolling capacity to  500 thousand tonnes and quality improvement                                                                                                  |       |   | $          | 20.0       | ** ** |   |       | 2006       | ** ** |   |       | 2007/2008/2009 | ** ** |   |
| Reconstruction of vacuum  machine                                                                                |       | Increase of capacity to200 thousand tonnes per   annum, decrease of production expenses                                                                                                |       |   | $          | 5.0        | ** ** |   |       | 2006       | ** ** |   |       | 2007           | ** ** |   |
| **Urals Stamping Plant, Beloretsk  Metallurgical Plant, Mechel Campia Turzii, Mechel Nemunas**                   |       |                                                                                                                                                                                   |       |   |       | ** ** |       |   |       | ** ** |       |   |       | ** **     |       |
| Modernization of hardware equipment                                                                              |       | Production of new products (wire, rope, nails and  forged piece). Quality increase                                                                                                     |       |   | $          | 105.0      |       |   |       | 2007       |       |   |       | 2007-2011      |       |   |

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*                     We estimate that approximately $31.4million of the aforementioned planned expenditures for these projects have beenmade as of December 31, 2006. In 2006, we spent $397.8  million in total for capital expenditures.

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**Research and Development**

We maintain researchprograms at the corporate level and at certain of our business units to carryout basic research and applied technology development activities, primarilyfocused on improving casting operations through improvements in workingpractices and operational methods. At our corporate level, we have theDepartment of Long-Term Planning and Technological Development, which isresponsible for research and development and employed a total of 8 researchers.We also contract with third-party consultants from the metallurgicalindustry and major Russian research institutions to produce developmentconcepts and conduct feasibility studies.

In addition to theseactivities performed at our corporate level, each of Chelyabinsk MetallurgicalPlant, Beloretsk Metallurgical Plant and Izhstal have specialized researchdivisions with a total of 201 researchers involved in the improvement ofexisting technologies and products.

We did not spent asignificant amount on research and development activities in 2006, 2005 and 2004.

**Insurance**

The insurance industry isnot yet well developed in Russia, and many forms of insurance protection commonin more economically developed countries are not yet available in Russia oncomparable terms, including coverage for business interruption. At present, ourfacilities are not insured, and we have no coverage for business interruptionor loss of key management personnel.

Our Russian subsidiariesmaintain obligatory insurance, which includes insurance for third-partyliability (including ecological) for injuries and losses caused by accidents indangerous industrial sites, insurance for third-party liability forinjuries caused during construction and operation of hydrotechnicalinstallations and auto insurance. Some of our Russian subsidiaries insureautomobiles, real estate interest and cargo, but it is not done in allinstances and for all significant assets. Mechel Trading Ltd, Zug, SchaanBranch maintains comprehensive insurance, including marine, liability,including products liability, and trade indemnity. Mechel Campia Turziimaintains insurance that covers its employees, property, plant and equipment. 

**Regulatory Matters**

We describe below certainregulatory matters that are applicable to our Russian operations.

**Licensing of Operations**

We are required to obtainnumerous licenses, authorizations and permits from Russian governmentalauthorities for our operations. The Federal Law on Licensing of Certain Typesof Activities of August 8, 2001, as amended, as well as other laws and regulations,set forth the activities subject to licensing and establish procedures forissuing licenses. In particular, some of our companies need to obtain licensesand permits to carry out their activities, including, inter alia:

·       theuse of subsoil, which is described in more detail in “—Subsoil Licensing”below;

·       theuse of water resources;

·       thedischarge of pollutants into the environment;

·       thehandling of hazardous waste;

·       storageand use of explosive, flammable and/or dangerous materials;

·       operationof industrial facilities (including mining and surveying activities);

·       construction;

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·       firecontrol and security;

·       medicaloperations; and

·       transportationactivities.

These licenses andpermissions are usually issued for a period of one to five years and may beextended upon application by the licensee. Licenses for the use of naturalresources may be issued for shorter or longer periods. Upon the expiration of alicense, it may be extended upon application by the licensee.

Regulatory authoritiesmaintain considerable discretion in the timing of issuing licenses and permits.The requirements imposed by these authorities may be costly, time-consuming andmay result in delays in the commencement or continuation of exploration orproduction operations. Further, private individuals and the public at largepossess rights to comment on and otherwise participate in the licensingprocess, including through challenges in the courts. Accordingly, the licenseswe need may not be issued, or if issued, may not be issued in a timely fashion,or may impose requirements which restrict our ability to conduct our operationsor to do so profitably.

As part of theirobligations under licensing regulations and the terms of our licenses andpermits, some of our companies must comply with numerous industrial standards,employ qualified personnel, maintain certain equipment and a system of qualitycontrols, monitor operations, maintain and make appropriate filings and, uponrequest, submit specified information to the licensing authorities that controland inspect their activities.

**Subsoil Licensing**

In Russia, mining mineralsrequires a subsoil license from the state authorities with respect to anidentified mineral deposit, as well as the right (through ownership, lease orother right) to use the land where such licensed mineral deposit is located. Inaddition, as discussed above, operating permits are required with respect tospecific mining activities.

The primary law regulatingsubsoil licensing is the Law on Subsoil Resources of February 21, 1992, asamended, or the Subsoil Law, which sets out the regime for granting licensesfor the exploration and production of mineral resources. The Procedure forSubsoil Use Licensing, or the Licensing Regulation, adopted by Resolution ofthe Supreme Soviet of the Russian Federation on July 15, 1992, as amended,also regulates the exploration and production of mineral resources. Accordingto both the Subsoil Law and the Licensing Regulation, subsurface mineralresources are subject to the joint jurisdiction of the federal and regionalauthorities.

Among different licensesrequired for mining minerals in Russia, the two major types of licenses are:(1) an exploration license, which is a non-exclusive license granting theright of geological exploration and assessment within the license area, and(2) a production license, which grants the licensee an exclusive right toproduce minerals from the license area. In practice, many of the licenses areissued as combined licenses, which grant the right to explore, assess andproduce minerals from the license area. A subsoil license defines the licensearea in terms of latitude, longitude and depth.

There are two major typesof payments with respect to the extraction of minerals: (1) periodicpayments for the use of subsoil under the Subsoil Law and (2) the mineralsextraction tax under the Tax Code. Failure to make these payments could resultin the suspension or termination of the subsoil license. The SubsoilLaw-mandated payments are not material to our mining segment’s results ofoperations. The minerals extraction tax is calculated as a percentage of thevalue of minerals extracted. Currently the tax rates are 4% for coal, 4.8% foriron ore and 8% for nickel. In 2006, we incurred the minerals extraction tax inthe amount of $27.0 million, out of which $25.7 million was included inthe income statement as other taxes. 

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The term of the license isset forth in the license. Prior to January 2000, exploration licensescould have a maximum term of five years, production licenses a maximum term of20 years, and combined exploration, assessment and production licenses amaximum term of 25 years. After amendments of the Subsoil Law inJanuary 2000 and in August 2004, exploration licenses still have amaximum term of five years; in the event that a prior license with respect to a particular field is terminatedearly (for example, when a licenseis withdrawn due non-usage of the licensed subsoil), a productionlicense may have a one-year term until a new licensee is determined, but isgenerally granted to another user for the term of the expected operational lifeof the field based on a feasibility study; and combined exploration, assessmentand production licenses can be issued for the term of the expectedoperational life of the field based on a feasibility study. These amendmentsdid not affect the terms of licenses issued prior to January 2000, butpermit licensees to apply for extensions of such licenses for the term of theexpected operational life of the field in accordance with the amended SubsoilLaw. The term of a subsoil license runs from the date the license is registeredwith the Russian Federal Geological Fund.

***Issuance of licenses***

Subsoil licenses areissued by the Federal Agency for Subsoil Use. Most of the currently existingproduction licenses owned by companies derive from (1) pre-existing rightsgranted during the Soviet era and up to the enactment of the Subsoil Law tostate-owned enterprises that were subsequently reorganized in the courseof post-Soviet privatizations; or (2) tender or auction procedures held inthe post-Soviet period. The Russian Civil Code, the Subsoil Law and theLicensing Regulation contain the major requirements relating to tenders andauctions. The Subsoil Law does not forbid production licenses to be issuedwithout a tender or auction procedure only in limited circumstances, such asinstances when a mineral deposit is discovered by the holder of an explorationlicense at its own expense during the exploration phase.

***Extension of licenses***

The Subsoil Law permits asubsoil licensee to request an extension of a production license in order tocomplete the production from the subsoil plot covered by the license or theprocedures necessary to vacate the land once the use of the subsoil iscomplete, provided the user complies with the terms and conditions of thelicense and the relevant regulations.

In order to extend aperiod of a subsoil license, a company must file an application with thefederal authorities to amend the license.

The Order of the Ministryof Natural Resources No. 439-R, dated October 31, 2002,requires that the following issues be considered by the relevant governmentalauthorities when determining whether to approve an amendment: (1) thegrounds for the amendments, with specific information as to how the amendmentsmay impact payments by the licensee to the federal and local budgets;(2) compliance of the licensee with the conditions of the license; and(3) the technical expertise and financial capabilities that would berequired to implement the conditions of the amended license.

The factors that may, inpractice, affect a company’s ability to obtain the approval of licenseamendments include (1) its compliance with the license terms andconditions; (2) its management’s experience and expertise relating tosubsoil issues, including experience in amending licenses; and (3) therelationship of its management with federal and/or local governmentalauthorities, as well as the local governments. For a description of additionalfactors that may affect Russian companies’ ability to extend their licenses,see “Item 3. Key Information—Risk Factors—Risks Relating to Our Business andIndustry—Our business could be adversely affected if we fail to obtain or renewnecessary licenses and permits or fail to comply with the terms of our licensesand permits.” See also “Item 3. Key Information—Risk Factors—Risks Relating toOur Business and Industry—Deficiencies in the legal framework relating tosubsoil licensing subject our licenses to the risk of governmental challengesand, if our licenses are 

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suspendedor terminated, we may be unable to realize our reserves, which could materiallyadversely affect our business and results of operations” and “—Item 3. KeyInformation—Risk Factors—Risks Relating to the Russian Federation—Legal Risksand Uncertainties—Weaknesses relating to the legal system and legislationcreate an uncertain environment for investment and business activity.”

***Maintenance and termination oflicenses***

A license granted under theSubsoil Law is accompanied by a licensing agreement. The law provides thatthere be two parties to any subsoil licensing agreement: the federalauthorities and the licensee. The licensing agreement sets out the terms andconditions for the use of the subsoil.

Under a licensingagreement, the licensee makes certain environmental, safety and productioncommitments. For example, the licensee makes a production commitment to bringthe field into production by a certain date and to extract an agreed-upon volumeof natural resources each year. The license agreement may also containcommitments with respect to social and economic development of the region. Whenthe license expires, the licensee must return the land to a condition which isadequate for future use. Although most of the conditions set out in a licenseare based on mandatory rules contained in Russian law, certain provisionsin a licensing agreement are left to the discretion of the licensingauthorities and are often negotiated between the parties. However, commitmentsrelating to safety and the environment are generally not negotiated. We expectthat we will be able to meet the commitments set forth in our licensingagreements.

The fulfillment of alicense’s conditions is a major factor in the good standing of the license. Ifthe subsoil licensee fails to fulfill the license’s conditions, upon notice,the license may be limited or terminated by the licensing authorities. However,if a subsoil licensee cannot meet certain deadlines or achieve certain volumesof exploration work or production output as set forth in a license, it mayapply to amend the relevant license conditions, though such amendments may bedenied.

The Subsoil Law and otherRussian legislation contain extensive provisions for license termination. Alicensee can be fined or the license can be suspended or terminated for thereasons noted above, for repeated breaches of the law, upon the occurrence of adirect threat to the lives or health of people working or residing in the localarea, or upon the occurrence of certain emergency situations. A license mayalso be terminated for violations of “material” license terms. Although theSubsoil Law does not specify which terms are material, failure to pay subsoiltaxes and failure to commence operations in a timely manner have been commongrounds for limitation or termination of licenses. Consistent underproductionand failure to meet obligations to finance a project would also likelyconstitute violations of material license terms. In addition, certain licensesprovide that the violation by a subsoil licensee of any of its obligations mayconstitute grounds for terminating the license.

If the licensee does notagree with a decision of the licensing authorities, including a decisionrelating to a license termination or the refusal to re-issue an existinglicense, the licensee may appeal the decision through administrative orjudicial proceedings. In certain cases of termination, the licensee has theright to attempt to cure the violation within three months of its receipt ofnotice of the violation. If the issue has been resolved within such a three-monthperiod, no termination or other action may be taken.

**Land Use Rights**

Russian legislationprohibits the carrying out of any commercial activity, including mineralextraction, on a land plot without appropriate land use rights. Land use rightsare needed and obtained for only the portions of the license area actuallybeing used, including the plot being mined, access areas and areas where othermining-related activity is occurring.

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Under the Land Code,companies generally have one of the following rights with regard to land in theRussian Federation: (1) ownership; (2) right of perpetual use; or(3) lease.

A majority of land plotsin the Russian Federation are owned by federal, regional or municipalauthorities which, through public auctions or tenders or through privatenegotiations, can sell, lease or grant other use rights to the land to thirdparties.

Companies may also have aright of perpetual use of land that was obtained prior to the enactment of theLand Code; however, the Federal Law on Introduction of the Land Code ofOctober 25, 2001, with certain exceptions, requires companies using landpursuant to rights of perpetual use either to purchase the land from, or toenter into a lease agreement relating to, the land with the relevant federal,regional or municipal authority owner of the land by January 1, 2008. See“Item 3. Key Information—Risk Factors—Risks Relating to Our Business and Industry—Thepotential implementation by the Russian government of a law requiring Russiancompanies to purchase or lease the land on which they operate may have amaterial adverse effect on our financial condition.”

Our mining subsidiariesgenerally have a right of perpetual use of their plots or have entered intolong-term lease agreements. A lessee generally has a priority right to enterinto a new land lease agreement with a lessor upon the expiration of a landlease. In order to renew a land lease agreement, the lessee must apply to thelessor (usually state or municipal authorities) for a renewal prior to theexpiration of the agreement. Any agreement for a period longer than one yearmust be registered with the relevant state authorities.

**Environmental**

We are subject to laws,regulations and other legal requirements relating to the protection of theenvironment, including those governing the discharge of substances into the airand water, the formation, distribution and disposal of hazardous substances andwaste, the cleanup of contaminated sites, flora and fauna protection andwildlife protection. Issues of environmental protection in Russia are regulatedprimarily by the Federal Law on Environmental Protection of January 10,2002, as amended, or the Environmental Protection Law, as well as by a numberof other federal and local legal acts.

***Pay-to-pollute***

The EnvironmentalProtection Law establishes a “pay-to-pollute” regime administered by federaland local authorities. The Russian government has established standardsrelating to the permissible impact on the environment and, in particular,limits for emissions and disposal of substances, waste disposal and resourceextraction. A company may obtain approval for exceeding these statutory limitsfrom the federal or regional authorities, depending on the type and scale ofenvironmental impact. As a condition to such approval, a plan for the reductionof the emissions or disposals must be developed by the company and cleared withthe appropriate governmental authority. Fees, as set forth in a governmentaldecree, are assessed on a sliding scale for both the statutory or individuallyapproved limits on emissions and effluents and for pollution in excess of theselimits: the lowest fees are imposed for pollution within the statutory limits,intermediate fees are imposed for pollution within the individually approvedlimits, and the highest fees are imposed for pollution exceeding such limits.Payments of such fees do not relieve a company from its responsibility to takeenvironmental protection measures and undertake restoration and clean-upactivities. In 2006, we incurred such fees in the amount of $3.0 million. 

***Ecologicalapproval***

Any activities that mayaffect the environment are subject to state ecological approval by federalauthorities in accordance with the Federal Law on Ecological Expert Examinationof November 23, 1995, 

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asamended. Conducting operations that may cause damage to the environment withoutstate expert ecological approval may result in the negative consequencesdescribed in “Environmental Liability” below.

***Enforcement authorities***

The Federal Service forthe Supervision of the Use of Natural Resources, the Federal Service forEnvironmental, Technological and Nuclear Supervision, the Federal Service forHydrometrology and Environmental Monitoring, the Federal Agency on Subsoil Use,the Federal Agency on Forestry, the Federal Agency on Water Resources (alongwith their regional branches) and the Federal Agency on Protection of ConsumersRights are involved in environmental control, implementation and enforcement ofrelevant laws and regulations. The federal government and Ministry of NaturalResources is responsible for coordinating the activities of the regulatoryauthorities in this area. Such regulatory authorities, along with other stateauthorities, individuals and public and non-governmental organizations, alsohave the right to initiate lawsuits for the compensation of damage caused tothe environment. The statute of limitations for such lawsuits is 20 years.

***Environmental liability***

If the operations of acompany violate environmental requirements or cause harm to the environment orany individual or legal entity, a court action may be brought to limit or banthese operations and require the company to remedy the effects of theviolation. Any company or employees that fail to comply with environmentalregulations may be subject to administrative and/or civil liability, andindividuals may be held criminally liable. Courts may also impose clean-up obligationson violators in lieu of or in addition to imposing fines or other penalties tocompensate for damages.

Subsoil licenses generallyrequire certain environmental commitments. Although these commitments can besubstantial, the penalties for failing to comply and the clean-up requirementsare generally low.

***Reclamation***

We conduct our reclamationactivities for land damaged by production in accordance with the BasicRegulation on Land Reclamation, Removal, Preservation, and Rational Use of theFertile Soil Layer, approved by Order No. 525/67 of December 22,1995, of the Ministry of Natural Resources. In general, our reclamationactivities involve both a technical stage and a biological stage. In the firststage, we backfill the pits, grade and terrace mound slopes, level the surfaceof the mounds, and add clay rock on top for greater adaptability of youngplants. In the biological stage, we plant conifers (pine, larch, cedar) onhorizontal and gently sloping surfaces, and shrubs and bushes to reinforce inclines.Russian environmental regulations do not require mines to achieve theapproximate original contour (AOC) of the property as is required, for example,in the United States.

***Environmental protection programs***

We have been developingand implementing environmental protection programs at all of our mining, steeland transportation subsidiaries. Such programs include measures to aid in ouradherence to the requirements and limits imposed on air and water pollution, aswell as allocation of industrial waste, introduction of environmentallyfriendly industrial technologies, the construction of purification andfiltering facilities, the repair and reconstruction of industrial water supplysystems, the installation of metering systems, reforestation and the recyclingof water and industrial waste. We are a member of “Ecological Movement forSpecific Activities,” a non-profit organization which develops and facilitatesthe implementation of environmental programs and individual projects for stateand private institutions.

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**Health and Safety**

Due to the nature of our business, much of ouractivity is conducted at industrial sites by large numbers of workers, andworkplace safety issues are of significant importance to the operation of thesesites.

The principal law regulating industrial safety is theFederal Law on Industrial Safety of Dangerous Industrial Facilities ofJuly 21, 1997, as amended, or the Safety Law. The Safety Law applies, inparticular, to industrial facilities and sites where certain activities areconducted, including sites where lifting machines are used, where alloys offerrous and non-ferrous metals are produced and where certain types of miningis done. 

There are also regulations that address safetyrules for coal mines, the production and processing of ore, the blast-furnaceindustry, steel smelting, alloy production and nickel production. Additionalsafety rules also apply to certain industries, including metallurgical andcoke chemical enterprises, and the foundry industry.

Any construction, reconstruction, liquidation or otheractivities in relation to regulated industrial sites is subject to a stateindustrial safety review. Any deviation from project documentation in theprocess of construction, reconstruction and liquidation of industrial sites is prohibitedunless reviewed by a licensed expert and approved by the Federal Service forEnvironmental, Technological and Nuclear Supervision.

Companies that operate such industrial facilities andsites have a wide range of obligations under the Safety Law and the Labor Codeof Russia effective February 1, 2002, as amended, or the Labor Code. Inparticular, they must limit access to such sites to qualified specialists,maintain industrial safety controls and carry insurance for third-partyliability for injuries caused in the course of operating industrial sites. TheSafety Law also requires these companies to enter into contracts withprofessional wrecking companies or create their own wrecking services incertain cases, conduct personnel training programs, create systems to cope withand inform the Federal Service for Environmental, Technological and NuclearSupervision of accidents and maintain these systems in good working order.

In certain cases, companies operating industrial sitesmust also prepare declarations of industrial safety which summarize the risksassociated with operating a particular industrial site and measures the companyhas taken and will take to mitigate such risks and use the site in accordancewith applicable industrial safety requirements. Such declarations must beadopted by the chief executive officer of the company, who is personallyresponsible for the completeness and accuracy of the data contained therein.The industrial safety declaration, as well as a state industrial safety review,are required for the issuance of a license permitting the operation of adangerous industrial facility.

The Federal Service for Environmental, Technologicaland Nuclear Supervision has broad authority in the field of control andmanagement of industrial safety. In case of an accident, a special commissionled by a representative of the Federal Service for Environmental, Technologicaland Nuclear Supervision conducts a technical investigation of the cause. Thecompany operating the hazardous industrial facility where the accident tookplace bears all costs of an investigation. The officials of the Federal Servicefor Environmental, Technological and Nuclear Supervision have the right toaccess industrial sites and may inspect documents to ensure a company’scompliance with safety rules. The Federal Service for Environmental,Technological and Nuclear Supervision may suspend or terminate operations ofcompanies and/or impose administrative liability on officers of such companies.

Any company or individualviolating industrial safety rules may incur administrative and/or civilliability, and individuals may also incur criminal liability. A company thatviolates safety rules in a way that negatively impacts the health of anindividual may also be obligated to compensate the individual for lostearnings, as well as health-related damages.

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**Employment andLabor**

Labor matters in Russiaare primarily governed by the Labor Code. In addition to this core legislation,relationships between employers and employees are regulated by federal laws,such as the Law on Employment in the Russian Federation of April 19, 1991,as amended, and the Federal Law on compulsory social insurance againstindustrial accidents and occupational diseases of July 24, 1998, asamended; legal acts of executive authorities; and local government acts relatedto labor issues.

***Employmentcontracts***

As a general rule, employment contracts for anindefinite term are concluded with all employees. Russian labor legislationexpressly limits the possibility of entering into term employment contracts.However, an employment contract may be entered into for a fixed term of up tofive years in certain cases where labor relations may not be established for anindefinite term due to the nature of the duties or the conditions of theperformance of such duties, as well as in other cases expressly identified byfederal law. In some cases it is also possible to enter into an employmentcontract for the employee to perform specified task(s). All terms andconditions of employment contracts are regulated by the Labor Code.

An employer mayterminate an employment contract only on the basis of the specific groundsenumerated in the Labor Code, including:

·       liquidationof the enterprise or downsizing of staff;

·       failureof the employee to comply with the position’s requirements due to incompetence,as confirmed by the results of an attestation;

·       employee’sfull incapability to work as confirmed in a medical certification;

·       changeof control of the employer;

·       repeatedfailure of the employee to fulfill his or her labor duties;

·       enteringthe workplace under the influence of alcohol, narcotics or other intoxicatingsubstances;

·       employee’sabsence without cause for more than four hours in a row within one working day;

·       disclosureof state secrets or other confidential information, which an employee has cometo know during fulfillment of his professional duties;

·       embezzlement,willful damage or destruction of assets, and misappropriation as confirmed bycourt decision;

·       failureto comply with safety requirements in the workplace if such failure to complycaused injuries, casualties or catastrophe; and

·       provisionby the employee of false documents to gain entry into the employment contract.

An employee dismissed from an enterprise due todownsizing or liquidation is entitled to receive compensation and salarypayments for a certain period of time, depending on circumstances.

The Labor Code also provides protections for specifiedcategories of employees. For example, except in cases of liquidation of anenterprise, an employer cannot dismiss minors, expectant mothers, mothers witha child under the age of three, single mothers with a child under the age offourteen or other persons caring for a child under the age of 14 without amother.

Any termination by anemployer that is inconsistent with the Labor Code requirements may beinvalidated by a court, and the employee may be reinstated. Lawsuits resultingin the reinstatement of illegally dismissed employees and the payment of damagesfor wrongful dismissal are increasingly frequent, 

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andRussian courts tend to support employees’ rights in most cases. Where anemployee is reinstated by a court, the employer must compensate the employeefor unpaid salary for the period between the wrongful termination andreinstatement, as well as for mental distress.

***Work time***

The Labor Code generally sets the regular working weekat 40 hours. Any time worked beyond 40 hours per week, as well aswork on public holidays and weekends, must be compensated at a higher rate.

For employees working in hazardous or harmfulconditions, the regular working week is decreased by 4 hours in accordance withgovernment regulations. Some of our employees working on steel and miningproduction entities qualify for this reduced working week.

Annual paid vacation leave under the law is 28calendar days. Our employees who work in mines and pits or work in harmfulconditions may be entitled to additional paid vacation ranging from 7 to 42working days.

The retirement age in theRussian Federation is 60 years for males and 55 years for females.However, employees who perform underground and open-pit mining works or otherwork in harmful conditions have a right to retire at an earlier age. Therules defining such earlier retirement ages are set by the Federal Law onLabor Pensions in the Russian Federation dated December 17, 2001, asamended.

***Salary***

The minimum monthly salaryin Russia, as established by federal law, was 800 rubles (approximately $30) inthe first four months of 2006 and was increased to 1,100 rubles (approximately$40) from May 1, 2006. It will be further increased to 2,300 rubles(approximately $84) from September 1, 2007. Although the law requires that theminimum wage be at or above a minimum subsistence level, the current minimumwage is generally considered to be less than a minimum subsistence level.

***Strikes***

The Labor Code defines astrike as the temporary and voluntary refusal of workers to fulfill their workduties with the intention of settling a collective labor dispute. Russianlegislation contains several requirements for legal strikes. Participation in alegal strike may not be considered by an employer as grounds for terminating anemployment contract, although employers are generally not required to pay wagesto striking employees for the duration of the strike. Participation in anillegal strike may be adequate grounds for termination.

***Trade Unions***

Although recent Russian labor regulations havecurtailed the authority of trade unions, they still retain significantinfluence over employees and, as such, may affect the operations of largeindustrial companies in Russia. In this regard, our management routinelyinteracts with trade unions in order to ensure the appropriate treatment of ouremployees and the stability of our business.

The activities of trade unions are generally governedby the Federal Law on Trade Unions, Their Rights and Guaranties of TheirActivity of January 12, 1996, as amended, or the Trade Union Law. Otherapplicable legal acts include the Labor Code, which provides for more detailedregulations relating to activities of trade unions.

The Trade Union Law defines a trade union as avoluntary union of individuals with common professional and other intereststhat is incorporated for the purposes of representing and protecting the 

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rights and interests ofits members. National trade union associations, which coordinate activities oftrade unions throughout Russia, are also permitted.

As part of theiractivities, trade unions may:

·       negotiatecollective contracts and agreements such as those between the trade unions andemployers, federal, regional and local governmental authorities and otherentities;

·       monitorcompliance with labor laws, collective contracts and other agreements;

·       accesswork sites and offices, and request information relating to labor issues fromthe management of companies and state and municipal authorities;

·       representtheir members and other employees in individual and collective labor disputeswith management;

·       participatein strikes; and

·       monitorredundancy of employees and seek action by municipal authorities to delay orsuspend mass layoffs.

Russian lawsrequire that companies cooperate with trade unions and do not interfere withtheir activities. Trade unions and their officers enjoy certain guarantees aswell, such as:

·       legalrestrictions as to rendering redundant employees elected or appointed to themanagement of trade unions;

·       protectionfrom disciplinary punishment or dismissal on the initiative of the employerwithout prior consent of the management of the trade union and, in certaincircumstances, the consent of the relevant trade union association;

·       retentionof job positions for those employees who stop working due to their election tothe management of trade unions;

·       protectionfrom dismissal for employees who previously served in the management of a tradeunion for two years after the termination of the office term; and

·       provisionof the necessary equipment, premises and transportation vehicles by theemployer for use by the trade union free of charge, if provided for by acollective bargaining contract or other agreement.

If a trade union discovers any violation of workcondition requirements, notification is sent to the employer with a request tocure the violation and to suspend work if there is an immediate threat to thelives or health of employees. The trade union may also apply to stateauthorities and labor inspectors and prosecutors to ensure that an employerdoes not violate Russian labor laws. Trade unions may also initiate collectivelabor disputes, which may lead to strikes.

To initiate a collective labor dispute, trade unionspresent their demands to the employer. The employer is then obliged to considerthe demands and notify the trade union of its decision. If the dispute remainsunresolved, a reconciliation commission attempts to end the dispute. If thisproves unsuccessful, collective labor disputes are generally referred tomediation or labor arbitration.

The Trade Union Law providesthat those who violate the rights and guaranties provided to trade unions andtheir officers may be subject to disciplinary, administrative and criminalliability. Although neither the Code of the Russian Federation onAdministrative Misdemeanors, nor the Criminal Code of the Russian Federation,currently has provisions specifically relating to these violations, generalprovisions and sanctions may be applicable.

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***Item 5.****                         **Operating and Financial Review andProspects*

*The following discussion of our financial conditionand results of operations should be read in conjunction with our consolidatedfinancial statements and the related notes and other information in thisdocument. This Item 5 contains forward-looking statements that involverisks and uncertainties. Our actual results may differ materially from thosediscussed in forward-looking statements as a result of various factors,including the risks described in Item 3 and under the caption “Cautionary NoteRegarding Forward-Looking Statements.”*

**The Reorganization**

Mechel OAO was incorporated on March 19, 2003,under the laws of the Russian Federation, in connection with a reorganizationto serve as holding company for various mining and steel companies owned byMessrs. Igor Zyuzin and Vladimir Iorich or parties affiliated with them.These individuals acted in concert from 1995 until December 2006 pursuant to anOwnership, Control and Voting Agreement which required them to vote the sameway. The reorganization involved the contribution of these companies by theseindividuals to Mechel in exchange for all the outstanding capital stock ofMechel. Many of the contributed companies had shareholders other thanMessrs. Zyuzin and Iorich, and these shareholders were not involved in thereorganization and continue to retain minority interests in certain of oursubsidiaries.

During the period fromMarch through December 2006, Mr. Iorich disposed of his entire interest inMechel OAO, and the Ownership, Control and Voting Agreement terminated onDecember 21, 2006.

**Business Structure**

**Segments**

We have organizedour businesses into two segments:

·       themining segment, comprising the production and sale of coal (coking and steam),iron ore and nickel, which supplies raw materials to our steel business andalso sells substantial amounts of raw materials to third parties; and

·       the steel segment,comprising the production and sale of semi-finished steel products; carbon andspecialty long products; carbon and stainless flat products; value-addeddownstream metal products including hardware, forgings and stampings; and cokeand coking products.

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Thetable below sets forth by segment our primary mining and steel subsidiaries,presented in chronological order by date of acquisition. 

| **Name**                              | ** ** | ** ** | ** ** | **Location**                                                                                                         | ** ** | **Business**       | ** ** | **Date Control  Acquired** | ** ** | **Voting  Interest(1)  %** |
|---------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|----------------------------|------------|----------------------------|
| ***Mining  Segment*(2)**              |       |       |       |                                                                                                                 |       |               |       |                       |
| Southern Kuzbass Coal  Company(3)     |       | Russia     |       | Coking coal concentrate, steam coal, steam coal concentrate                                                          |       | January 1999  |       |  

93.1               |
| Tomusinsk Open  Pit Mine         |       | Russia     |       | Coking coal, steam coal                                                                                              |       | January 1999  |       | 74.4                       |
| Southern Urals Nickel  Plant          |       | Russia     |       | Ferronickel                                                                                                          |       | December 2001 |       | 79.9                       |
| Korshunov Mining Plant                |       | Russia     |       | Iron ore concentrate                                                                                                 |       | October 2003  |       | 85.6                       |
| Port Posiet                           |       | Russia     |       | Shipping                                                                                                             |       | February 2004 |       | 96.9                       |
| Port Kambarka                         |       | Russia     |       | River shipping                                                                                                       |       | April 2005    |       | 90.4                       |
| ***Steel  Segment***                  |       |       |       |                                                                                                                 |       |               |       |                       |
| Chelyabinsk  Metallurgical Plant |       | Russia     |       | Semi-finished steel products, carbon and specialty long and flat steel  products, forgings, coke and coking products |       | December 2001      |       | 95 8                       |
| Vyartsilya Metal  Products Plant |       | Russia     |       | Hardware                                                                                                             |       | May 2002      |       | 93.5                       |
| Beloretsk Metallurgical  Plant        |       | Russia     |       | Long steel products,  hardware, limestone(4)                                                                         |       | June 2002     |       | 90.4                       |
| Mechel Targoviste                     |       | Romania    |       | Carbon and specialty  long steel products, forgings, hardware                                                        |       | August 2002   |       | 86.6                       |
| Urals Stampings Plant                 |       | Russia     |       | Stampings                                                                                                            |       | April 2003    |       | 93.8                       |
| Mechel Campia Turzii                  |       | Romania    |       | Long steel products,  hardware                                                                                       |       | June 2003     |       | 86.6                       |
| Mechel Nemunas                        |       | Lithuania  |       | Hardware                                                                                                             |       | October 2003  |       | 100.0                      |
| Izhstal                               |       | Russia     |       | Specialty and carbon  steel long products, hardware, stampings and forgings                                          |       | May 2004      |       | 88.1                       |
| Mechel Recycling                      |       | Russia     |       | Metal scrap processing                                                                                               |       | March 2006         |       | 100.0                      |
| Moscow Coke Gas Plant                 |       | Russia     |       | Coke and gas works                                                                                                   |       | October 2006       |       | 98.9                       |
| Southern Kuzbass Power  Plant         |       | Russia     |       | Power                                                                                                                |       | March 2007         |       | 93.5                       |

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(1)          The percentages providedin this table are as of June 30, 2007. As of that date, some of ourRussian subsidiaries had preferred shares outstanding that have voting rightscommensurate with common shares if dividends on those shares have not been paid.We have calculated voting interests by including these preferred shares forsubsidiaries where dividends have not been paid. 

(2)          The mining segmentincludes our shipping operations, which support both our mining and steelsegments.

(3)          We merged the following entities into Southern Kuzbass Coal Company:Tomusinsk Processing Mills in October 2004; Sibirginsk Open Pit Mine, KuzbassCentral Processing Plant and Siberian Central Processing Plant fromOctober-December 2005; and Olzherassk Open Pit Mine, Lenin Mine, Usinsk Mine,Tomusinsk Auto Depot and Krasnogorsk Open Pit Mine from October 2006-February2007.

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(4)          Our Pugachev limestonequarry is owned by Beloretsk Metallurgical Plant and is within the steelsegment.

In 2005, we commenced the restructuring of SouthernKuzbass Coal Company, pursuant to which we began merging the company withcertain of its subsidiaries, including Tomusinsk Processing Mills inOctober 2004; Siberian Central Processing Plant, Kuzbass Central ProcessingPlant and Sibirginsk Open Pit Mine in October-December 2005; Lenin Mine,Krasnogorsky Open Pit Mine and Tomusinsk Auto Depot in October 2006; andOlzherassk Open Pit Mine in February 2007. As a result of the merger of thesesubsidiaries into Southern Kuzbass Coal Company, our current ownership stake inSouthern Kuzbass Coal Company is 93.5%.

We also undertookrestructuring activity at the Chelyabinsk Metallurgical Plant in 2006.Specifically, coke production and specialty steel production were separatedfrom Chelyabinsk Metallurgical Plant into separate entities called Mechel Cokeand Specialty Steel, respectively. Mechel Coke, formed in June 2006, producesand sells coke, and Specially Steel, formed in April 2006, produces and sellsspecialty steel. Both Mechel Coke and Specialty Steel are wholly ownedsubsidiaries of Chelyabinsk Metallurgical Plant.

**Intersegment sales**

We are an integratedmining and steel group. Our mining segment supplies 80% of our steel segment’scoking coal requirements, 40% of our iron requirements, and 67% of our nickelrequirements. Our steel segment also supplies wires, ropes and other hardwareto our mining segment for use in its day-to-day operations, as wellas coke for use in the production of nickel. The prices at which we recordthese transfers are based on market prices, and these transactions areeliminated as intercompany transactions for purposes of our consolidatedfinancial statements. For the years ended December 31, 2006, 2005, and2004, mining segment sales to the steel segment amounted to $376.6 million,$336.6 million and $323.0 million, respectively. For the years endedDecember 31, 2006, 2005 and 2004, steel segment sales to the miningsegment amounted to $23.7 million, $56.6 million and $74.7 million,respectively.

**Summary ofAcquisitions**

We have sought to develop an integrated mining andsteel business through the purchase of under-performing assets which webelieve offer significant upside potential, particularly as we implementimprovements in working practices and operational methods. Pending the implementationof these practices and our other integration strategies, our margins areinitially adversely affected after each acquisition.

The followingsummary describes the terms of acquisition of our primary mining and steelsubsidiaries and significant investments since 2001. Each of the acquisitionswas accounted for using the purchase method of accounting, so the results ofoperations of each acquired business are included in our consolidated incomestatements since their respective dates of acquisition of control. In certaincases where we acquired our interest in a business over a period of time andcontrol was not acquired until subsequent acquisitions of shares, suchbusinesses were accounted for using the equity method of accounting or at cost,as appropriate until such controlling stake was acquired. Our results ofoperations for the periods presented herein are thus not comparable from periodto period due to these acquisitions and their accounting treatment. 

·       *Chelyabinsk Metallurgical Plant.  *ChelyabinskMetallurgical Plant is an integrated blast furnace and BOF/EAF steel mill thatproduces coke, semi-finished and rolled carbon and specialty steel products andforgings. Glencore International, a global trading company, which is currentlyone of our biggest customers, acquired a 65.1% stake in ChelyabinskMetallurgical Plant during its privatization by the Russian government in 1992.In December 2001, we acquired Glencore International’s stake inChelyabinsk Metallurgical Plant. We have subsequently purchased shares on 

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the secondary market toincrease our stake in Chelyabinsk Metallurgical Plant to 95.8%. We have paid atotal of $219.3 million for our current stake in Chelyabinsk MetallurgicalPlant.

·       *Southern Urals Nickel Plant.  *SouthernUrals Nickel Plant operates two open-pit nickel mines and a nickel processingfacility. Southern Urals Nickel Plant was privatized by the Russian governmentin 1993. We acquired a 46.0% stake in Southern Urals Nickel Plant inSeptember 2001 and increased that stake to a controlling stake inDecember 2001. We have subsequently purchased shares on the secondarymarket to increase our stake in Southern Urals Nickel Plant to 79.9%. We havepaid a total of $10.0 million for our current stake in Southern Urals NickelPlant.

·       *Vyartsilya Metal Products Plant.  *VyartsilyaMetal Products Plant is a hardware plant that produces wire, nails and steelnets. Vyartsilya Metal Products Plant was formed in June 1996 as aspin-off from Vyartsilya Metal Products Plant OAO, which was privatized by theKarelian government in 1994. We acquired an 88.1% stake in Vyartsilya MetalProducts Plant from employee-shareholders in May 2002. We havesubsequently purchased shares on the secondary market to increase our stake inVyartsilya Metal Products Plant to 93.5%. We have paid a total of $0.1 millionfor our current stake in Vyartsilya Metal Products Plant.

·       *Beloretsk Metallurgical Plant.  *BeloretskMetallurgical Plant is a hardware plant that produces wire rod and a broadrange of hardware. Beloretsk Metallurgical Plant was privatized by the Bashkirgovernment in 1994. We acquired a 33.3% stake in Beloretsk Metallurgical Plantfrom third parties in 2001, and increased our stake to a controlling interestin June 2002. In November 2003, we acquired another 29.4% stake inBeloretsk Metallurgical Plant from the regional government, and inMarch 2004, we acquired another 9.7% stake in Beloretsk MetallurgicalPlant. During 2005 we acquired an additional stake of 0.1% in BeloretskMetallurgical Plant, bringing our total stake to 90.4% Beloretsk MetallurgicalPlant also owns the Pugachev limestone quarry. The regional government has agolden share in Beloretsk Metallurgical Plant, giving it the right to vetocertain shareholder decisions and appoint a voting representative on the boardof directors. We have paid a total of $15.2 million for our current stake of 90.4% in Beloretsk Metallurgical Plant.

·       *Mechel Targoviste.  *Mechel Targovisteis a Romanian steel mill that produces long products and forgings. We acquireda 79.7% stake in Mechel Targoviste from the Romanian government inAugust 2002. At the time we acquired Mechel Targoviste, it was inbankruptcy proceedings. The consideration consisted of $3.5 million incash and a commitment on our part to invest $21.1 million in themodernization of the plant, upgrade of its capacity over five years andenvironmental protection, as well as a commitment to maintain its workforcelevel for five years. Under the transaction documents, our stake in MechelTargoviste was pledged to the Romanian government and was gradually released aswe fulfilled our commitments. As a result of our fulfillment of thesecommitments in 2006, our stake in Mechel Targoviste was fully released frompledge and increased to 86.6%. We paid a total of $22.3 million for our currentstake in Mechel Targoviste.

·       *Urals Stampings Plant.  *UralsStampings Plant is Russia’s largest producer of stampings from specialty steeland heat-resistant titanium alloys for the aerospace, power and otherindustries. Urals Stampings Plant was privatized by the Russian government in1993. We acquired a 93.8% stake in Urals Stampings Plant from third parties inApril 2003 for $11.3 million in cash. 

·       *Mechel Campia Turzii.  *Mechel CampiaTurzii is a Romanian steel mill that produces rolled products and hardware,including wires, ropes and nails. We acquired a 73.4% stake in Mechel CampiaTurzii from the Romanian government in June 2003. The considerationconsisted of $2.8 million in cash and a commitment on our part to invest$19.0 million in the modernization of the plant and upgrade of itscapacity over five years, a commitment to spend $3.6 million inenvironmental protection, as well as a commitment to maintain its workforcelevel for five years. In connection with the acquisition, certain debt ofMechel Campia Turzii was converted into shares, 

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and we subsequentlyacquired these shares for $1.3 million, increasing our stake to 79.8%.Under the transaction documents, our stake in Mechel Campia Turzii was pledgedto the Romanian government until we fulfilled our commitments. As a result ofour fulfillment of these commitments in 2007, our stake in Mechel Campia Turziiwas fully released from pledge and increased to 86.6%. We paid a total of $37.2 millionfor our current stake in Mechel Campia Turzii. 

·       *Mechel Nemunas.  *Mechel Nemunas is aLithuanian hardware plant that produces wire, calibrated steel products, nails,rods and nets. We acquired a 75.1% stake in Mechel Nemunas for$4.0 million in cash in October 2003. From November toDecember 2003, we acquired the remaining 24.9% stake in Mechel Nemunas for$1.0 million in cash.

·       *Korshunov Mining Plant.  *KorshunovMining Plant operates three surface iron ore mines and an iron oreconcentrating plant. Korshunov Mining Plant was privatized by the localgovernment in 1993. We acquired a 62.5% interest in Korshunov Mining Plant inDecember 2002 when it was in bankruptcy proceedings. InSeptember 2003, a court approved a debt settlement plan. We recorded ourinvestment in Korshunov Mining Plant at cost until we acquired control inOctober 2003, and have consolidated its results since that time. We havesubsequently purchased shares on the secondary market to increase our stake inKorshunov Mining Plant to 85.6%. We have paid a total of $135.8 million(including loans and advances) for our current stake in Korshunov Mining Plant.

·       *Port Posiet.  *Port Posiet is locatedin Russia’s Far East on the Sea of Japan. We acquired an 80.0% stake in PortPosiet for $30.0 million in cash in February 2004. InFebruary 2006, we acquired an additional 13.3% stake in Port Posiet atauction for a purchase price of $1.1 million and an additional 3.6% fromindividuals for a purchase price of $0.2 million increasing our total stake to 96.9%.We have paid a total of $31.2 million for our current stake in PortPosiet.

·       *Izhstal.  *Izhstal is a Russianspecialty steel plant which produces rolled products, hardware, stampings andforgings. We acquired a 62.3% stake in Izhstal for $25.3 million in cashin February through December 2004. In April 2005, we acquired anadditional 25.0% stake in Izhstal for approximately $15.7 million in cash.Subsequent acquisitions of additional stakes have resulted in an increase ofour share in Izhstal to 87.9%. We have paid a total of $41.0 million for ourcurrent stake in Izhstal.

·       *Yakutugol.  *Yakutugol, located ineastern Siberia, extracts predominantly coking coal, as well as steam coal, inopen-pit and underground mines. We acquired a blocking minority stake of 25%plus one share for $411.2 million in January 2005. 

·       *Port Kambarka.  *Port Kambarka is ariver port located in Kama in the Republic of Udmurtia, and processed 543tonnes of cargo, mostly sand and crushed stone, in 2006. We acquired a 90.4%stake in Port Kambarka in April 2005 while Port Kambarka was in bankruptcyproceedings. The bankruptcy proceedings were terminated in May 2005, andwe paid $3.4 million in cash for this stake in June 2005. 

·       *Mechel Recycling.*   Mechel Recycling is aChelyabinsk-based metal scrap processing company. We acquired a 100% stake inMechel Recycling in March 2006 for $4.8 million.

·       *Moscow Coke Gas Plant.  *Moscow CokeGas Plant is a coke and chemical producer located in the Moscow Region. Theplant’s annual production capacity is approximately 1.5 million tonnes of coke.Its products are sold domestically, mainly to manufacturers located in Russia’sCentral Region, as well as shipped abroad, in particular to Ukraine andEuropean Union countries. We acquired a 98.9% stake in Moscow Coke Gas Plantand its subsidiaries during the period from July—October 2006 in exchange forconsideration comprising $179.0 million in cash and 18,645,058 shares ofMechel. The total cost of our investment was $298.9 million.

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·       *SouthernKuzbass Power Plant.  *Southern Kuzbass Power Plant was separated in July 2006 fromKuzbassenergo as the result of Kuzbassenergo’s reorganization. The plant islocated in the Kemerovo Region. As of January 1, 2007, its installed electricpower capacity was 554 MWt, and the heat power capacity was 560 Gcal/h. OnMarch 29, 2007, we acquired at auction 93.4% of the charter capital of SouthernKubzass Power Plant for approximately $265 million.

The acquisition ofChelyabinsk Metallurgical Plant in December 2001, an integrated steel mill withits own coking batteries, was our most significant steel acquisition and it isthe center of our steel segment operations. Prior to its acquisition, we wereprimarily a coal mining and trading company. In the year of its acquisition, wehad been running Chelyabinsk Metallurgical Plant on a contract basis, ourtrading operations had been selling Chelyabinsk Metallurgical Plant’s productsand we had supplied it with most of its coking coal requirements, so we werealready familiar with its operations and customers. The addition of BeloretskMetallurgical Plant in June 2002, a market leader in hardware in Russia andwhose products our trading operations had been selling prior to itsacquisition, significantly expanded our presence in this product category,which was further bolstered by our acquisition of Vyartsilya Metal ProductsPlant in May 2002. Beloretsk Metallurgical Plant and Vyartsilya MetalProducts Plant are supplied with semi-finished steel and rolled wire byChelyabinsk Metallurgical Plant. Our downstream product mix was also furtherwidened by the purchase of Urals Stampings Plant in April 2003, which usesChelyabinsk Metallurgical Plant’s specialty steel to make value addedstampings. We further solidified our presence in the Russian specialty steelmarket by the acquisition of Izhstal in May 2004. Additionally, ouracquisitions of Mechel Targoviste in August 2002, Mechel Campia Turzii in June2003 and Mechel Nemunas in October 2003, marked our expansion outside Russia.Mechel Targoviste produces specialty long products and Mechel Campia Turzii andMechel Nemunas produce hardware. Izhstal is supplied with cast iron fromChelyabinsk Metallurgical Plant and Mechel Campia Turzii, and Mechel Nemunas issupplied with semi-finished steel from our Russian operations.

**DiscontinuedOperations**

In August 2004, we terminated production atMechel Zeljezara, a Croatian steel mill that produced pipes. Mechel Zeljezara’sassets were acquired out of bankruptcy proceedings in March 2003. Wedecided to terminate production at Mechel Zeljezara due to significantincreases in input costs and a persistent weakness in pipe prices. InSeptember 2004, we concluded a termination agreement providing for thereturn to the seller of the Mechel Zeljezara assets, the redemption of the bankguarantee that we granted to the government of Croatia in the amount of$4.3 million and the donation of spare parts at Mechel Zeljezara in theamount of $1.8 million, in return for a waiver of any and all claimsagainst us.

We started accounting for Mechel Zeljezara asdiscontinued operations in September 2004. Mechel Zeljezara is currentlyin bankruptcy, which is expected to be concluded in 2007. The results ofoperations of Mechel Zeljezara were included in the consolidated financialstatements from the date of acquisition in March 2003. For the years endedDecember 31, 2006 and 2005 these results were reflected in theconsolidated financial statements as discontinued operations.

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**Results of Operations**

The following table setsforth our income statement data for the years ended December 31, 2006,2005 and 2004. 

| ** **                                                                                                                     | ** ** | **Year ended December 31,**                                                   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2006**                                                                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenues**                                                                                                                   | ** ** | ** **                                                                                   | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** |
| ** **                                                                                                                     | ** ** | **(in millions of U.S. dollars, except for percentages)** | ** ** |
| Revenue, net                                                                                                                   |       | 4,397,811                                                                                    |       |   | 100.0 |   |   | 3,804,995 |   |   | 100.0 |   |   | 3,635,955 |   |   | 100.0 |   |   |
| Cost of goods sold                                                                                                             |       | (2, 868,564                                                                             | )          |   | (65.2 | ) |   | (2,469,134 |   |   | (64.9 | ) |   | (2,225,088 | ) |   | (61.2 | ) |   |
| Gross margin                                                                                                                   |       | 1,529,247                                                                                    |       |   | 34.8 |   |   | 1,335,861 |   |   | 35.1 |   |   | 1,410,867 |   |   | 38.8 |   |   |
| Selling, distribution  and operating expenses                                                                                  |       | (803,549                                                                                     | )          |   | (18.3 | ) |   | (820,133 | ) |   | (21.6 | ) |   | (660,060 | ) |   | (18.2 | ) |   |
| Operating income                                                                                                               |       | 725,698                                                                                      |       |   | 16.5 |   |   | 515,728 |   |   | 13.5 |   |   | 750,807 |   |   | 20.6 |   |   |
| Other income and expense,  net                                                                                                 |       | 139,135                                                                                      |       |   | 3.2 |   |   | 10,131 |   |   | 0.3 |   |   | 794,288 | ) |   | 21.9 |   |   |
| Income before income  tax, minority interest, discontinued operations, extraordinary gain and  changes in accounting principle |       | 864,833                                                                                      |       |   | 19.7 |   |   | 525,859 |   |   | 13.8 |   |   | 1,545,095 |   |   | 42.5 |   |   |
| Income tax expense                                                                                                             |       | (230,599                                                                                     | )          |   | (5.2 | ) |   | (136,643 | ) |   | (3.6 | ) |   | (175,776 | ) |   | (4.8 | ) |   |
| Minority interest in  loss (income) of subsidiaries                                                                       |       | (31,528                                                                                      | )          |   | (0.7 | ) |   | (6,879 | ) |   | (0.2 | ) |   | (11,673 | ) |   | (0.3 | ) |   |
| Income from  continuing operations                                                                                             |       | 602,706                                                                                      |       |   | 13.7 |   |   | 382,337 |   |   | 10.0 |   |   | 1,357,646 |   |   | 37.3 |   |   |
| Loss from discontinued  operations, net of tax                                                                                 |       | 543                                                                                          |       |   | 0.0 |   |   | (1,157 | ) |   | — |   |   | (15,211 | ) |   | (0.4 | ) |   |
| Extraordinary gain, net  of tax                                                                                                |       | —                                                                                       |       |   | — |   |   | — |   |   | — |   |   | 271 |   |   | — |   |   |
| Changes in accounting  principle, net of tax                                                                              |       | —                                                                                       |       |   | — |   |   | — |   |   | — |   |   | — |   |   | — |   |   |
| Net income                                                                                                                     |       | 603,249                                                                                      |       |   | 13.7 |   |   | 381,180 |   |   | 10.0 |   |   | 1,342,706 |   |   | 36.9 |   |   |
|                                                                                                                                |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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***Revenues***

**Year endedDecember 31, 2006 compared to year ended December 31, 2005**

***Revenues***

Consolidatedrevenues increased by $592.8 million, or 15.6%, to $4,397.8 millionin the year ended December 31, 2006, from $3,805.0 million in theyear ended December 31, 2005. The following table sets out revenues bysegment.

| ** **                        | ** ** | **Year ended December 31,**                                   | ** ** |
|-----------------------------------|------------|------------------------------------------------------------------------------|------------|
| **Revenues by segment** | ** ** | ** **                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(in thousands of  U.S. dollars,  except percentages)** | ** ** |
| **Mining segment**                | ** ** | ** **                                                                   | ** ** | ** ** | ** ** |
| To third parties                  |       | 1,336,142                                                                    |       | 1,094,782 |   |
| To steel segment                  |       | 376,569                                                                      |       | 336,593 |   |
| Total                             |       | 1,712,711                                                                    |       | 1,431,375 |   |
| **Steel segment**                 | ** ** | ** **                                                                   | ** ** | ** ** | ** ** |
| To third parties                  |       | 3,061,669                                                                    |       | 2,710,213 |   |
| To mining segment                 |       | 23,664                                                                       |       | 56,633 |   |
| Total                             |       | 3,085,333                                                                    |       | 2,766,846 |   |
| Eliminations                      |       | 400,233                                                                      |       | 393,226 |   |
| Consolidated revenues             |       | 4,397,811                                                                    |       | 3,804,995 |   |
| % from mining segment             |       | 30.4                                                                         | %          | 28.8 | % |
| % from steel  segment             |       | 69.6                                                                         | %          | 71.2 | % |
|                                   |            |                                                                              |            |  |  |  |  |

 

*Mining segment*

Our total mining segment sales in the year endedDecember 31, 2006 increased by $281.3 million, or 19.7%, to$1,712.7  million from $1,431.4  million in the year endedDecember 31, 2005.

Coking coal concentrate sales to third partiesincreased by $55.3  million, or 12.0%, primarily due to volumeincreases, partially offset by sales price decreases in both the domestic andexport markets. Coking coal concentrate supplied to the steel segment decreasedby $29.6 million, or 13.6%, primarily as a result of decrease in thevolume supplied to our Chelyabinsk Metallurgical Plant. Steam coal and steamcoal concentrate sales to third parties increased by $37.6 million, or13.8%, primarily due to volume increases partially offset by sales pricedecreases in both the domestic and export markets.

Sales of iron ore to third parties increasedinsignificantly by $1.1****million, or****0.7%, to $168.2 million and supplies to the steelsegment increased by $5.8 million, or 6.5%, to $95.5 million, primarily due tovolume increases.

Nickel sales to third parties increased by$108.2 million, or 71.9%, primarily due to price increases. Nickelsupplies to the steel segment increased by $57.1 million, or 258.0%, dueto price increases as well as an increase of sales volumes supplied to oursteel production plants, Chelyabinsk Metallurgical Plant, Izhstal and MechelTargoviste.

Excluding intersegmentsales, export sales were 48.6% of mining segment sales in the year endedDecember 31, 2006, compared to 55.7% in the year ended December 31,2005. The decrease in the proportion of our export sales was due to the higherdomestic volumes generated by increased demand from domestic steelmakers andlower export volumes. The decreased export volumes were due to thesignificantly lower weighted average export prices (on an FCA basis) for coaland iron ore in 2006 as 

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comparedto the weighted average sales prices on the domestic market ($35.1 per tonne incomparison to $53.9 per tonne).

*Steel segment*

Our steel segmentrevenues increased by $318.5  million, or 11.5%, to$3,085.3  million in the year ended December 31, 2006, from$2,766.8  million in the year ended December 31, 2005. Theincrease in steel segment revenues was primarily due to the followingincreases:

·       Rebarsales increased by $136.2 million, or 22.1%, mainly due to price increases onthe domestic market linked to the expansion of construction market.

·       Stainlessflat products sales increased by $79.3 million, or 172.8%, mainly due to salesvolume increases linked to the expectation that import duties on flat productswould be introduced on the Russian market (which duties were ultimately imposedin 2007). In particular, the introduction of import duties on flat productsproduced by foreign companies was expected to result in a decrease in flatproducts available on the Russian market and an increase in prices for domesticstainless flat products. As a result, our sales volumes for flat productsincreased in 2006.

·       Hardwaresales increased by $84.2 million, or 22.5%, primarily as a result of priceincreases on the domestic market and a change in our product mix to include anincreased share of high valued added products.

·       Stampingssales increased by $29.9 million, or 24.6%, primarily as a result of priceincreases on the domestic market.

Excluding intersegmentsales, export sales comprised 32.3% of steel segment sales in the year endedDecember 31, 2006, compared to 44.7% in the year ended December 31,2005. The decrease in the proportion of our export sales was largely due to adecrease in export sales volumes in 2006 compared to 2005. The decreased exportvolumes were primarily due to the more favorable prices on the domestic market,as described above.

***Cost of goods sold and gross margin***

Consolidatedcost of goods sold was 65.2% of consolidated revenues in the year endedDecember 31, 2006, as compared to 64.9% of consolidated revenues in the yearended December 31, 2005, resulting in a decrease in the consolidated grossmargin percentage in the year ended December 31, 2006 to 34.8% from 35.1%in the year ended December 31, 2005. Cost of goods sold primarily consistsof costs relating to raw materials (including products purchased for resale),direct payroll, depreciation and energy. The table below sets forth cost ofgoods sold and gross margin by segment for the years ended December 31,2006 and 2005, including as a percentage of segment revenues.

| ** **                                                                                 | ** ** | **Year ended  December 31, 2006**                                              | ** ** | **Year ended  December 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Cost of goods sold and gross margin by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                                                                 | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| **Mining  segment**                                                                        | ** ** | ** **                                                                                    | ** ** |                                             | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Cost of goods  sold                                                                        |       | 1,033,321                                                                                     |       |                                             | 60.3       | ** ** |   | 715,739 |   |   | 50.0 | ** ** |   |
| Gross margin                                                                               |       | 679,390                                                                                       |       |                                             | 39.7       | ** ** |   | 715,636 |   |   | 50.0 | ** ** |   |
| **Steel  segment**                                                                         | ** ** | ** **                                                                                    | ** ** |                                             | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Cost of goods  sold                                                                        |       | 2,235,476                                                                                     |       |                                             | 72.5       | ** ** |   | 2,146,621 |   |   | 77.6 | ** ** |   |
| Gross margin                                                                               |       | 849,857                                                                                       |       |                                             | 27.5       | ** ** |   | 620,225 |   |   | 22.4 | ** ** |   |
|                                                                                            |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

92

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*Mining segment*

Mining segment cost ofgoods sold increased by $317.6 million, or 44.4%, to $1,033.3 million in theyear ended December 31, 2006, from $715.7 million in the year endedDecember 31, 2005. Mining segment gross margin percentage decreased from50.0% in the year ended December 31, 2005, to 39.7% in the year endedDecember 31, 2006. The decrease in the mining segment’s gross marginpercentage is explained by the sharp decrease of coking and steam coal salesprices on both the export and domestic markets.

*Steel segment*

Steel segment cost ofgoods sold increased by $88.9 million, or 4.1%, to $2,235.5 million in the yearended December 31, 2006, from $2,146.6 million in the year endedDecember 31, 2005. Steel segment cost of goods sold was 72.5% of thesegment’s revenues in the year ended December 31, 2006, as compared to77.6% in the year ended December 31, 2005, resulting in an increase ingross margin from 22.4% to 27.5%. Such increase is attributable to favorablemarket prices, particularly on the Russian market, as well as a decrease inproduction costs at most of our plants following the implementation of costcutting measures.

***Selling, distribution and operatingexpenses***

Selling,distribution and operating expenses decreased by $16.6 million, or 2.0%, to$803.5 million in the year ended December 31, 2006, from $820.1 million inthe year ended December 31, 2005. As a percentage of consolidatedrevenues, selling, distribution and operating expenses decreased to 18.3% inthe year ended December 31, 2006, as compared to 21.6% in the year endedDecember 31, 2005. Our selling, distribution and operating expensesconsist primarily of selling and distribution expenses, taxes other than incometax, loss on write off of property, plant and equipment, provision for doubtfulaccounts and general, administrative and other operating expenses. The tablebelow sets forth these costs by segment for the years ended December 31,2006 and 2005, including as a percentage of segment revenues.

| ** **                                                                                | ** ** | **Year ended  December 31, 2006**                                              | ** ** | **Year ended  December 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Selling, distribution and operating expenses by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                                                                | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| **Mining segment**                                                                        | ** ** | ** **                                                                                    | ** ** |                                             | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Selling and  distribution expenses                                                        |       | 217,929                                                                                       |       |                                             | 12.7       | ** ** |   | 190,441 |   |   | 13.3 | ** ** |   |
| Taxes other than  income tax                                                              |       | 37,495                                                                                        |       |                                             | 2.2        | ** ** |   | 29,506 |   |   | 2.1 | ** ** |   |
| Loss on write off  of property, plant and equipment                                       |       | 0                                                                                             |       |                                             | 0.0        | ** ** |   | 0 |   |   | 0.0 | ** ** |   |
| Accretion expense                                                                         |       | 2,344                                                                                         |       |                                             | 0.1        | ** ** |   | 1,625 |   |   | 0.1 | ** ** |   |
| Provision for  doubtful accounts                                                          |       | (45                                                                                           | )          |                                             | 0.0        | ** ** |   | 1,231 |   |   | 0.1 | ** ** |   |
| General, administrative and other operating expenses                                      |       | 99,706                                                                                        |       |                                             | 5.8        | ** ** |   | 91,581 |   |   | 6.4 | ** ** |   |
| Total                                                                                     |       | 357,429                                                                                       |       |                                             | 20.9       | ** ** |   | 314,384 |   |   | 22.0 | ** ** |   |
| **Steel  segment**                                                                        | ** ** | ** **                                                                                    | ** ** |                                             | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |   |
| Selling and  distribution expenses                                                        |       | 200,972                                                                                       |       |                                             | 6.5        | ** ** |   | 259,797 |   |   | 9.4 | ** ** |   |
| Taxes other than  income tax                                                              |       | 44,645                                                                                        |       |                                             | 1.4        | ** ** |   | 61,177 |   |   | 2.2 | ** ** |   |
| Loss on write off  of property, plant and equipment                                       |       | 2,418                                                                                         |       |                                             | 0.1        | ** ** |   | 12,667 |   |   | 0.5 | ** ** |   |
| Accretion expense                                                                         |       | 5,089                                                                                         |       |                                             | 0.2        | ** ** |   | 1,623 |   |   | 0.1 | ** ** |   |
| Provision for  doubtful accounts                                                          |       | 2,767                                                                                         |       |                                             | 0.1        | ** ** |   | 2,338 |   |   | 0.1 | ** ** |   |
| General,  administrative and other operating expenses                                     |       | 190,229                                                                                       |       |                                             | 6.2        | ** ** |   | 168,147 |   |   | 6.1 | ** ** |   |
| Total                                                                                     |       | 446,120                                                                                       |       |                                             | 14.5       | ** ** |   | 505,749 |   |   | 18.3 | ** ** |   |
|                                                                                           |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

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*Mining segment*

Selling and distribution expenses consisted almostentirely of transportation expenses related to our selling activities, andincreased by $27.5 million in line with sales volume increases in 2006. As apercentage of mining segment revenues, they decreased from 13.3% to 12.7% dueto the decrease in our share of mining segment export sales from 55.7% to48.6%.

Taxes other than income tax increased by $8.0 million,or 27.1%, from $29.5 million in the year ended December 31, 2005, to $37.5million in the year ended December 31, 2006. The increase is mainlyexplained by the accrual of tax claims, including fines and penalties formineral extraction and other taxes at Korshunov Mining Plant for the years 2002-2005in the amount of $27.3 million (including $20.5 million of operating expense),which was partially offset by a gain from the release of social taxes accruedin previous periods in the amount of $11.0 million for Korshunov Mining Plantfollowing resolution of a claim by the tax authorities in our favor.

Provision for doubtful accounts decreased by $1.3million, from $1.2 million expenses in the year ended December 31, 2005,to $0.05 million income in the year ended December 31, 2006, due toimprovement in trade receivables collectibility and in the ageing ofreceivables as at the year end.

General, administrativeand other expenses increased by $8.1 million, or 8.9%, to $99.7 million in theyear ended December 31, 2006, from $91.6 million in the year endedDecember 31, 2005, representing a decrease as a percentage of segmentrevenues from 6.4% to 5.8%. Salaries and related social taxes increased by$11.6 million mainly due to indexation of salary rates to inflation at ourproduction companies, increases in management bonuses, and increases in legaland consulting fees and insurance services which increased by $3.8 million dueto increases in such fees. Rent and maintenance, business travel expenses, bankcharges and office expenses increased by $4.4 million, and depreciationincreased by $0.6 million due to the overall expansion of segment activities in2006. Finally, additional expenses, including penalties for delays in thedelivery of finished goods, security expenses, expenses related to disposal ofproperty, plant and equipment, social expenses, release of provisions foradvances paid and other accounts receivable and other expenses, decreased by$12.3 million due to tighter control over administrative expenses resulting ina decrease in fines and penalties and security expenses.

*Steel segment*

Selling and distribution expenses consisted almostentirely of transportation expenses related to our selling activities, anddecreased as a percentage of steel segment revenues from 9.4% in the year endedDecember 31, 2005, to 6.5% in the year ended December 31, 2006,primarily as a result of the decrease in the share of export sales from 44.7%to 32.3%.

Taxes other than income tax include property and landtaxes, and other taxes. These amounted to $44.6 million in the year endedDecember 31, 2006, a decrease of $16.5 million, or 27.0%, from $61.2million in the year ended December 31, 2005. As a percentage of segmentrevenues, these taxes decreased from 2.2% to 1.4%. Property and land taxesamounted to $35.5 million in the year ended December 31, 2006, an increaseof $6.3 million, or 21.6%, from $29.2 million in the year endedDecember 31, 2005, due to an increase in the property tax base (as aresult of putting into operation new fixed assets). At the same time, in theyear ended December 31, 2006, our non-deductible VAT expenses decreased by$21.0 million (including $10.0 million claimed as a result of a tax audit ofprior periods at certain of our subsidiaries).

In December 2005, we decided to restructure theproduction process for each of Mechel Targoviste and Mechel Campia Turzii inorder to increase their efficiency and profitability. As a result of thisrestructuring, certain production workshops of Mechel Targoviste and MechelCampia Turzii were discontinued in early 2006, with some property, plant andequipment abandoned rather than disposed of by sale. As of December 31,2005, the carrying value of the property, plant and equipment at theseworkshops 

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was $12.7 million and waswritten off in the full amount. In the year ended December 31, 2006similar expenses of $2.4 million related to Port Kambarka were written off.

Provision for doubtful accounts increased  by $0.4 million from $2.3 million in the yearended December 31, 2005, to $2.8 million in the year endedDecember 31, 2006, due to changes in our estimate of bad debts as of therespective period ends.

General, administrativeand other expenses, which consisted of payroll and related social taxes,depreciation, rent and maintenance, legal and consulting expenses, officeexpenses and other expenses, increased by $22.1 million, or 13.1%, to $190.2million in the year ended December 31, 2006, from $168.1 million in theyear ended December 31, 2005, and decreased as a percentage of segmentrevenues from 6.1% in the year ended December 31, 2005, to 6.2% in theyear ended December 31, 2006. Payroll and related social taxes increased by$13.5 million mainly due to indexation of salary rates to inflation at ourproduction companies and also due to increases in management bonuses. Socialexpenses (including pension) decreased by $4.1 million due to disposal ofnon-core social divisions of our production entities in 2006 and increases incharity expenses and donations. Rent and maintenance, business travel expenses,bank charges and office expenses decreased by $1.7 million primarily due totighter control over administrative expenses at our production companies.Professional expenses, which include auditing, accounting, legal andengineering fees, and insurance services decreased by $2.2 million, primarilydue to a decrease in the volume of external consultants’ work in 2006. Finally,additional expenses, including directors and officers insurance, penalties fordelays in deliveries of finished goods, security expenses and other expensesincreased by $16.6 million due to refinement of future asset removal and siterestorations costs at our Chelyabinsk Metallurgical Plant.

***Operating income***

Operating income increased by $210.0 million, or40.7%, to $725.7 million in the year ended December 31, 2006, from $515.7million in the year ended December 31, 2005. Operating income as apercentage of consolidated revenues increased from 13.6% in the year ended December 31, 2005, to 16.5% in theyear ended December 31, 2006, due to an increase in the gross marginrelating to the favorable market conditions in the steel segment,implementation of cost cutting measures, decreased selling and distributionexpenses (due to a change in our sales strategy, namely significant increase ofshare of domestic sales in both of our segments), decreased taxes other than onincome and decreased losses from write-offs of property, plant and equipment.

Thetable below sets out operating income by segment, including as a percentage ofsegment revenues.

| ** **                                     | ** ** | **Year ended  December 31, 2006**                                              | ** ** | **Year ended  December 31, 2005** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Operating income by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                     | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| Mining segment                                 |       | 321,962                                                                                       |       |                                             | 18.8       | % |   | 401,252 |   |   | 28.0 | % |   |
| Steel segment                                  |       | 403,736                                                                                       |       |                                             | 13.1       | % |   | 114,476 |   |   | 4.1 | % |   |
|                                                |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

*Mining segment*

Mining segment operatingincome in the year ended December 31, 2006, decreased by $79.3 million, or19.8%, to $322.0 million from $401.3 million in the year endedDecember 31, 2005. Operating margin percentage decreased  from 28.0% to 18.8% due to a decrease in thesegment gross profit margin and increases in general, administrative and otherexpenses.

95

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*Steel segment*

Steel segment operatingincome in the year ended December 31, 2006, increased by $289.3 million,or 252.7%, to $403.7 million from $114.5 million in the year endedDecember 31, 2005. Operating margin percentage increased from 4.1% to13.1% due to an increase in gross margin percentage, as well as a decrease inselling and distribution expenses, taxes other than on income and losses fromwrite-off of property, plant and equipment.

***Other income and expense, net***

Otherincome and expense, net consists of income (loss) of equity investees, interestincome, interest expense, gain on revaluation of trading securities, otherincome and foreign exchange gain. The table below sets forth these costs forthe years ended December 31, 2006 and 2005, including as a percentage ofsales

| ** **                                            | ** ** | **Year ended  December 31, 2006**                                              | ** ** | **Year ended  December 31, 2005** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Other income and expense, net** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of     revenues** | ** ** | **Amount** | ** ** | **% of     revenues** | ** ** |
| ** **                                            | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| Income (loss)  from equity investees                  |       | (9,858                                                                                        | )          |                                             | (0.2       | ) |   | 12,426 |   |   | 0.3 |   |   |
| Interest income                                       |       | 8,314                                                                                         |       |                                             | 0.2        |   |   | 10,049 |   |   | 0.3 |   |   |
| Interest expense                                      |       | (38,183                                                                                       | )          |                                             | (0.9       | ) |   | (40,829 | ) |   | (1.1 | ) |   |
| Gain on  revaluation of trading securities            |       | 50,688                                                                                        |       |                                             | 1.2        |   |   |   |   |   |   |   |   |
| Other income, net                                     |       | 69,401                                                                                        |       |                                             | 1.6        |   |   | 65,920 |   |   | 1.7 |   |   |
| Foreign exchange  gain (loss)                         |       | 58,773                                                                                        |       |                                             | 1.3        |   |   | (37,435 | ) |   | (1.0 | ) |   |
| Total                                                 |       | 139,135                                                                                       |       |                                             | 3.2        |   |   | 10,131 |   |   | 0.3 |   |   |
|                                                       |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

Most of the loss/income from equity investees in theyears ended December 31, 2006 and December 31, 2005 related to ourparticipation interest in Yakutugol, in which we acquired a 25% + 1 share in2005. The loss in the year ended December 31, 2006 is due to decrease ofaverage sales prices and an increase in Yakutugol’s productions costs.

Interest income decreased by $1.7 million to $8.3million in the year ended December 31, 2006, from $10.0 million in theyear ended December 31, 2005. The decrease was due to lower average cashbalances held in short-term deposits with financial institutions during 2006.Interest expense decreased by $2.6 million, or 6.5%, to $38.2 million in theyear ended December 31, 2006, from $40.8 million in the year endedDecember 31, 2005. The decrease was due to lower average loan balances ofour companies in 2006.

In the year ended December 31, 2006, we recordedother income of $69.4 million, primarily consisting of gains related to theforgiveness of restructured tax liabilities (including fines and penalties) inour Russian and Romanian subsidiaries of $69.8 million (namely, MechelTargoviste—$44.6 million, Chelyabinsk Metallurgical Plant—$9.0 million,Southern Urals Nickel Plant—$5.8 million). In 2005, we recorded gains onforgiveness of restructured tax liabilities of $38.4 million and gains on accounts payable of $23.3 million.

In the year endedDecember 31, 2006, foreign exchange gain was $58.8 million, as compared toa loss of $37.4 million in the year ended December 31, 2005. This foreignexchange gain is primarily attributable to gains from revaluation of our cashbalances in euro accounts.

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***Income tax expense***

Income tax expenseincreased  by $94.0 million to $230.6million in the year ended December 31, 2006, from $136.6 million in theyear ended December 31, 2005, while our effective tax rate increased to26.7% from 26.0%. The increase in the absolute figure of income tax expenses isdue to the increase in the taxable income of our Russian subsidiaries in 2006.

***Minority interest***

Minority interest inincome of subsidiaries amounted to $31.5 million in the year endedDecember 31, 2006, compared to  $6.9million in the year ended December 31, 2005. The minority interest in theincome of our subsidiaries in 2006 consisted primarily of the share of minorityshareholders in the net income of Southern Urals Nickel Plant of $12.2 million,of our coal companies of $8.2 million, Korshunov Mining Plant of $4.7 millionand of Chelyabinsk Metallurgical Plant of $2.9 million.

***Income from continuing operations***

Income from continuingoperations in the year ended December 31, 2006, was $602.7 million,compared to $382.3 million in the year ended December 31, 2005, as aresult of the factors explained above.

***Loss from discontinued operations***

Income from discontinuedoperations amounted to $0.5 million in the year ended December 31, 2006,compared to loss from discontinued operations of $1.2 million in the year endedDecember 31, 2005. In both periods it related to Mechel Zeljezara. Theincome in 2006 resulted from a reversal of a provision for bad debts of MechelZelejezara recorded in prior periods due to the settlement of such debts.Mechel Zeljezara performed its activities until August 2004 when wedecided to terminate production; in 2006 no significant activities wereperformed by this company.

***Net income***

For the reasons set forth above,our net income increased in the year ended December 31, 2006, by $222.0million, or 58.3%, from $381.2 million in the year ended December 31,2005, to $603.2 million in the year ended December 31, 2006.

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**Year endedDecember 31, 2005 compared to year ended December 31, 2004**

Consolidatedrevenues increased by $169.0 million, or 4.6%, to $3,805.0 million inthe year ended December 31, 2005, from $3,636.0 million in the yearended December 31, 2004. The following table sets out revenues by segment.

| ** **                        | ** ** | **Year ended December 31,**                                   | ** ** |
|-----------------------------------|------------|------------------------------------------------------------------------------|------------|
| **Revenues by segment** | ** ** | ** **                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(in thousands of  U.S. dollars,  except percentages)** | ** ** |
| **Mining  segment**               | ** ** | ** **                                                                   | ** ** | ** ** | ** ** |
| To third parties                  |       | 1,094,782                                                                    |       | 878,417 |   |
| To steel segment                  |       | 336,593                                                                      |       | 322,992 |   |
| Total                             |       | 1,431,375                                                                    |       | 1,201,409 |   |
| **Steel  segment**                | ** ** | ** **                                                                   | ** ** | ** ** | ** ** |
| To third parties                  |       | 2,710,213                                                                    |       | 2,757,538 |   |
| To mining segment                 |       | 56,633                                                                       |       | 74,651 |   |
| Total                             |       | 2,766,846                                                                    |       | 2,832,189 |   |
| Eliminations                      |       | 393,226                                                                      |       | 397,643 |   |
| Consolidated revenues             |       | 3,804,995                                                                    |       | 3,635,955 |   |
| % from mining segment             |       | 28.8                                                                         | %          | 24.2 | % |
| % from steel  segment             |       | 71.2                                                                         | %          | 75.8 | % |
|                                   |            |                                                                              |            |  |  |  |  |

 

*Mining segment*

Our total mining segment sales in the year endedDecember 31, 2005 increased by $230.0 million, or 19.1%, to$1,431.4 million from $1,201.4 million in the year endedDecember 31, 2004.

Coking coal concentrate sales to third partiesincreased by $60.8 million, or 15.1%, primarily due to price increases,partially offset by volume decreases. Coking coal concentrate supplied to thesteel segment decreased by $7.7 million, or 3.2%, primarily as a result ofdecrease in the volume supplied to our Chelyabinsk Metallurgical Plant. Steamcoal and steam coal concentrate sales to third parties increased by$61.9 million, or 29.3%, primarily due to price increases.

Sales of iron ore to third parties increased by $53.2****million, or****46.8%, to$167.1 million and supplies to the steel segment increased by $36.9million, or 70.0%, to $89.7 million, primarily due to price increases.

Nickel sales to third parties increased by$42.5 million, or 39.4%, primarily due to price increases. Nickel suppliesto the steel segment decreased by $16.6 million, or 42.9%, due to adecrease in production of products that require nickel at our ChelyabinskMetallurgical Plant.

Excluding intersegmentsales, export sales were 55.7% of mining segment sales in the year endedDecember 31, 2005, compared to 67.0% in the year ended December 31,2004. The decrease in the proportion of our export sales was due to the higherdomestic volumes generated by increased demand from domestic steelmakers andlower export volumes. Although export prices were higher compared with domesticprices, the world market for materials was down (the weighted average exportprice of our mining products increased by $13.5 per tonne whereas the weightedaverage domestic price for our mining products increased by $19.8 per tonne).

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*Steel segment*

Our steel segmentrevenues decreased by $65.5 million, or 2.3%, to $2,766.7 million inthe year ended December 31, 2005, from $2,832.2 million in the yearended December 31, 2004. The decrease in steel segment revenues is primarilyexplained by the following decreases totaling $340.0****million:

·       Wirerod sales decreased by $120.3 million or 39.5% due to sales volume decreasesthat occurred as a result of excess supply of this product on both Russian andinternational markets;

·       Stainlessflat product sales decreased by $48.4 million, or 51.3%, mostly due tovolume decreases that occurred as a result of decreases of production volumesof these products at our Chelyabinsk Metallurgical Plant caused by excess ofimported stainless products on the Russian market;

·       Salesof other products and services decreased by $150.7 million, or 78.1%, mainly due to reductions in our salesvolumes of products of third parties in line with our strategy to sell more ofour own products rather than resell products of third parties; and

·       Pigiron sales decreased by $20.6 million, or 55.2%, primarily as a result ofhigher internal consumption.

Counteracting thesedecreases were the following increases for the year ended December 31,2005:

·       Rebarsales increased by $11.3 million, or 1.8%, due to volume increasespartially offset by price decreases;

·       Salesof coke and coking products to third parties increased by $9.5 million, or16.6%, due to sales volume increases, while supplies to the mining segment,which uses coke in the production of nickel, decreased by $18.9 million,or 27.9%, due to lower production volumes.

·       Hardwaresales were higher by $47.6 million, or 14.6%, including an increase inwire sales of $40.9 million, or 19.2%, mainly due to sales volume increases,and an increase in rope sales of $3.3 million, or 6.3%, mainly due toprice increases;

·       Salesof carbon and low-alloy flat products increased by $34.5 million, or24.8%, mainly due to volume increases but also price increases;

·       Salesof stainless and alloyed long products increased by $47.3 million, or41.0%, due to price increases partially offset by volume decreases;

·       Carbonand low-alloyed long product sales grew by $170.0 million, or 96.1%,mostly as a result of price increases; and

·       Forgingsand forged alloy sales increased by $21.9 million, or 30.6%, due to volumeincreases.

Excluding intersegmentsales, export sales were 44.7% of steel segment sales in the year endedDecember 31, 2005, compared to 51.0% in the year ended December 31,2004. The decrease in the proportion of our export sales was largely due to adecrease in export prices in 2005 compared to 2004.

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***Cost of goods sold and gross margin***

Consolidatedcost of goods sold was 64.8% of consolidated revenues in the year endedDecember 31, 2005, as compared to 61.2% of consolidated revenues in theyear ended December 31, 2004, resulting in a decrease in the consolidatedgross margin percentage in the year ended December 31, 2005, to 35.1% from38.8% in the year ended December 31, 2004. Cost of goods sold primarilyconsists of costs relating to raw materials (including products purchased forresale), direct payroll, depreciation and energy. The table below sets forthcost of goods sold and gross margin by segment for the year ended December 31,2005 and 2004, including as a percentage of segment revenues.

| ** **                                                                                 | ** ** | **Year ended  December 31, 2005**                                              | ** ** | **Year ended  December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Cost of goods sold and gross margin by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                                                                 | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| **Mining  segment**                                                                        |       |                                                                                          |       |                                             |       |   |   |   |   |   |   |   |   |
| Cost of goods  sold                                                                        |       | 715,738                                                                                       |       |                                             | 50.0       |   |   | 557,251 |   |   | 46.4 |   |   |
| Gross margin                                                                               |       | 715,637                                                                                       |       |                                             | 50.0       |   |   | 644,158 |   |   | 53.6 |   |   |
| **Steel  segment**                                                                         |       |                                                                                          |       |                                             |       |   |   |   |   |   |   |   |   |
| Cost of goods  sold                                                                        |       | 2,146,621                                                                                     |       |                                             | 77.6       |   |   | 2,065,480 |   |   | 72.9 |   |   |
| Gross margin                                                                               |       | 620,225                                                                                       |       |                                             | 22.4       |   |   | 766,709 |   |   | 27.1 |   |   |
|                                                                                            |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

*Mining segment*

Mining segment cost ofgoods sold increased by $158.5 million, or 28.4%, to $715.7 millionin the year ended December 31, 2005, from $557.3 million in the yearended December 31, 2004. Mining segment gross margin percentage decreasedfrom 53.6% in the year ended December 31, 2004, to 50.0% in the year endedDecember 31, 2005. The slight decrease in the mining segment’s grossmargin percentage is explained by the fact that in 2005 our costs grew fasterthan sales prices for coal, nickel and iron ore.

*Steel segment*

Steel segment cost ofgoods sold increased by $81.1 million, or 3.9%, to $2,146.6 millionin the year ended December 31, 2005, from $2,065.5 million in theyear ended December 31, 2004. Steel segment cost of goods sold was 77.6%of the segment’s revenues in the year ended December 31, 2005, as comparedto 72.9% in the year ended December 31, 2004, resulting in a decline ingross margin from 27.1% to 22.4%. This decline is attributed to costsincreasing faster than prices.

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***Selling, distribution and operatingexpenses***

Selling,distribution and operating expenses increased by $160.1 million, or 24.3%,to $820.1 million in the year ended December 31, 2005, from$660.1 million in the year ended December 31, 2004. As a percentageof consolidated revenues, selling, distribution and operating expensesincreased to 21.6% in the year ended December 31, 2005, as compared to18.2% in the year ended December 31, 2004. Our selling, distribution andoperating expenses consist primarily of selling and distribution expenses,taxes other than income tax, loss on write off of property, plant andequipment, provision for doubtful accounts and general, administrative andother operating expenses. The table below sets forth these costs by segment forthe year ended December 31, 2005 and 2004, including as a percentage ofsegment revenues.

| ** **                                                                                | ** ** | **Year ended  December 31, 2005**                                              | ** ** | **Year ended  December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Selling, distribution and operating expenses by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                                                                | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| **Mining  segment**                                                                       |       |                                                                                          |       |                                             |       |   |   |   |   |   |   |   |   |
| Selling and  distribution expenses                                                        |       | 190,440                                                                                       |       |                                             | 13.3       |   |   | 160,578 |   |   | 13.4 |   |   |
| Taxes other than  income tax                                                              |       | 29,506                                                                                        |       |                                             | 2.1        |   |   | 27,140 |   |   | 2.3 |   |   |
| Loss on write off  of property, plant and equipment                                       |       | —                                                                                        |       |                                             | —     |   |   | — |   |   | — |   |   |
| Accretion expense                                                                         |       | 1,625                                                                                         |       |                                             | 0.1        |   |   | 1,137 |   |   | 0.1 |   |   |
| Provision for  doubtful accounts                                                          |       | 1,230                                                                                         |       |                                             | 0.1        |   |   | (3,323 | ) |   | (0.3 | ) |   |
| General,  administrative and other operating expenses                                     |       | 91,581                                                                                        |       |                                             | 6.4        |   |   | 74,568 |   |   | 6.2 |   |   |
| Total                                                                                     |       | 314,383                                                                                       |       |                                             | 22.0       |   |   | 260,100 |   |   | 21.7 |   |   |
| **Steel  segment**                                                                        |       |                                                                                          |       |                                             |       |   |   |   |   |   |   |   |   |
| Selling and  distribution expenses                                                        |       | 259,797                                                                                       |       |                                             | 9.4        |   |   | 206,933 |   |   | 7.3 |   |   |
| Taxes other than  income tax                                                              |       | 61,177                                                                                        |       |                                             | 2.2        |   |   | 42,145 |   |   | 1.5 |   |   |
| Loss on write off  of property, plant and equipment                                       |       | 12,667                                                                                        |       |                                             | 0.5        |   |   | — |   |   | — |   |   |
| Accretion expense                                                                         |       | 1,622                                                                                         |       |                                             | 0.1        |   |   | 944 |   |   | 0.0 |   |   |
| Provision for  doubtful accounts                                                          |       | 2,338                                                                                         |       |                                             | 0.1        |   |   | (4,536 | ) |   | (0.2 | ) |   |
| General,  administrative and other operating expenses                                     |       | 168,147                                                                                       |       |                                             | 6.1        |   |   | 154,471 |   |   | 5.5 |   |   |
| Total                                                                                     |       | 505,749                                                                                       |       |                                             | 18.3       |   |   | 399,957 |   |   | 14.1 |   |   |
|                                                                                           |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

*Mining segment*

Selling and distribution expenses consisted almostentirely of transportation expenses related to our selling activities, andincreased by $29.8 million in line with sales volume increases in 2005. As apercentage of mining segment revenues they remained constant in 2005 incomparison with 2004.

Taxes other than income tax increased by $2.4 million,or 8.7%, from $27.1 million in the year ended December 31, 2004, to$29.5 million in the year ended December 31, 2005. The increase ismainly explained by the increase in penalties and fines paid to environmentalagencies and other non-budgeted items at the Korshunov Mining Plant.

Provision for doubtful accounts increased by $4.6million, from $(3.3) million in the year ended December 31, 2004, to$1.2 million in the year ended December 31, 2005, due to changes inour estimates of bad debts at the respective period ends.

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General, administrativeand other expenses increased by $17.0 million, or 22.8%, to$91.6 million in the year ended December 31, 2005, from$74.6 million in the year ended December 31, 2004, representing anincrease as a percentage of segment revenues from 6.2% to 6.4%. Salaries andrelated social taxes increased by $13.2 million mainly due to indexationof salary rates to inflation at our production companies and also due toincreases in management bonuses, social expenses (including pension) increasedby $4.7 million due to the expansion in social activities of our productioncompanies and increases in charity expenses and donations, and legal andconsulting fees and insurance services increased by $4.0 million due toincreases in consulting fees. Rent and maintenance, business travel expenses,bank charges and office expenses increased by $2.5 million, anddepreciation increased by $0.7 million due to the overall expansion ofsegment activities in 2005. Finally, additional expenses, including penaltiesfor delays in the delivery of finished goods, security expenses, expensesrelated to acquiring equipment and other expenses, decreased by$8.0 million due to tighter control over administrative expenses resultingin a decrease in fines and penalties and security expenses.

*Steel segment*

Selling and distribution expenses consisted almostentirely of transportation expenses related to our selling activities, andincreased as a percentage of steel segment revenues from 7.3% in the year endedDecember 31, 2004, to 9.4% in the year ended December 31, 2005,primarily as a result of increases in transportation tariffs.

Taxes other than income tax includes property and landtaxes, and other taxes. These amounted to $61.2 million in the year endedDecember 31, 2005, an increase of $19.0 million, or 45.1%, from$42.1 million in the year ended December 31, 2004. As a percentage ofsegment revenues, these taxes increased from 1.5% to 2.2%. Property and landtaxes amounted to $29.2 million in the year ended December 31, 2005,an increase of $5.4 million, or 22.6%, from $23.8 million in the yearended December 31, 2004, due to an increase in the property tax base (as aresult of putting into operation new fixed assets). In 2005, an additional taxcharge of $10.0 million was recognized in certain of our subsidiaries as aresult of tax audits of previous periods. The amounts claimed by taxauthorities were mainly comprised of export VAT payable and related fines andpenalties.

In December 2005, we decided to restructure theproduction process for each of Mechel Targoviste and Mechel Campia Turzii inorder to increase their efficiency and profitability. As a result of thisrestructuring, certain production workshops of Mechel Targoviste and MechelCampia Turzii were discontinued in early 2006, with some property, plant andequipment abandoned rather than disposed of by sale. As of December 31,2005, the carrying value of the property, plant and equipment at theseworkshops was $12.7 million and was written off in the full amount (see alsonote 3(l) to our consolidated financial statements).

Provision for doubtful accounts increased by$6.8 million from $(4.5) million in the year ended December 31,2004, to $2.3 million in the year ended December 31, 2005, due tochanges in our estimate of bad debts as of the respective period ends.

General, administrativeand other expenses, which consisted of payroll and related social taxes,depreciation, rent and maintenance, legal and consulting expenses, officeexpenses and other expenses, increased by $13.7 million, or 8.9%, to$168.1 million in the year ended December 31, 2005, from$154.5 million in the year ended December 31, 2004, and increased asa percentage of segment revenues from 5.5% in the year ended December 31,2004, to 6.1% in the year ended December 31, 2005. Payroll and relatedsocial taxes increased by $8.4 million mainly due to indexation of salaryrates to inflation at our production companies and also due to increases inmanagement bonuses. Social expenses (including pension) increased by$5.8 million due to the expansion in social activities of our productioncompanies and increases in charity expenses and donations. Rent andmaintenance, business travel expenses, bank 

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chargesand office expenses decreased by $1.3 million primarily due to tightercontrol over administrative expenses at our production companies. Professionalexpenses, which include auditing, accounting, legal and engineering fees, andinsurance services increased by $4.9 million, primarily due to an increasein consulting fees in 2005. Finally, additional expenses, including directorsand officers insurance, penalties for delays in deliveries of finished goods,security expenses and other expenses decreased by $5.2 million due totighter control over administrative expenses resulting in a decrease in finesand penalties and security expenses.

***Operating income***

Operating income decreased by $235.1 million, or31.3%, to $515.7 million in the year ended December 31, 2005, from$750.5 million in the year ended December 31, 2004. Operating incomeas a percentage of consolidated revenues decreased from 20.7% in the year endedDecember 31, 2004, to 13.6% in the year ended December 31, 2005, dueto deterioration in the gross margin percentage, which occurred as a result ofincreased selling, distribution and operating expenses (including lossesresulting from write-offs of property, plant and equipment related to MechelTargoviste and Mechel Campia Turzii) compared to growth in consolidatedrevenues.

Thetable below sets out operating income by segment, including as a percentage ofsegment revenues.

| ** **                                     | ** ** | **Year ended  December 31, 2005**                                              | ** ** | **Year ended  December 31, 2004** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Operating income by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                     | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| Mining segment                                 |       | 401,252                                                                                       |       |                                             | 28.0       |   |   | 384,053 |   |   | 32.0 |   |   |
| Steel segment                                  |       | 114,475                                                                                       |       |                                             | 4.1        |   |   | 366,754 |   |   | 12.9 |   |   |
|                                                |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

*Mining segment*

Mining segment operatingincome in the year ended December 31, 2005, increased by$17.2 million, or 4.5%, to $401.3 million from $384.1 million inthe year ended December 31, 2004. Operating margin percentage decreasedfrom 32.0% to 28.0% due to a decrease in segment gross profit margin andincreases in general, administrative and other expenses.

*Steel segment*

Steel segment operatingincome in the year ended December 31, 2005, decreased by $252.2 million,or 65.7%, to $114.5 million from $366.8 million in the year endedDecember 31, 2004. Operating margin percentage decreased from 12.9% to4.1% due to a decrease in gross margin percentage, as well as the increase inselling, distribution and operating expenses (including losses resulting fromwrite-offs of property, plant and equipment related to Mechel Targoviste andMechel Campia Turzii).

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***Other income and expense, net***

Otherincome and expense, net consists of income (loss) of equity investees, interestincome, interest expense, other income and foreign exchange gain. The tablebelow sets forth these costs for the year ended December 31, 2005 and2004, including as a percentage of sales

| ** **                                            | ** ** | **Year ended  December 31, 2005**                                              | ** ** | **Year ended  December 31, 2004**           | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **Other income and expense, net** | ** ** | ** **                                                                                    | ** ** | **    Amount    ** | ** ** | **% of     revenues** | ** ** | **    Amount    ** | ** ** | **% of     revenues** | ** ** |
| ** **                                            | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| Income (loss)  from equity investees                  |       |                                                                                          | 12,426     |                                                       |       |   | 0.3 |   |   |   | 4,621 |   |   |   | 0.1 |   |   |
| Interest income                                       |       |                                                                                          | 10,049     |                                                       |       |   | 0.3 |   |   |   | 2,375 |   |   |   | 0.1 |   |   |
| Interest expense                                      |       |                                                                                          | (40,829    | )                                                          |       |   | (1.1 | ) |   |   | (51,409 | ) |   |   | (1.4 | ) |   |
| Other income, net                                     |       |                                                                                          | 65,920     |                                                       |       |   | 1.7 |   |   |   | 836,817 |   |   |   | 23.0 |   |   |
| Foreign exchange  gain (loss)                         |       |                                                                                          | (37,435    | )                                                          |       |   | (1.0 | ) |   |   | 1,884 |   |   |   | 0.1 |   |   |
| Total                                                 |       |                                                                                          | 10,131     |                                                       |       |   | 0.3 |   |   |   | 794,288 |   |   |   | 21.9 |   |   |
|                                                       |            |                                                                                               |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Most of the income from equity investees in the yearended December 31, 2004, related to Mechel Energy AG, and also includedincome from investees of Southern Kuzbass Coal Company. The income from equityinvestees in the year ended December 31, 2005, in the amount of $9.3million related to Yakutugol, in which we acquired a 25% + 1 share in 2005.

Interest income increased by $7.7 million to$10.0 million in the year ended December 31, 2005, from$2.4 million in the year ended December 31, 2004. The increase wasdue to higher average cash balances held in short-term deposits with financialinstitutions during 2005, partly resulting from the cash received in the saleof our stake in MMK at the end of 2004. Interest expense decreased by$10.6 million, or 20.6%, to $40.8 million in the year endedDecember 31, 2005, from $51.4 million in the year endedDecember 31, 2004. The decrease was due to lower average loan balances ofour companies in 2005 due to repayment of short-term loans and also due to anincrease in interest expense capitalized in the cost of property, plant andequipment of $7.6 million.

In the year ended December 31, 2005, we recordedother income of $65.9 million, primarily consisting of gains related tothe forgiveness of restructured tax liabilities in our Russian subsidiaries andaccounts payable on expired contracts of $61.7 million. In 2004, other incomehad primarily consisted of a gain from the sale of our stake in MMK of $800.0million.

In the year ended December 31,2005, foreign exchange loss was $37.3 million, as compared to a gain of$1.9 million in the year ended December 31, 2004. This foreignexchange loss is primarily attributed to losses from devaluation of our cashbalances in euro accounts.

***Income tax expense***

Income tax expensedecreased by $39.1 million to $136.6 million in the year endedDecember 31, 2005, from $175.8 million in the year endedDecember 31, 2004, while our effective tax rate increased to 26.0% from11.4%. The increase in the effective tax rate in 2005 is due primarily to theabsence in our taxable income of the gain on the sale of our stake in MMK of$800.0 million that took place in 2004.

***Minority interest***

Minority interest inincome of subsidiaries amounted to $6.9 million in the year endedDecember 31, 2005, compared to a minority interest in income ofsubsidiaries of $11.7 million in the year ended December 31, 2004.The minority interest in the income of our subsidiaries in 2005 consistedprimarily of the share of minority shareholders in the net income of KorshunovMining Plant of $2.7 million and of our 

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coalcompanies of $8.2 million, which was partially offset by the share of minorityshareholders in the net losses of Chelyabinsk Metallurgical Plant of $9.3million.

***Income from continuing operations***

Income from continuingoperations in the year ended December 31, 2005, was $382.3 million,compared to $1,357.6 million in the year ended December 31, 2004, asa result of the factors explained above.

***Loss from discontinued operations***

Loss from discontinuedoperations amounted to $1.1 million in the year ended December 31, 2005,compared to loss from discontinued operations of $15.2 million in the yearended December 31, 2004. In both periods it related to Mechel Zeljezara. MechelZeljezara performed its activities until August 2004 when we decided toterminate production; in 2005 no significant activities were performed by thiscompany.

***Net income***

For the reasons set forthabove, our net income decreased in the year ended December 31, 2005, by$961.5 million, or 71.6%, from $1,342.7 million in the year endedDecember 31, 2004, to $381.2 million in the year endedDecember 31, 2005.

**Liquidity andCapital Resources**

**Capitalrequirements**

Our principalon-going financing requirements are to finance our mining operations andproduction of steel and steel products, and to fund the following majoractivities:

·       Futuregrowth through acquisitions;

·       Capitalexpenditures, including the purchase of equipment, modernization of facilities;

·       Retirementof our short-term and portions of our long-term debt;

·       Changesin working capital; and

·       Generalcorporate purposes.

We anticipate that acquisitions, capital expendituresand repayments of outstanding debt will represent the most significant uses offunds for the next several years.

We continue to consider acquisitions as one of ourmajor growth strategies. Historically, funding of this strategy came from cashflows from existing operations, external financing sources and our shareholdersin the form of contributions to our charter capital. We intend to financeacquisitions in the future through a mix of cash flow generated by ourbusiness, as well as external debt.

Our business is heavily dependent on plant andmachinery for the production of steel and steel products, as well asinvestments in our mining operations. Investments to maintain and expandproduction facilities are, accordingly, an important priority and have asignificant effect on our cash flows and future results of operations. Weexpect our capital expenditures to increase significantly in the next fewyears. See “Item 4. Information on the Company—Capital Improvements Program”for the objectives of our capital expenditure program and its details. Over thenext five years, *i.e.*, through 2011, we expect ouroverall capital expenditures to total approximately $1.8 billion,approximately 43% of which will be in 2007-2008 and approximately 57% in2008-2011. We plan to finance our capital expenditures out of our cashflows 

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from operations and externaldebt. Our failure to undertake planned expenditures on production facilitiescould adversely affect our ability to maintain and/or enhance our competitiveposition and develop higher margin products.

Our total outstanding debt as of December 31,2006 and December 31, 2005 was $489.1 million and$435.0 million, respectively. See “Item 11. Quantitative and QualitativeDisclosures About Market Risk” for information regarding the type of financialinstruments, the maturity profile of debt, currency and interest ratestructure.

In 2006, we paid dividendsfor 2005 in an amount equal to $189.5 million, which was approximately 50% ofour annual net income in 2005, as determined under U.S. GAAP and in accordancewith our dividend policy established in March 2006. See “Item 8. FinancialInformation—Dividend Distribution Policy.”

**Capital resources**

We plan to finance our capital requirements through amix of cash flows from operating and financing activities. Historically, ourmajor sources of cash have been cash provided by operations and short-termdebt. However, since 2006, we began financing our investment expenditures withlong-term debt including ruble bonds and long-term bank loans. We have alsostarted to exploit new products emerging in the fast-developing financialmarkets, in particular, for financing of our investment program, such asECA-financing. We are planning to increase the share of long-term debt in ourcredit portfolio in the future. We do not depend on off-balance sheet financingarrangements.

Net cash provided by operating activities was $554.9million, $620.9 million and $296.1 million in the years endedDecember 31, 2006, 2005 and 2004, respectively. The principal reason forthe growth of net cash provided by operating activity is better management ofworking capital. The operating cash inflows are derived from payments receivedfrom sales of our mining and steel products, reduced by cash disbursements fordirect labor, raw materials and parts, selling, distribution and operatingexpenses, interest expense and income taxes.

Net cash used in investing activities was $552.5 millionin 2006, net cash used in investing activities was $994.7 million in theyear ended December 31, 2005 and net cash provided by investing activitieswas $455.7 million in the year ended December 31, 2004. Investingactivities provided cash in 2004 due to the proceeds from the sale of our stakein MMK in the amount of $870.0 million; otherwise, substantially all of thecash used for investing activities in 2006, 2005 and 2004 related to theacquisition of businesses, mineral licenses and property, plant and equipment.Expenditures for the acquisition of businesses, equity method investments andminority interests in our subsidiaries amounted to $162.6 million, $488.6 millionand $90.7 million in the years ended December 31, 2006, 2005 and2004, respectively. The cash used by investing activities in 2006 included$176.9 million (net of $20.4 million of cash held by Moscow Coke and Gas Plantat the date of acquisition) paid for the acquisition of a 98.9% stake in MoscowCoke and Gas Plant. Capital expenditures have steadily increased and amountedto $397.8 million, $520.6 million and $303.4 million in the yearsended December 31, 2006, 2005 and 2004, respectively.

Net cash used in financingactivities was $162.8 million in the year ended December 31, 2006, netcash used in financing activities was $308.9 million in the year endedDecember 31, 2005 and net cash provided by financing activities was$252.3 million in the year ended December 31, 2004. In general, werely heavily on short term debt, receiving proceeds of $0.9, $1.6 billion and$1.0 billion in 2006, 2005 and 2004, respectively. In the same years, we repaidshort term debt in the amounts of $1.1, $1.7 billion and $0.9 billion,respectively. In 2006, we issued a seven-year ruble-denominated bond, theproceeds of which amounted to $189.9 million, and received additional long-termfinancing amounting to $225.4 million. These funds were used to financemodernization of our metallurgical and mining assets and new acquisitions.During 2006, our short term debt decreased by $233.5 million and we paiddividends in the 

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amountof $189.6 million. In 2005, financing activities used cash due to a higherlevel of repayments of short term debt as compared to the prior year, thepayment of dividends in an amount of $194.2 million, and a lower level ofproceeds from long term debt as compared to the prior year. In 2004, we and ourRussian subsidiaries issued long term ruble-denominated bonds, theproceeds of which were used to acquire property, plant and equipment and repayour short-term borrowings. In 2004, we also completed our initial publicoffering, the proceeds of which amounted to $213.4 million and were used toacquire property, plant and equipment and acquire businesses.

**Liquidity**

We had cash and cash equivalents of$172.6 million at December 31, 2006, and $311.8 million atDecember 31, 2005. Of these amounts, $58.5 million and$271.4 million was held in U.S. dollars, euros and other hard currenciesand $114.1 million and $40.4 million was held in rubles and othercurrencies of the CIS and Eastern Europe, respectively.

As of December 31, 2006 and 2005, we had unusedcredit lines of approximately $198.4 million and $182.5 million, respectively,out of total available credit lines of $687.5 million and$617.6 million, respectively. These credit lines permit drawings at aweighted average interest rate of approximately 7.61% and 9.94% atDecember 31, 2006, and 2005, respectively. We have not had, and do notbelieve that we will have, difficulty gaining access to short-term financingsufficient to meet our current requirements.

Thefollowing table summarizes our liquidity as of December 31, 2006, and2005.

| **Estimated Liquidity**               | ** ** | ** **                                            | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **(in millions of U.S. dollars)** | ** ** |
| Cash and cash  equivalents                 |       |                                                  | 172.6      |                        |       |                        | 311.8      |   |   |
| Amounts available  under credit facilities |       |                                                  | 198.4      |                        |       |                        | 182.5      |   |   |
| Total estimated  liquidity                 |       |                                                  | 371.0      |                        |       |                        | 494.3      |   |   |

 

We had working capital of $879.7 million and$390.2 million as of December 31, 2006 and 2005, respectively. Theincrease in working capital was primarily due to our acquisition of Moscow CokeGas Plant, including its investment portfolio with shares of various Russianpublic companies, which were recorded as short term investments of Moscow CokeGas Plant with the intention to be sold in future, as well as a decrease in theamount of short term loans as of December 31, 2006 as compared toDecember 31, 2005.

We believe that our working capital is sufficient forour present requirements. Future requirements for our business needs, includingthe funding of acquisitions and capital expenditures, debt service foroutstanding financings, and any amounts that may ultimately be paid inconnection with contingencies (including those described under “Item 8.Financial Information—Litigation”), are expected to be financed by acombination of internally generated funds (including non-core asset sales),borrowings and other external financing sources. We expect the combination ofoperating cash flow generated by our business and external financing sources tobe sufficient to enable us to service or refinance our indebtedness or to fundother liquidity needs. However, our ability to rely on some of these alternativescould be affected by factors such as the liquidity of the Russian and otherfinancial markets, prevailing interest rates, our credit rating and the Russiangovernment’s policies regarding ruble and foreign currency borrowings.

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Our opinion concerningliquidity and our ability to avail ourselves in the future of the financingoptions mentioned in the above forward-looking statements are based oncurrently available information. To the extent that this information proves tobe inaccurate, future availability of financing may be adversely affected.Factors that could affect the availability of financing include our performance(as measured by various factors including cash provided from operatingactivities), levels of inventories and accounts receivable, the state ofinternational debt and equity markets, investor perceptions and expectations ofpast and future performance, the global financial climate, and, in particular,with respect to borrowings, the level of our outstanding debt and creditratings by rating agencies.

**Contractualobligations and commercial commitments**

Thefollowing table sets forth the amount of our contractual obligations andcommercial commitments as of December 31, 2006.****

| ** **                                                                                                                       | ** ** | ** **                                             | ** ** | **Payments due by period** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations and Commercial Commitments**                                                       | ** ** | ** **                                             | ** ** | **Total**                                 | ** ** | **Less than 1  year** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **More than 5  years** | ** ** |
| ** **                                                                                                                       | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| Short-Term  Borrowings(1)                                                                                                        |       | 166,517                                                |       |                                      | 166,517    |   |   | — |   |   | — |   |   |   | — |   |   |
| Long-Term  Debt Obligations(1)                                                                                                   |       | 322,604                                                |       |                                      | —     |   |   | 133,349 |   |   | 165 |   |   |   | 189,089 |   |   |
| Operating Lease  Obligations(2)                                                                                                  |       | 149,165                                                |       |                                      | 4,512      |   |   | 7,909 |   |   | 9,454 |   |   |   | 127,290 |   |   |
| Purchase  Obligations(3)                                                                                                         |       | 34,683                                                 |       |                                      | 34,683     |   |   | — |   |   | — |   |   |   | — |   |   |
| Restructured  Taxes Payable(4)                                                                                                   |       | 7,782                                                  |       |                                      | —     |   |   | 7,782 |   |   |   |   |   |   |   |   |   |
| Asset Retirement  Obligations(5)                                                                                                 |       | 92,358                                                 |       |                                      | 3,444      |   |   | 11,054 |   |   | 10,523 |   |   |   | 67,336 |   |   |
| Pension and Post-retirement  Benefits(6)                                                                                         |       | 66,105                                                 |       |                                      | 10,698     |   |   | 10,972 |   |   | 11,909 |   |   |   | 32,526 |   |   |
| Short-term  Finance Lease Obligations(7)                                                                                         |       | 6,066                                                  |       |                                      | 6,066      |   |   |   |   |   |   |   |   |   |   |   |   |
| Long-term Finance  Lease Obligations(7)                                                                                          |       | 51,068                                                 |       |                                      |       |   |   | 15,283 |   |   | 21,661 |   |   |   | 14,124 |   |   |
| Contractual commitments  to acquire plant, property and equipment, raw materials and for delivery  of goods and services(8) |       | 775,835                                                |       |                                      | 641,575    |   |   | 134,260 |   |   | — |   |   |   | — |   |   |
|                                                                                                                                  |            |                                                        |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Does not includeinterest. In 2006, our interest expense was $38.2 million and we paid out$38.9 million for interest, net of amounts capitalized.

(2)          See note 22 to ourconsolidated financial statements.

(3)          Accounts payable forcapital expenditures.

(4)          Consists of Russian andRomanian restructured prior period taxes and social charges and related finesand penalties. This does not include $143.0 million in current periodtaxes and social contributions due as of December 31, 2006. Seenote 15 to our consolidated financial statements. This also does notinclude income taxes. In 2006, our income tax expense amounted to$208.3 million and we paid out $196.9 million in income taxes.

(5)          See note 16 to ourconsolidated financial statements.

(6)          See note 17 to ourconsolidated financial statements.

(7)          See note 18 to ourconsolidated financial statements.

(8)          See note 25 to ourconsolidated financial statements.

In the course of acquisition of our Romaniansubsidiaries, we undertook certain commitments in respect of future capitalexpenditures connected with the development of production facilities andimprovements in environmental compliance. For Mechel Targoviste, we committedto invest $21.1 million over a period of five years from the date ofacquisition (August 2002). For Mechel Campia Turzii, we 

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committed to invest$22.7 million over a period of five years from the date of acquisition(June 2003). These investments were required to be made in annualinstallments from the dates of their respective acquisitions, and ourinvestment commitments were secured by our shares in these subsidiaries. Wecompleted our investment obligations in their entirety with respect to bothRomanian subsidiaries in 2007, and the shares pledged in connection with thesecommitments were released.

We have also guaranteed the fulfillment of obligationsto third parties under various debt agreements. The maximum potential amount offuture payment under these guarantees as of December 31, 2006 amounted to$478.5 million out of which $472.1 million related to guarantees given by usfor our subsidiaries.

Commitments for capitalexpenditures as of December 31, 2006 amounted to $26.5 million and thegeneral purpose of such commitments was to improve operating efficiency andmaintain existing output. We plan to finance our capital expenditures out of ourcash flows from operations and external debt.

**Inflation**

Inflation in the RussianFederation was 11.7% in 2004, 10.9% in 2005 and 9.7% in 2006. With theexception of our coal operations in 2002, inflation has generally not had amaterial impact on our results of operations in recent years, primarily becauseproducers in the market segments in which we compete are able to increaseselling prices in line with increases in ruble-denominated costs.

**Critical AccountingPolicies and Estimates**

The preparation of our consolidated financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities, the disclosure of contingentassets and liabilities at year-end, and the reported amount of revenues andexpenses during the year. Management regularly evaluates these estimates.Management estimates are based on historical experience and various otherassumptions that are believed to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that are not readily apparent from other sources.Accordingly, actual results may differ materially from current expectationsunder different assumptions or conditions.

The value of property, plant and equipment pertainingto non-controlling shareholders in the accounting for minority interestsresulting from acquisitions of various subsidiaries has been recorded atappraised values rather than at historical cost as required by U.S. GAAP.

Management believes thatthe following are the more significant policies, judgments and estimates usedin the preparation of the financial statements.

**Accounting forbusiness combinations**

During the past years, we have completed severalsignificant business combination transactions. In the future, we may continueto grow our business through business combinations. We accounted for allcombinations using the purchase method of accounting.

The accounting for business combinations under thepurchase method is complicated and involves the use of significant judgment.Under the purchase method of accounting, a business combination is accountedfor at a purchase price based upon the fair value of the consideration given,whether it is in the form of cash, assets, stock or the assumption ofliabilities. The assets and liabilities acquired are measured at their fairvalues, and the purchase price is allocated to the assets and liabilities basedupon these fair values. Determining the fair values of the assets andliabilities acquired involves the use of judgment, since the majority of theassets and liabilities acquired do not have fair values that are readilydeterminable. Different techniques may be used to determine fair values,including market prices, where available, 

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appraisals, comparisons totransactions for similar assets and liabilities and present value of estimatedfuture cash flows, among others. Since these estimates involve the use ofsignificant judgment, they can change as new information becomes available.

The most difficult estimations of individual fairvalues are those involving property, plant and equipment and identifiableintangible assets. We use all available information to make these fair valuedeterminations and, for major business acquisitions, typically engage anoutside appraisal firm to assist in the fair value determination of theacquired long-lived assets. We have, if necessary, up to one year after theacquisition closing date to finish these fair value determinations and finalizethe purchase price allocation.

Purchase price has been allocated to the fair value of net assets acquired.Purchase price in excess of the fair value of identified assets and liabilitiesacquired was capitalized as goodwill. The excess of the fair value of netassets acquired over cost is called negative goodwill, and was allocated to theacquired non-current assets, except for deferred taxes, if any, untilthey were reduced to zero. SFAS No. 142 prohibits the amortization ofgoodwill and negative goodwill. Instead, goodwill is tested for impairment atleast annually and on an interim basis when an event occurs or circumstanceschange between annual tests that would more-likely-than-not result inimpairment.

For the investees accounted for under the equity method, the excess of costof the stock of those companies over our share of fair value of their netassets as of the acquisition date is treated as goodwill embedded in theinvestment account. Goodwill arising from equity method investments is not amortized,but tested for impairment at least annually and on an interim basis when anevent occurs or circumstances change between annual tests that wouldmore-likely-than-not result in impairment.

As of December 31,2006, 2005 and 2004, we reported goodwill of $45.9 million,$39.6 million and $39.4 million, respectively. During the years endedDecember 31, 2006, 2005 and 2004, we recognized goodwill impairments of$nil, $nil and $nil, respectively.

**Mineral licensesand mining long-lived assets**

We use estimates for proven and probable reserves,recoverable resources therefrom, and/or assumptions of future coal, nickel andiron ore prices. Such estimates and assumptions affect the fair value of themineral reserves rights at the date of its acquisition, impairment of mineralreserves rights and other long-lived assets and the ability to realize incometax benefits associated with deferred tax assets.

Our estimate of mineral reserves together withestimates of sales volumes and prices for the products are significant factorsused in performing annual impairment assessments of our long-lived miningassets, including mineral reserves rights. Changes in estimates of reserves andother assumptions regarding pricing and volumes could materially influencethese assessments. Should our estimates of the quantity of sales and prices notmaterialize, significant impairments of our long-lived mining assets mayresult. These estimates and assumptions also affect the rate at whichdepreciation and depletions are charged to earnings.

Because currently there is no history of subsoillicenses’ renewals, our existing mineral reserves rights and long-lived miningassets are being depleted/depreciated over the periods covered by existinglicenses on the deposit-by-deposit basis using the units-of-production method overthe shorter of the license term or the estimated proven and probable reservedepletion period.

Management evaluates itsestimates and assumptions on an ongoing basis; however, actual amounts coulddiffer from those based on such estimates and assumptions. As ofDecember 31, 2006, 2005 and 2004, the carrying amount of our minerallicenses amounted to $272.4****million,$242.0 million and $166.5 million, respectively.

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**Retirement benefitobligations**

Our Russian subsidiaries are legally obligated to makedefined contributions to the Russian Pension Fund, managed by the RussianFederation Social Security (a defined contribution plan financed on a pay-as-you-gobasis). Our contributions to the Russian Pension Fund relating to definedcontribution plans are charged to income in the year to which they relate.

Contribution to the Russian Pension Fund together withother social contributions are included within a unified social tax (“UST”),which is calculated by the application of a regressive rate from 26% (appliedto the part of the annual gross salary below 280,000 rubles or approximately$10,000 translated at the exchange rate of the rubles to the U.S. dollar atDecember 31, 2006) to 2% (applied to the part of the annual gross salary above600,000 rubles or approximately $21,000 translated at the exchange rate of theruble to the U.S. dollar at December 31, 2006) to the annual grossremuneration of each employee. UST is allocated to three social funds(including the Russian Pension Fund), where the rate of contributions to theRussian Pension Fund varies from 14% to 5.5%, respectively, depending on theannual gross salary of each employee. Contributions to the Russian Pension Fundfor the years ended December 31, 2006, 2005 and 2004 were $53.3 million,$47.9 million and $39.5 million, respectively.

In addition, we have anumber of defined benefit pension plans that cover the majority of productionemployees. Benefits under these plans are primarily based upon years of serviceand average earnings. The payments to former employees under benefit pensionand post retirement plans are performed on a voluntary basis. We account forthe cost of defined benefit plans using the projected unit credit method. Underthis method, the cost of providing pensions is charged to the income statement,so as to attribute the total pension cost over the service lives of employeesin accordance with the benefit formula of the plan. Our obligation in respectof defined retirement benefit plans is calculated separately for each definedbenefit plan by discounting the amounts of future benefits that employees havealready earned through their service in the current and prior periods. Thediscount rate applied represents the yield at the year end on highly rated long-termbonds.

**Revenue recognition**

Revenue is recognized on an accrual basis when earnedand realizable, which generally occurs when products are delivered tocustomers. In some instances, while title of ownership has been transferred,the revenue recognition criteria have not been met as the selling price issubject to adjustment based upon the market price when the customer receivesthe product. Accordingly, in those instances, revenue and the related cost ofgoods sold are recorded as deferred revenues and deferred cost of inventory intransit in the consolidated balance sheets and are not recognized in theconsolidated income statement until the price becomes fixed and determinable,which typically occurs when the price is settled with the end-customer. In certainforeign jurisdictions (e.g., Switzerland), we generally retain title to thegoods sold to the end-customers solely in order to ensure that theaccounts receivable are protected. In such instances, all other salesrecognition criteria are met, which allows us to recognize sales revenue inconformity with the underlying sales contracts. Sales are recognized netof applicable provisions for discounts and allowances and associated salestaxes (VAT) and export duties.

We categorizerevenues as follows:

·       Domestic;

·       Russia:sales of Russian production within Russia;

·       Otherdomestic: sales of non-Russian production within the country of production; and

·       Export: sales of production outside of countryof production.

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**Property, plant andequipment**

Capitalized production costs for internally developed assets includematerial, direct labor costs, and allocable material and manufacturing overheadcosts. When construction activities are performed over an extended period,interest costs incurred during construction are capitalized.Construction-in-progress and equipment held for installation are notdepreciated until the constructed or installed asset is substantially ready forits intended use.

The costs of planned major maintenance activities are recorded as the costsare actually incurred and are not accrued in advance of the plannedmaintenance. Costs for activities that lead to the prolongation of useful lifeor to expanded future use capabilities of an asset are capitalized. Maintenanceand repair costs are expensed as incurred.

For other than mineral licenses and other long-livedmining assets and processing plant and equipment, we record depreciationprimarily using the straight-line method on a pro rata basis.

Thefollowing useful lives are used as a basis for recording depreciation:

| **Category of asset**        | ** ** | ** ** | ** **    | **Useful economic  lives estimates,  years** | ** ** |
|----------------------------------------|------------|------------|---------------|--------------------------------------------------------|------------|
| Buildings                              |       |       | 20 –  45 |                                                   |       |
| Land improvements                      |       |       | 20 –  50 |                                                   |       |
| Operating  machinery and equipment     |       |       | 7 –  30  |                                                   |       |
| Transportation  equipment and vehicles |       |       | 4 –  15  |                                                   |       |
| Tools, furniture,  fixtures and other  |       |       | 4 – 8    |                                                   |       |

 

The remaining usefuleconomic lives of our property, plant and equipment are being revised on anannual basis.

**Impairment of long-lived assets**

We follow the requirements of SFAS No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets”, which addresses financialaccounting and reporting for the impairment and disposal of long-lived assets,and SFAS No. 142, with respect to impairment of goodwill. We review thecarrying value of its long-lived assets, including property, plant andequipment, investments, goodwill, licenses to use mineral reserves (inclusiveof capitalized costs related to assets retirement obligations (ARO)), andintangible assets, for impairment whenever events or changes in circumstancesindicate that the carrying amount of such assets may not be fully recoverableas prescribed by SFAS No. 144 and SFAS No. 142. Recoverability oflong-lived assets, excluding goodwill, is assessed by a comparison of thecarrying amount of the asset (or the group of assets, including the asset inquestion, that represents the lowest level of separately-identifiable cashflows) to the total estimated undiscounted cash flows expected to be generatedby the asset or group of assets. If the estimated future net undiscounted cashflows are less than the carrying amount of the asset or group of assets, theasset or group of assets is considered impaired and expense is recognized equalto the amount required to reduce the carrying amount of the asset or group of assetsto their fair value. Fair value is determined by discounting the cash flowsexpected to be generated by the asset, when the quoted market prices are notavailable for the long-lived assets. For assets and groups of assets relatingto and including the licenses to use mineral reserves, future cash flowsinclude estimates of recoverable minerals, mineral prices (considering currentand historical prices, price trends and other factors), production levels,capital and reclamation costs, all based on the engineering life of mine plans. Recoverable minerals refer to the estimatedamount that will be obtained from proven and probable reserves. Estimatedfuture cash flows are based on assumptions and are subject to risk anduncertainty.

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SFAS No. 142 prohibits the amortization of goodwill and negativegoodwill. Instead, goodwill is tested for impairment at least annually and onan interim basis when an event occurs or circumstances change between annualtests that would more-likely-than-not result in impairment. Under SFASNo. 142, goodwill is assessed for impairment by using the fair value basedmethod. We determine fair value by utilizing discounted cash flows. The fairvalue test required by SFAS No. 142 for goodwill includes a two-stepapproach. Under the first step, companies must compare the fair value of a“reporting unit” to its carrying value. A reporting unit is the level at whichgoodwill impairment is measured and it is defined as an operating segment orone level below it if certain conditions are met. If the fair value of thereporting unit is less than its carrying value, goodwill is impaired.

Under step two, the amount of goodwill impairment is measured by the amountthat the reporting unit’s goodwill carrying value exceeds the “implied” fairvalue of goodwill. The implied fair value of goodwill can only be determined bydeducting the fair value of all tangible and intangible net assets (includingunrecognized intangible assets) of the reporting unit from the fair value ofthe reporting unit (as determined in the first step). In this step, the fairvalue of the reporting unit is allocated to all of the reporting unit’s assetsand liabilities (a hypothetical purchase price allocation). SFAS No. 142requires companies to perform the impairment test at least annually.

If goodwill and another asset (or asset group) of areporting unit are tested for impairment at the same time, the other asset (orasset group) shall be tested for impairment before goodwill. If the asset groupwas impaired, the impairment loss would be recognized prior to goodwill beingtested for impairment. We did not have any impairment loss as a result ofadopting SFAS No. 142 and perform the required impairment test.

We performed an impairment analysis of property, plant and equipment andmineral reserves at Southern Urals Nickel Plant (mining segment) and relatedgoodwill originated from its acquisition as several impairment indicatorsexisted as of December 31, 2004 and 2005, including operating losses andchange in market environment. As a result of this analysis, we concluded thatno impairment loss existed as of those dates.

In December 2005, we decided torestructure the production process in Mechel Targoviste and Mechel CampiaTurzii (steel segment) in order to increase their efficiency and profitability.As a result of this restructuring certain production workshops of MechelTargoviste and Mechel Campia Turzii will be closed and abandoned in early 2006with property, plant and equipment being disposed of other than by sale. As of December 31,2005, the carrying value of property, plant and equipment of these workshopswas $5.8 million for Mechel Targoviste and $6.8 million for Mechel CampiaTurzii and was written off in full amount. As of December 31, 2005 andDecember 31, 2006, we reviewed the remaining property, plant and equipmentof these Romanian subsidiaries for impairment. As a result of such impairmentanalysis, we did not consider the assets impaired.

**Accounts receivable**

Accounts receivable arestated at net realizable value. We review the valuation of accounts receivableon a regular basis. The allowance for doubtful accounts is estimated based onhistorical experience of cash collections and future expectations of conditionsthat might affect the collectibility of accounts.

**Deferred incometaxes**

We record a valuationallowance to reduce our deferred tax assets to an amount that is more likelythan not to be realized. In estimating levels of future taxable income, we haveconsidered historical results of operations in recent years and would, ifnecessary, consider the implementation of prudent and feasible tax planningstrategies to generate future taxable income. If future taxable income is lessthan the amount that has been assumed in determining the deferred tax asset, thenan increase in the valuation reserve will 

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berequired, with a corresponding charge against income. On the other hand, iffuture taxable income exceeds the level that has been assumed in calculatingthe deferred tax asset, the valuation reserve could be reduced, with acorresponding credit to income.

**Litigation, claimsand assessments**

We are subject to various lawsuits, claims andproceedings related to matters incidental to our business. Accruals of probablecash outflows have been made based on an assessment of a combination oflitigation and settlement strategies. It is possible that results of operationsin any future period could be materially affected by changes in assumptions orby the effectiveness of these strategies.

We record liabilities forpotential tax deficiencies. These liabilities are based on management’sjudgment of the risk of loss. In the event that we were to determine thattax-related items would not be considered deficiencies or that items previouslynot considered to be potential deficiencies could be considered as potentialtax deficiencies (as a result of an audit, tax ruling or other positions orauthority) an adjustment to the liability would be recorded through income inthe period such determination was made. See “Item 8. Financial Information—Litigation”for a description of certain tax-related contingencies.

**Asset RetirementObligations**

Effective January 1, 2003, we adopted SFASNo. 143, “Accounting for Asset Retirement Obligations,” which applies tolegal obligations associated with the retirement and removal of long-livedassets. SFAS No. 143 requires entities to record the fair value of anasset retirement obligation (ARO) as a liability in the period when it isincurred (typically when the asset is installed at the production location).When the liability is recorded, the entity capitalizes the cost by increasingthe carrying amount of the related properties, plant and equipment. Over time,the liability is increased for the change in its present value each period, andthe capitalized cost is depreciated over the useful life of the related asset.

Upon adoption of SFAS No. 143 on January 1,2003, we recorded approximately $3.8 million, net of taxes, as a charge tocumulative effective changes in accounting principles. Application of this newaccounting principle resulted in an increase in property, plant and equipmentof $5.5 million and an asset retirement obligation liability of$9.3 million. The application of SFAS No. 143 reduced income fromcontinuing operations by $2.6 million, net income by $6.4 million(after income taxes of $nil), or $0.02 per basic and diluted share, for theyear ending December 31, 2003.

Wehave numerous asset removal obligations that we are required to perform underlaw or contract once an asset is permanently taken out of service. Most ofthese obligations are not expected to be paid until many years into the futureand will be funded from general company resources at the time of removal. Ourasset retirement obligations primarily relate to our mining and steelproduction facilities with related to landfills and dump areas and our mines.The following table presents the movements in ARO for the year endingDecember 31, 2006.

| **Asset retirement obligation**      | ** ** | ** ** | ** ** | **Year ended  December 31, 2006** | ** ** |
|------------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| Balance at beginning  of year                  |       |       | 59,052     |                                             |       |
| Liabilities  incurred in the current period    |       |       | 2,160      |                                             |       |
| Liabilities  settled in the current period     |       |       | (510       | )                                                |       |
| Liabilities  disposed of in the current period |       |       | —     |                                             |       |
| Accretion expense                              |       |       | 7,433      |                                             |       |
| Revision in  estimated cash flow               |       |       | 17,876     |                                             |       |
| Translation and  other                         |       |       | 6,347      |                                             |       |
| Balance at end of year                         |       |       | 92,358     |                                             |       |

 

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**Recently IssuedAccounting Pronouncements**

**Inventory costs**

InDecember 2004, the FASB issued SFAS No. 151, “Inventory costs” (“SFASNo. 151”), which amends ARB 43, Chapter 4, to clarify that abnormalamounts of idle facility expenses, freight, handling costs and wasted materials(spoilage) should be recognized as current period expenses. In addition, SFASNo. 151 requires that allocation of fixed production overhead to the costsof conversion be based on the normal capacity of the production facilities. Theprovisions of SFAS No. 151 are effective for inventory costs incurredduring fiscal years beginning after June 15, 2005. We have applied theprovisions of SFAS No. 151 prospectively to inventory costs incurred on orafter January 1, 2006. The adoption of this standard in 2006 did not havea material impact on our financial position and results of operations.

**Share-based payment**

In December 2004, the FASB issuedrevised SFAS No. 123R, “Share-based payment” (“SFAS No. 123R”). SFASNo. 123R establishes standards for the accounting for transactions inwhich an entity exchanges its equity instruments for goods or services. It alsoaddresses transactions in which an entity incurs liabilities in exchange forgoods or services that are based on the fair value of the entity’s equityinstruments or that may be settled by the issuance of those equity instruments.SFAS No. 123R requires a public entity to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award (with limited exceptions). SFAS No. 123R iseffective as of the beginning of the first interim or annual reporting periodthat begins after June 15, 2005. The adoption of this standard did nothave a material impact on our financial position and results of operations.

**Exchanges of non-monetary assets**

In December 2004, the FASB issuedSFAS No. 153, “Exchanges of Non-monetary Assets—An Amendment of APB OpinionNo. 29” (“SFAS No. 153”). SFAS No. 153 amends Opinion 29 toeliminate the exception for non-monetary exchanges of similar productive assetsand replaces it with a general exception for exchanges of non-monetary assetsthat do not have commercial substance. The Statement specifies that anon-monetary exchange has commercial substance if the future cash flows of theentity are expected to change. The adoption of SFAS No. 153 in 2005 didnot have a material impact on our financial position and results of operations.

**Accounting for conditional assetsretirement obligations**

In March 2005, the FASB issuedInterpretation No. 47, “Accounting for Conditional Assets RetirementObligations” (“FIN 47”), that requires an entity to recognize a liability for aconditional asset retirement obligation when incurred if the liability can bereasonably estimated. FIN 47 clarifies that the term Conditional AssetRetirement Obligation refers to a legal obligation to perform an assetretirement activity in which the timing and/or method of settlement isconditional on a future event that may or may not be within the control of theentity. The Interpretation is effective for fiscal years ending afterDecember 15, 2005. The adoption of FIN 47 in 2006 did not have a materialimpact on our financial position and results of operations.

**Accounting for stripping costs incurredduring production in the mining industry**

On March 17, 2005, the EITF issuedIssue No. 04-6, “Accounting for Stripping Costs Incurred duringProduction in the Mining Industry” (“EITF 04-6”). EITF 04-6provides that stripping costs incurred during the production phase of a mineare variable production costs that should be included in the costs of theinventory produced during the period that the stripping costs are incurred.EITF 04-6 is effective for the 

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first reportingperiod in fiscal years beginning after December 15, 2005. The adoption ofEITF 04-6 in 2006 did not have a material impact on our financialposition and results of operations.

**Accounting for preexisting relationshipsbetween the parties to a business combination**

In October 2004, the FASB ratifiedthe consensus reached by the EITF on Issue 04-1 “Accounting forPreexisting Relationships between the Parties to a Business Combination” (“EITF04-1”). EITF 04-1 requires that a business combination between twoparties that have a preexisting relationship be evaluated to determine if asettlement of a preexisting relationship exists. EITF 04-1 is effectiveprospectively for business combinations consummated in reporting periodsbeginning after October 13, 2004. The adoption of EITF 04-1 in 2005did not have a material impact on our financial position and results ofoperations.

**Mining assets: impairment and businesscombinations**

In March 2004, the EITF reached consensuson Issue 04-3, “Mining Assets: Impairment and Business Combinations”(“EITF 04-3”). EITF 04-3 relates to estimating cash flows used tovalue mining assets or assess those assets for impairment. We currently assessimpairment on the projected mine life of each project utilizing existingtechnology. The adoption of EITF 04-3 in 2005 did not have a materialimpact on our financial position and results of operations.

**Accounting for the impairment or disposalof long-lived assets**

In November 2004, the EITF reached afinal consensus on EITF No. 03-13, “Applying the Conditions inParagraph 42 of FASB Statement No. 144, Accounting for the Impairment orDisposal of Long-Lived Assets, in Determining Whether to Report DiscontinuedOperations” (“EITF 03-13”). EITF 03-13 addresses the evaluation ofwhether the operations and cash flows of a disposed component have been or willbe eliminated from the ongoing operations of the entity and whether the sellingentity will have significant continuing involvement in the operations of thedisposed entity. The consensus should be applied to a component that is eitherdisposed of or classified as held for sale in periods beginning afterDecember 15, 2004. The adoption of EITF 03-13 in 2005 did not have amaterial impact on our financial position and results of operations.

**Accounting and reporting of a change inaccounting principle**

In May 2005, the FASB issued SFAS154, “Accounting Changes and Error Corrections—A replacement of APBOpinion No. 20 and FASB Statement No. 3” (“SFAS 154”), which changes therequirements for the accounting and reporting of a change in accountingprinciple. FAS 154 eliminates the requirement to include the cumulative effectof changes in accounting principle in the income statement and instead requiresthat changes in accounting principle be retroactively applied. FAS 154 iseffective for accounting changes and correction of errors made on or afterJanuary 1, 2006, with early adoption permitted. We will begin applying theprovisions of this statement in 2006. The adoption of SFAS No.154 in 2006 didnot have a material impact on our financial position and results of operations.

**Accounting forpurchases and sales of inventory with the same counterparty**

In September 2005,EITF reached consensus on Issue No. 04-13 “Accounting for purchasesand sales of inventory with the same counterparty” (“EITF 04-13”). EITF04-13 relates to defining the circumstances under which two or moreinventory purchase and sales transactions with the same counterparty should beviewed as a single exchange transaction; and defining whether there arecircumstances under which nonmonetary exchanges of inventory within the sameline of business should be recognized at fair value. EITF 04-13 iseffective prospectively for new arrangements entered into, and modifications orrenewals of existing arrangements, beginning in the first interim or annualreporting period beginning after 

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March 15, 2006.We will begin applying the provisions of this statement in2006. The adoption of EITF 04-13 in 2006 did not have a material impact onour financial position and results of operations.

**Accounting forcertain hybrid financial instruments**

In February 2006,FASB issued SFAS No. 155 “Accounting for Certain Hybrid FinancialInstruments” (SFAS No. 155), which amends SFAS No. 133 andSFAS No. 140, “Accounting for Transfers and Servicing of FinancialAssets and Extinguishments of Liabilities,” and improves the financialreporting of certain hybrid financial instruments by requiring more consistentaccounting that eliminates exemptions and simplifies the accounting for thoseinstruments. SFAS No. 155 allows financial instruments that haveembedded derivatives to be accounted for as a whole (eliminating the need tobifurcate the derivative from its host) if the holder elects to account for thewhole instrument on a fair value basis. SFAS No. 155 is effective forall financial instruments acquired or issued after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006. We have not issuedor acquired the hybrid instruments included in the scope ofSFAS No. 155 and do not expect the adoption of SFAS No. 155to have a material impact on our financial condition, results of operations orcash flows.

**Accounting forservicing of financial assets**

In March 2006, theFASB issued SFAS 156 “Accounting for servicing of financial assets—An amendmentof FASB Statement No. 140 (SFAS 156), which changes the requirements ofaccounting for servicing of financial assets. SFAS 156 requires an entity torecognize a servicing asset or servicing liability each time it undertakes anobligation to service a financial asset by entering into a servicing contract.In addition, all separately recognized servicing assets and servicingliabilities are to be initially measured at fair value. SFAS No. 156 iseffective as of beginning of the first fiscal year that begins afterSeptember 15, 2006. We will begin applying the provisions ofthis statement in 2007. The adoption of SFAS No. 156 is notexpected to have a material impact on our financial position and results ofoperation.

**Accounting foruncertainty in income taxes**

In June 2006, FASB issued FASBInterpretation No. 48 “Accounting for Uncertainty in Income Taxes—AnInterpretation of FASB Statement No. 109” (FIN 48), effective forfiscal years beginning after December 15, 2006. FIN 48 prescribes theminimum recognition threshold a tax position must meet before being recognizedin the financial statements and provides guidance on derecognition,measurement, classification, interest and penalties, accounting in interimperiods, disclosure and transition. We estimate that the adoption of FIN 48will result in a $68 million to $100 million increase of our tax liabilities,which would be accounted for as a cumulative adjustment to the January 1,2007 retained earnings.

**Fair valuemeasurements**

In September 2006,the FASB issued SFAS No. 157 “FairValue Measurements” (SFAS No. 157). SFAS No. 157defines fair value, establishes a framework for measuring fair value andrequires enhanced disclosures about fair value measurements.SFAS No. 157 requires companies to disclose the fair value of theirfinancial instruments according to a fair value hierarchy as defined in thestandard. Additionally, companies are required to provide enhanced disclosureregarding financial instruments in one of the categories (level 3),including a reconciliation of the beginning and ending balances separately foreach major category of assets and liabilities. SFAS No. 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007, and interim periods within those fiscal years. Webelieve that the adoption of SFAS No. 157 will not have a materialimpact on our consolidated financial statements.

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**Employers’accounting for defined benefit pension and other post-retirement plans**

OnSeptember 29, 2006, FASB issued SFAS No. 158 “Employers’Accounting for Defined Benefit Pension and Other Post-Retirement Plans, anamendment of FASB Statements No. 87, 88, 106 and 132R”(SFAS No 158). The standard is effective for fiscal years endingafter December 15, 2006, and requires us to:

·       Recognizethe funded status of our defined benefit plans in our consolidated financialstatements;

·       Recognize,as a component of other comprehensive income, any actuarial gains and lossesand prior service costs and credits that arise during the period but are notimmediately recognized as components of net periodic benefit cost;

·       Measuredefined benefit plan assets and obligations as of our fiscal year end; and

·       Thestandard is effective for fiscal years ending after December 15, 2006.

The standard is effectivefor fiscal years ending after December 15, 2006. Our adoption of SFASNo. 158 in 2006 resulted in the increase in recognized pension benefit obligationsby $9.3 million with a corresponding decrease in other comprehensive income(see note 17 to our consolidated financial statements).

**Fair value optionfor financial assets and financial liabilities**

On February 15, 2007, the FASB issued SFASNo. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—Including an Amendment of FASB Statement No. 115” (SFASNo.159). SFAS No.159 permits an entity to choose to measure many financialinstruments and certain other items at fair value.

Most provisions of SFAS No.159 are elective; however,the amendment to SFAS No. 115, Accounting for Certain Investments in Debtand Equity Securities, applies to all entities with available-for-sale andtrading securities.

The fair value option established by SFAS No.159permits all entities to choose to measure eligible items at fair value atspecified election dates. A business entity will report unrealized gains andlosses on items for which the fair value option has been elected in earnings(or another performance indicator if the business entity does not reportearnings) at each subsequent reporting date.

The fair valueoption: 

·       maybe applied instrument by instrument, with a few exceptions, such as investmentsotherwise accounted for by the equity method; 

·       isirrevocable (unless a new election date occurs); and 

·       isapplied only to entire instruments and not to portions of instruments.

SFAS No.159 is effectiveas of the beginning of an entity’s first fiscal year that begins afterNovember 15, 2007. We do not expect the adoption of SGAS No.159 tohave a material impact on our financial position or results of operations.

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**Derivativesimplementation**

On April 27, 2007,the FASB issued Guidance on SFAS No.133 (“Derivative Implementation”)Implementation Issues. This guidance provides explanations on questions thatcompanies may face when implementing SFAS No.133. Additional issues will beadded to this Implementation Guide as the FASB approves them.

**Effect of prioryear misstatements when qualifying misstatements**

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, Considering the Effectof Prior Year Misstatements when Qualifying Misstatements in Current YearFinancial Statements (‘SAB No.108’)/ SAB No. 108 provides guidance on theconsideration of the effects of prior year misstatements in qualifying currentyear misstatements for the purpose of a materiality assessment. SAB No.108establishes a dual approach that requires qualification of financial statementerrors based on both the roll-over method and iron curtain method regarding theeffects of each of our balance sheets and statement of operations and the relatedfinancial statement disclosures. SAB No.108 permits existing public companiesto record the cumulative effect of initially applying this approach in thefirst reporting period ending after November 15, 2006, by recording thenecessary correcting adjustments to the carrying values of assets andliabilities as at the beginning of that year with the offsetting adjustmentsrecorded to the opening balance of retained earnings. The adoption of SABNo.108 did not have an impact on our financial statements.

**Trend Information**

**Coal industry**

Countries in Asia are among the world’s major netimporters of sea-borne steam and coking coal. During 2006, demand in Asia forcoking coal was generally satisfied and, as a result, the spot prices for hardcoking coal (HCC) decreased during the second half of the year in line with thedecreasing deficit for this type of coal. We expect that this trend willcontinue in 2007 and HCC prices will continue to decline by an estimated 13%.At the same time, semi-soft coking coal (SSCC) prices declined to $55/ton in2006 from $80/ton in 2005 due the availability of supply in excess of demand.However, we expect SSCC prices to increase in 2007 due to the general rise insteam coal prices and the increasing share of SSCC in the coal mix used byconsumers (according to AME). We also expect that the world steel marketdynamics will continue to support coking coal prices in 2007 since we do notexpect any significant steel price decreases. 

The steam coal market isdriven by non-steel related factors, such as growth in electricity consumption,balance between supply and demand and seasonality. Prices increased in thesecond half of 2006 due to a deficit in domestic supply in China and the UnitedStates and the high freight costs for delivering the material from majorinternational suppliers (Australia and South Africa) to major consumers (Asiaand Europe). Another limitation for the sea-borne steam coal market supply isthe shortage of sea port capacity in coal-exporting countries. Thus, we expectthat steam coal prices will increase in 2007 and will remain flat in 2008 assupply and demand become more even.

**Iron ore industry**

The iron ore market iscurrently characterized by high demand from Asia and supply and transportationconstraints. Capacity expansions by producers such as CVRD, Rio Tinto and BHPBilliton are primarily targeted at meeting the demand increase, generatedprimarily in China. The outlook for 2007 and beyond will generally depend onsupply and demand balance in the industry, which we believe will be affected bythe following factors. Actions taken by the Indian government in the beginningof 2006, including its imposition of an iron ore export duty, aimed at limitingIndian iron ore exports has caused an increase in contract prices in 2007 andcould potentially lead to further price increases. We believe the continuedhigh level of demand in China will further support iron ore prices, despite theChinese 

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government’seffort to reduce the rate of growth of its domestic steel productioncapacities. Based on these factors, we believe that prices for iron ore willremain at high levels until 2009, when the world’s three major producers, CVRD,Rio Tinto Group and BHP Billiton, which together control 75% of worldwide ironore supplies (according to AME), are expected to complete their capacityexpansion programs.

**Nickel industry**

Nickel prices haveincreased since 2001. The average nickel price in 2006 was $24,000 per ton, a57% increase year-on-year. This increase was due primarily to the nickeldeficit in the world market caused by the high rate of growth internationallyin stainless steel production, speculative trading on the LME and a decrease innickel storage stock. We expect that a deficit will remain through 2007 in anamount of up to 30-70 thousand tonnes. We also expect nickel demand in 2007will continue to rise due to increasing stainless steel production capacitiesin China coupled with the limited nickel supply caused by the difficulty inexpanding nickel extraction capabilities and developing new nickel ore fields.We expect that the foregoing factors will result in the increase of averagenickel prices in 2007 by 45-47% year-on-year to $34,000 per ton.

**Steel industry**

We expect the Russian steel industry to continue tobenefit from both domestic and global demand for steel. On the back of GDP andindustrial production growth in Russia of 6.7% and 4%, respectively,consumption of rolled steel in Russia increased 16% to 35.6 million tonnes in2006. In terms of end-uses, growth was driven by pipe production, which was up18%, and the construction industry, which increased 16% in monetary terms. Weexpect these two industries will remain key drivers of domestic steel demand,and that rolled steel demand will increase an additional 12-15% in 2007. 

As the Russian domestic market in 2006 continued tosupport higher prices than export prices, domestic sales in physical terms grew16% year on year, while export sales increased a modest 2%. As a result,exports decreased to 48% of total Russian rolled steel sales in 2006 from 51%in 2005. As we expect domestic prices to remain above export prices in 2007, weanticipate a further reduction in export sales.

Imports of steel increased 18% year on year in 2006 to4.6 million metric tonnes; however, imported steel continued to comprise only13% of the Russian steel market as in 2005. Steel imports from Ukrainecomprised 40% of total imports in 2006. We expect imports will increase giventhe attractive pricing in the Russian market; however, we believe that themarket share of imports in the Russian steel market will remain flat, as thegrowth rate of steel consumption in Russia is expected to outpace the growthrate of imports.

The main concern regarding the balance of supply anddemand and pricing the global steel markets during 2007-2008 relates to thepossibility of oversupply coming from Chinese steel exports. However, webelieve this risk is mitigated by several factors, including the favorableoutlook for steel demand on the back of global and Chinese GDP growth, which isexpected to be 2.8% and 10%, respectively in 2007; possible strengthening ofthe Chinese currency; tight supply of scrap and iron ore, with the anticipated9.5% increase in iron ore prices for 2007 expected to put additional pressureon the margins of Chinese steelmakers; and continuing high coking coal prices. 

Global consolidation in the steel sector should resultin the increased bargaining power of steel makers in their negotiations withboth suppliers of iron ore and coking coal and consumers of steel, as well asmore coordinated industry responses to market demands and price decreasesthrough capacity reductions. 

In 2007, we expect steelprices to remain relatively flat due to the slowing of global demand, and wefurther expect that the domestic premium on steel prices will be 10% over CISexport prices.

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**Sales**

We expect our miningsegment sales to increase as we continue production increases. We expect thatour coking coal sales will trend towards a split between internal consumptionand third-party sales, depending on sales in the domestic market andexport trade. We also expect to increase our export sales of steam coal, giventhe significant price differential which currently exists with the domesticmarket. Due to our construction of a sinter plant at Chelyabinsk MetallurgicalPlant and the high prices for domestic sales of iron ore concentrate, we expectthat our sales of iron ore concentrate to third parties will decrease, and mostof our iron ore concentrate production will be supplied to the sinter plant atChelyabinsk Metallurgical Plant. We expect to maintain our current level ofsteel production and that our steel segment sales will remain steady andpossibly increase based on the high level of steel prices in 2007. 

**Inventory**

Overall, our inventory was$667.2 million at December 31, 2006, as compared to $546.6 million atDecember 31, 2005. This increase was due to an increase in steel segmentinventory as a result of planned production increases and the increase ofpurchase prices for iron-ore raw materials and coal.

**Costs**

Our steel costs per tonne should remain relativelystable, as higher production volumes, cost savings from the continuingintegration of our recent steel acquisitions and efficiency and output gainsarising as a result of the targeted capital expenditure program, particularlyat Chelyabinsk Metallurgical Plant, help to offset increasing payroll costs andraw material prices and potential increases in electricity and natural gastariffs. Specifically, as we continue to introduce operational and technicalchanges at our plants allowing us to better integrate their products, we expectto be better able to control our cost increases. The new sinter plant atChelyabinsk will allow us to substantially increase our ability to internallysource our iron ore feed requirements, without the need to utilize third-partyprocessing, while the increasing use of continuous casters should provide bothefficiency and production increases. We also expect these technologyimprovements to reduce our energy requirements per tonne, partially reducingthe impact of potential increases in electricity and natural gas tariffs.

Within our mining segment,we expect our nickel costs per tonne to increase as a result of increasingenergy costs, while coal costs per tonne should remain relatively stable in2007. We expect our iron ore costs per tonne to gradually increase as a resultof increasing payroll and energy costs in 2007. 

**Seasonality**

Seasonal effects have a relatively limited impact onour results. Nonetheless, slowing of demand and, thus, a reduction in salesvolumes (and a related increase in inventories) is typically evident in thefirst and fourth quarters of the financial year as a result of the generalreduction in economic activity associated with the New Year holiday period inRussia and elsewhere. We also maintain larger stockpiles of scrap during thewinter months in order to avoid potential supply disruptions due to inclementweather. We are also dependent on the Russian construction market, which alsoexperiences slowdowns in the winter months. However, our sales of steam coaltypically increase during the second and third quarters as a result ofincreased steam coal purchases by utilities for the winter.

Consumption of combustive,lubricative and energy supplies during the winter months is generally higherthan during the rest of the year. In addition, railroad carriers demand thatiron ore concentrate be fully dried and coal concentrate be partially dried fortransportation during the winter months, resulting in higher costs during thattime.

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***Item6.***                          Directors,Senior Management and Employees

**Directors andExecutive Officers**

Ourdirectors and executive officers include: 

| **Name**                   | ** ** | ** ** | ** ** | **Year of  Birth** | ** ** | **Position**                                     | ** ** |
|----------------------------|------------|------------|------------|-------------------------|------------|--------------------------------------------------|------------|
| Igor V. Zyuzin             |       |       | 1960       |                    |       | Director  and Chief Executive Officer            |       |
| Alexey G.  Ivanushkin      |       |       | 1962       |                    |       | Director  and Chief Operating Officer            |       |
| Vladimir A. Polin          |       |       | 1962       |                    |       | Director                                         |       |
| Roger I. Gale(1)           |       |       | 1952       |                    |       | Director                                         |       |
| A. David  Johnson(1)       |       |       | 1937       |                    |       | Director                                         |       |
| Serafim V.  Kolpakov       |       |       | 1933       |                    |       | Director                                         |       |
| Alexander E.  Yevtushenko  |       |       | 1947       |                    |       | Director                                         |       |
| Valentin V.  Proskurnya(1) |       |       | 1945       |                    |       | Chairman  and Director                           |       |
| Alex Polevoy               |       |       | 1970       |                    |       | Director                                         |       |
| Anton V.  Vishanenko(2)    |       |       | 1979       |                    |       | Chief  Financial Officer                         |       |
| Victor A. Trigubko         |       |       | 1956       |                    |       | Senior Vice  President—Government Relations |       |

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(1)          Member of the AuditCommittee of the Board of Directors.

(2)          Mr. Vishanenko hasconfirmed his intention to step down as Chief Financial Officer inJuly 2007.

**Igor V. Zyuzin**has been our Chief Executive Officer anddirector since December 2006. He served as the Chairman of our Board ofDirectors from March 2003, when Mechel was organized, untilDecember 2006. Mr. Zyuzin also serves as the Chairman of the Board ofDirectors of our Southern Kuzbass Coal Company, a position he has held sinceMay 1999, and has served as a member of the Board of Directors ofChelyabinsk Mettalurgical Plant since 2001. From 1997 to 1999, Mr. Zyuzinwas the Chairman of the Board of Directors of Mezhdurechensk Coal Company,which was merged into Southern Kuzbass Coal Company, and a member of the Boardof Directors of Kuzbass Central Processing Plant. Mr. Zyuzin has over17 years of experience in the coal mining industry and holds a degree incoal mining from Tula Polytechnic Institute. Mr. Zyuzin also has a degreein coal mining engineering economics and a PhD in coal mining technicalsciences. Mr. Zyuzin beneficially owns 68.3% of our common shares.

**Alexey G.Ivanushkin** has been ourChief Operating Officer since January 2004 and a member of our Board ofDirectors since March 2003. Mr. Ivanushkin served as our ChiefExecutive Officer from March 2003 until January 2004. FromDecember 1999 to April 2002, Mr. Ivanushkin served as theGeneral Director of our Chelyabinsk Metallurgical Plant. From 1993 toNovember 1999, he was the director of the ferrous metals and ferroalloydepartment of the Moscow office of Glencore International AG, an internationaldiversified natural resources group from whom we acquired ChelyabinskMetallurgical Plant. Mr. Ivanushkin graduated from the Moscow StateUniversity of Foreign Relations (MGIMO) with a degree in economics andinternational affairs. Mr. Ivanushkin beneficially owns 0.03% of ourcommon shares.

**Vladimir A.**Polin hasbeen a member of our Board of Directors since June 2007. He has alsoserved as the Chief Executive Officer of Mechel Management Company sinceJune 2006. From July 2003 to June 2006, he was our SeniorVice President-Production. From July 2002 until June 2003,Mr. Polin served as the Executive Director-First Deputy General Directorof our Beloretsk Metallurgical Plant. Mr. Polin has almost 20 years offloor and management experience in the manufacture and marketing of steelproducts, and holds a degree in metallurgy from Chelyabinsk PolytechnicUniversity.

**Roger I. Gale**has been a member of our Board of Directorssince October 2004. Mr. Gale is currently Chairman of the Board ofDirectors and Chief Executive Officer of Calypte Biomedical Corporation, a 

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**US companyheadquartered in Portland, Oregon. From 2002 until mid-2006, Mr. Gale wasthe Chairman of the Board of Directors and CEO of Wavecrest Group EnterprisesLimited, a communications service provider. From 1999 to 2001, he was Chairmanand co-founder of End2End Wireless Limited, a wireless access servicesprovider. From 1996 to 1998, Mr. Gale was Chief Executive Officer ofAIG-Brunswick Capital Management, a $300 million Russian investment fund.From 1988 to 1996, Mr. Gale worked for the International Finance Corporation,or IFC, including as the Chief of IFC’s Resident Mission to the RussianFederation from 1991 to 1996. Mr. Gale also worked for the AsianDevelopment Bank for nine years, and has lectured in economics at theUniversity of New England (Australia) and Lincoln College (New Zealand).Mr. Gale holds a Higher National Diploma from The Royal AgriculturalCollege and holds a Master of Economics from the University of New England.**

**A. David Johnson**has been a member of our Board of Directorssince October 2004. Mr. Johnson is currently Chairman of the Board ofDirectors of Joy Mining Machinery UK Ltd., a leading global supplier ofunderground mining systems and services, a position he has held since 2002.From 1990 to 2002, Mr. Johnson was Managing Director of Joy MiningMachinery UK Ltd. From 1986 to 1990, Mr. Johnson was the ManagingDirector of Dosco Overseas Engineering, a UK-based mining equipmentmanufacturer, where he began as a mining engineer in 1960. He also worked atthe UK National Coal Board from 1953 to 1960. Mr. Johnson is Joy MiningMachinery’s representative on both the Coal Industry Advisory Board and theWorld Coal Institute. From 1990 to 1992, he served as President of theAssociation of British Mining Equipment Companies. In 1998, he was awarded theOrder of Friendship by the Russian government for services to the Russian coalindustry. Mr. Johnson is a qualified mining engineer having obtained theUK Mining Qualifications Board Certificate in 1958.

**Serafim V. Kolpakov** has been a member of our Board of Directors sinceJune 2004. Since 1992, Dr. Kolpakov has served as President of theInternational Metallurgists Union, a steel industry-focused researchorganization. From 1991 to 1992, he was Vice President of the AdvancedMaterials Association in Moscow, a public consulting and research organization.From 1985 to 1991, Dr. Kolpakov was Minister of Metallurgy of the USSRand, from 1978 to 1985, First Deputy Minister and Deputy Minister of Metallurgyof the USSR. From 1970 to 1978, he was the General Director of Novolipetsk Ironand Steel Works, a Russian integrated steel mill, where he began as a foremanin 1963. Dr. Kolpakov graduated from the Moscow Institute of Steel andAlloys with an engineering degree and is a Doctor of Technical Sciences. He isa member of the International Engineering Academy, the Engineering Academy ofRussia (holding the position of Vice President) and the Presidium of Academy ofInformation Technologies and Processes. Dr. Kolpakov has invented morethan 400 steel-making technology improvements, and authored over 500scientific publications. He has received a number of government awards,including the State Prize of the USSR in 1981 and 1985, the Prize of theCouncil of Ministers of the USSR (twice) and the title of HonorableMetallurgist of the Russian Federation and Czechoslovakia.

**Alexander E. Yevtushenko**has been a member of our Board of Directors sinceJune 2004. From 2001 to 2004, Dr. Yevtushenko served as First VicePresident of Sokolovskaya OAO, a holding company for a group of Russian coalmining and engineering enterprises. From 1999 to 2000, he was President of theGeneral Committee of Inter-State Eurasian Association of Coal and Metals.From 1992 to 1999, Dr. Yevtushenko was First Deputy Fuels and EnergyMinister of the Russian Federation. From 1973 to 1991 he worked in variouspositions, including as General Director at Raspadskaya Mine in Kuzbass, one ofthe Soviet Union’s largest coal mines. Dr. Yevtushenko graduated from theSiberian Metallurgical Institute with a degree in mining engineering. He is aDoctor of Engineering and a member of Academy of Mining Sciences of Russia.Dr. Yevtushenko is the author of more than 50 scientific publications,including “Mineral Resources of the Coal Industry of Russia,” a study for whichhe was awarded the 2002 Science and Technology Prize of the Russian government.He has received a number of government awards, including the title of HonorableMiner of the Russian Federation in 1997.

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**Valentin V. Proskurnya** has served as the Chairman of our Board ofDirectors since June 29, 2007. He has been a member of our Board ofDirectors since March 2003. Prior to April 2005, Mr. Proskurnyaserved as a member of the Board of Directors of MMK, a major Russian steelproducer. From March 2002 until March 2003, Mr. Proskurnyaserved as the Deputy General Director of Mechel Trading House, and was itsGeneral Director from January 2001 to March 2002. From 1998 to 2001,Mr. Proskurnya served as the First Deputy Director of our Southern KuzbassCoal Company, in charge of economic and financial analysis. Mr. Proskurnyahas over 37 years of engineering, financial and management experience inthe coal mining industry and holds a degree in labor economics from the HigherSchool of Trade Unions. Mr. Proskurnya has been decorated with all threegrades of the “Miner’s Glory” order by the Russian government. In addition, in1996, the Russian government awarded him the title of Honorable Economist ofthe Russian Federation.

**Alex Polevoy** has been a member of our Board of Directors sinceJune 2006. He served as our Chief Financial Officer from October 2005to June 2006. From 2004 to August 2005, Mr. Polevoy served asthe Director of the Corporate Audit Department of TNK-BP Management, a holdingcompany for oil-related companies. From 2001 to 2004, he held the position ofHead of Monitoring and Control Group of TNK-BP Management.Mr. Polevoy graduated from Northern Alberta Institute, Canada, with adegree in management and accounting.

**Anton Vishanenko** has been our Chief Financial Officer sinceJune 2006. From April 2003 until June 2006 he served as theDirector of our Financial Reporting Department. From December 2000 toApril 2003, he held different positions in the finance department atWimm-Bill-Dann Foods OJSC, a Russian company listed on New Stock Exchange, mostrecently serving as the Deputy Head of the US GAAP Reporting Department.Mr. Vishanenko graduated from the Moscow Aviation Institute with a degreein Economics and received his Ph.D. in economics from the St. Petersburg StateAcademy of Economics and Finance. He is a member of ACCA (Association ofChartered Certified Accountants of the United Kingdom) and an associate memberof AICPA (American Institute of Certified Public Accountants).Mr. Vishanenko has confirmed his intention to step down as Chief FinancialOfficer in July 2007.

**Victor A. Trigubko** has been our Senior Vice President for GovernmentRelations since August 2006. From 2005 until August 2006 he served asour Vice President for Government Relations, and from 2003 to 2005 he served asour Vice President for Representation in Central and Eastern Europe, Chairmanof the Board of Directors of Mechel Campia Turzii and Member of the Board ofDirectors of Mechel Targoviste. From 2002 to 2003 Mr. Trigubko was Directorof Mechel International Holdings AG’s Representative Office in Romania. From1997 to 2002 he was the head of Izhstal OAO’s Representative Office in Moscow.From 1992 to 1997 he held executive positions with the metallurgical company,Unibros Steel Co. LTD, with his last position there being Deputy GeneralDirector. Mr. Trigubko graduated in 1982 from the Economic Faculty ofKalinin (now Tver) State University. Upon his graduation, Mr. Trigubkoworked in the Foreign Relations Department of the USSR State Committee forLabor and Social Issues and then in the USSR Trade Representation Office inRomania.

All of our directors wereelected on June 29, 2007, and their terms expire on the date of our nextannual shareholders’ meeting, which will take place in June 2008. Thebusiness and mailing address for all our directors and executive officers isKrasnoarmeyskaya Street 1, Moscow 125993, Russian Federation.

**Compensation**

Our directors andexecutive officers were paid an aggregate of $6.0 million for services in allcapacities provided to us during 2006. The total amount set aside for pension,retirement and other similar benefits for our directors and executive officersas of December 31, 2006, was $0.2 million. Our directors and executiveofficers are also provided with voluntary medical insurance and the use ofwireless services.

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**Board Practices**

**Board of Directors**

Members of our Board ofDirectors are elected by a majority vote of shareholders at our annual generalmeeting using a cumulative voting system. Directors are elected to serve untilthe next annual general meeting and may be re-elected an unlimited numberof times. Our Board of Directors currently consists of nine members, five ofwhom are independent. The Board of Directors is responsible for our overall management,except matters reserved for our shareholders. See “Item 10. AdditionalInformation—Charter and Certain Requirements of Russian Legislation—GeneralMeetings of Shareholders” for more information regarding the competence of ourshareholders’ meetings. Some of the members of our Board of Directors, as wellas the members of the boards of directors of our subsidiaries, serve pursuantto contracts. These contracts do not provide for any benefits upon terminationof their directorship.

**Audit Committee**

Our audit committeeconsists of Roger Gale, Valentin V. Proskurnya and David Johnson, each of whomis a non-management member. Our audit committee operates pursuant to a bylaw,which is available at www.mechel.com and www.mechel.ru. The purpose of this committeeis to assist the Board with its oversight responsibilities regarding:

·       the quality and integrityof our financial statements;

·       our compliance with legaland regulatory requirements;

·       theindependent auditor’s qualifications and independence; and

·       theperformance of our internal audit function and independent auditor.

**Review Commission**

The review commissionverifies the accuracy of our financial reporting under Russian law andgenerally supervises our financial activity. The members of our review commissionare nominated and elected by our shareholders to serve until the next annualgeneral shareholders meeting. A CEO, director or officer may not simultaneouslybe a member of the review commission. Our review commission currently has threemembers: Dmitry Kletsky, Lyudmila Radishevskaya and Natalia Michailova. Thepowers and duties of our review commission were determined by regulationsapproved by our shareholders’ meeting.

**CorporateGovernance Principles**

Our corporategovernance principles are based on the Russian Corporate Governance Coderecommended by the FSFM and supplement the obligations of the Board ofDirectors prescribed by Russian law, our charter and internal rules ofprocedure. The principles are intended to ensure that we are managed andmonitored in a responsible and value-driven manner. They include theprotection of shareholders’ rights, comprehensive disclosure and transparencyrequirements and rules governing conflicts of interest. We are committedto continue to adapt our corporate governance principles to best-practicedevelopments. Our corporate governance principles are reflected in ourcorporate documents, such as:

·       theCharter;

·       theBylaw on the Board of Directors;

·       theBylaw on the General Meeting of Shareholders;

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·       theBylaw on the General Director;

·       theBylaw on the Audit Committee of the Board of Directors;

·       theCode of Business Conduct and Ethics; and

·       theBylaw on the Prohibition and Prevention of Insider Trading.

These documents are available at www.mechel.com andwww.mechel.ru.

We also comply withapplicable corporate governance requirements of the NYSE. The NYSE permitslisted companies that are foreign private issuers, such as Mechel, to followtheir home jurisdiction governance practice where it differs from the NYSErequirements. In addition, we have voluntarily complied with certain otherrequirements applicable to U.S. companies under NYSE listing standard 303A. Asummary description of NYSE listing standard 303A showing our compliancetherewith and/or the alternative corporate governance practices followed by usis available at www.mechel.com.

**Employees**

AtDecember 31, 2006, we employed approximately 76,566 people as follows:

| **Company**                                | ** ** | ** **                                        | ** ** | **Primary Location**             | ** ** | **Primary Function** | ** ** | **Total  Employees** | ** ** | **%  Unionized** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|----------------------|------------|------------------|------------|
| Chelyabinsk  Metallurgical Plant           |       | Russia                                            |       | Steel                                 |       |                      | 20,528     |                 |       |             | 68.0       | % |   |
| Southern Kuzbass  Coal Company             |       | Russia                                            |       | Coal                                  |       |                      | 12,018     |                 |       |             | 83.0       | % |   |
| Izhstal                                    |       | Russia                                            |       | Steel                                 |       |                      | 9,242      |                 |       |             | 89.0       | % |   |
| Beloretsk  Metallurgical Plant             |       | Russia                                            |       | Steel                                 |       |                      | 7,678      |                 |       |             | 90.0       | % |   |
| Mechel Campia  Turzii                      |       | Romania                                           |       | Steel                                 |       |                      | 3,817      |                 |       |             | 87.0       | % |   |
| Mechel Targoviste                          |       | Romania                                           |       | Steel                                 |       |                      | 4,253      |                 |       |             | 90.0       | % |   |
| Southern Urals  Nickel Plant               |       | Russia                                            |       | Nickel                                |       |                      | 4,293      |                 |       |             | 40.0       | % |   |
| Korshunov Mining  Plant                    |       | Russia                                            |       | Iron  Ore                             |       |                      | 4,217      |                 |       |             | 97.0       | % |   |
| Urals Stampings  Plant                     |       | Russia                                            |       | Steel                                 |       |                      | 2,905      |                 |       |             | 81.0       | % |   |
| Vyartsilya Metal  Products Plant           |       | Russia                                            |       | Steel                                 |       |                      | 400        |                 |       |             | —     |   |   |
| Mechel Nemunas                             |       | Lithuania                                         |       | Steel                                 |       |                      | 354        |                 |       |             | —     |   |   |
| Port Posiet                                |       | Russia                                            |       | Shipping                              |       |                      | 331        |                 |       |             | 15.0       | % |   |
| Port Kombarka                              |       | Russia                                            |       | Shipping                              |       |                      | 218        |                 |       |             | —     |   |   |
| Mecheltrans                                |       | Russia                                            |       | Railway  transportation               |       |                      | 193        |                 |       |             | —     |   |   |
| Mechel Trading  House                      |       | Russia                                            |       | Sales  and Distribution               |       |                      | 283        |                 |       |             | —     |   |   |
| Mechel                                     |       | Russia                                            |       | Corporate                             |       |                      | 115        |                 |       |             | —     |   |   |
| Mechel-Service                             |       | Russia                                            |       | Sales  and Distribution               |       |                      | 274        |                 |       |             | —     |   |   |
| Specialty Steel                            |       | Russia                                            |       | Steel                                 |       |                      | 1,313      |                 |       |             | 91.0       | % |   |
| Mechel Coke                                |       | Russia                                            |       | Coke                                  |       |                      | 1,703      |                 |       |             | 67.0       | % |   |
| Kaslinsky  Architectural Art Casting Plant |       | Russia                                            |       | Steel                                 |       |                      | 139        |                 |       |             | —     |   |   |
| Mechel Recycling                           |       | Russia                                            |       | Scrap  metal                          |       |                      | 155        |                 |       |             | —     |   |   |
| Moscow Coke Gas  Plant                     |       | Russia                                            |       | Coke                                  |       |                      | 1,542      |                 |       |             | 81.0       | % |   |
| Other                                      |       | Russia, CIS,  Switzerland  and Liechtenstein |       | Coal,  Steel, Sales  and Distribution |       |                      | 595        |                 |       |             | —     |   |   |
| Total                                      |       |                                              |       |                                  |       |                      | 76,566     |                 |       |             | 69.0       | % |   |

 

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AtDecember 31, 2005, we employed approximately 78,426 people as follows:

| **Company**                      | ** ** | ** **                                        | ** ** | **Primary Location**             | ** ** | **Primary Function** | ** ** | **Total  Employees** | ** ** | **%  Unionized** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|----------------------|------------|------------------|------------|
| Chelyabinsk  Metallurgical Plant |       | Russia                                            |       | Steel                                 |       |                      | 23,710     |                 |       |             | 89.0       | % |   |
| Southern Kuzbass  Coal Company   |       | Russia                                            |       | Coal                                  |       |                      | 12,928     |                 |       |             | 88.0       | % |   |
| Izhstal                          |       | Russia                                            |       | Steel                                 |       |                      | 10,043     |                 |       |             | 95.0       | % |   |
| Beloretsk  Metallurgical Plant   |       | Russia                                            |       | Steel                                 |       |                      | 8,065      |                 |       |             | 96.0       | % |   |
| Mechel Campia  Turzii            |       | Romania                                           |       | Steel                                 |       |                      | 5,024      |                 |       |             | 95.0       | % |   |
| Mechel Targoviste                |       | Romania                                           |       | Steel                                 |       |                      | 4,676      |                 |       |             | 96.0       | % |   |
| Southern Urals  Nickel Plant     |       | Russia                                            |       | Nickel                                |       |                      | 4,327      |                 |       |             | 91.0       | % |   |
| Korshunov Mining  Plant          |       | Russia                                            |       | Iron  Ore                             |       |                      | 4,308      |                 |       |             | 93.0       | % |   |
| Urals Stampings  Plant           |       | Russia                                            |       | Steel                                 |       |                      | 2,957      |                 |       |             | 96.0       | % |   |
| Vyartsilya Metal  Products Plant |       | Russia                                            |       | Steel                                 |       |                      | 471        |                 |       |             | —     |   |   |
| Mechel Nemunas                   |       | Lithuania                                         |       | Steel                                 |       |                      | 375        |                 |       |             | —     |   |   |
| Port Posiet                      |       | Russia                                            |       | Shipping                              |       |                      | 337        |                 |       |             | 97.0       | % |   |
| Mechel Trading  House            |       | Russia                                            |       | Sales  and Distribution               |       |                      | 310        |                 |       |             | —     |   |   |
| Mechel                           |       | Russia                                            |       | Corporate                             |       |                      | 220        |                 |       |             | —     |   |   |
| Mechel-Service                   |       | Russia                                            |       | Sales  and Distribution               |       |                      | 199        |                 |       |             | —     |   |   |
| Other                            |       | Russia, CIS,  Switzerland and  Liechtenstein |       | Coal,  Steel, Sales  and Distribution |       |                      | 476        |                 |       |             | —     |   |   |
| Total                            |       |                                              |       |                                  |       |                      | 78,426     |                 |       |             | 88.0       | % |   |

 

At December 31,2004, we employed approximately 82,324 people as follows:

| **Company**                      | ** ** | ** **                                        | ** ** | **Primary Location**             | ** ** | **Primary Function** | ** ** | **Total  Employees** | ** ** | **%  Unionized** | ** ** |
|----------------------------------|------------|---------------------------------------------------|------------|---------------------------------------|------------|---------------------------|------------|----------------------|------------|------------------|------------|
| Chelyabinsk  Metallurgical Plant |       | Russia                                            |       | Steel                                 |       |                      | 24,685     |                 |       |             | 90.0       | % |   |
| Southern Kuzbass  Coal Company   |       | Russia                                            |       | Coal                                  |       |                      | 12,675     |                 |       |             | 90.0       | % |   |
| Izhstal                          |       | Russia                                            |       | Steel                                 |       |                      | 10,891     |                 |       |             | 87.0       | % |   |
| Beloretsk  Metallurgical Plant   |       | Russia                                            |       | Steel                                 |       |                      | 8,910      |                 |       |             | 93.0       | % |   |
| Mechel Campia  Turzii            |       | Romania                                           |       | Steel                                 |       |                      | 5,379      |                 |       |             | 92.0       | % |   |
| Mechel Targoviste                |       | Romania                                           |       | Steel                                 |       |                      | 4,821      |                 |       |             | 98.0       | % |   |
| Southern Urals  Nickel Plant     |       | Russia                                            |       | Nickel                                |       |                      | 4,686      |                 |       |             | 91.0       | % |   |
| Korshunov Mining  Plant          |       | Russia                                            |       | Iron  Ore                             |       |                      | 4,363      |                 |       |             | 89.0       | % |   |
| Urals Stampings  Plant           |       | Russia                                            |       | Steel                                 |       |                      | 3,006      |                 |       |             | 69.0       | % |   |
| Vyartsilya Metal  Products Plant |       | Russia                                            |       | Steel                                 |       |                      | 531        |                 |       |             | —     |   |   |
| Mechel Nemunas                   |       | Lithuania                                         |       | Steel                                 |       |                      | 378        |                 |       |             | 49.0       | % |   |
| Port Posiet                      |       | Russia                                            |       | Shipping                              |       |                      | 323        |                 |       |             | 15.0       | % |   |
| Mechel Trading  House            |       | Russia                                            |       | Sales  and  Distribution              |       |                      | 533        |                 |       |             | —     |   |   |
| Mechel                           |       | Russia                                            |       | Corporate                             |       |                      | 156        |                 |       |             | —     |   |   |
| Other                            |       | Russia, CIS,  Switzerland and  Liechtenstein |       | Coal,  Steel, Sales  and Distribution |       |                      | 987        |                 |       |             | —     |   |   |
| Total                            |       |                                              |       |                                  |       |                      | 82,324     |                 |       |             | 88.0       | % |   |

 

Employees of Chelyabinsk Metallurgical Plant,Beloretsk Metallurgical Plant, Southern Urals Nickel Plant, Korshunov MiningPlant and Urals Stampings Plant are members of the Ore Mining and Smelting 

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Trade Union of Russia,employees of Urals Stamping Plant are members of Russian Trade Union ofMachinists, and employees of Southern Kuzbass Coal Company are members ofRussian Independent Trade Union of Coal Industry Workers and of RussianIndependent Trade Union of Miners. Employees of Port Posiet are members ofRussian Independent Trade Union of Dockers. Employees of Mechel Targoviste aremembers of Independent Trade Union of Mechel Targoviste. 

We consider ourrelationship labor unions to be good. 

**Management ShareBonus and Share Option Plans**

We are consideringestablishing a share bonus plan and/or share option plan for officers and keyemployees. 

***Item7.***                          MajorShareholders and Related Party Transactions

**Major Shareholders**

Thefollowing table sets forth information regarding the beneficial ownership ofour shares as of June 27, 2007, based on our share register and certainadditional information provided by our major shareholders:

| **Name of Beneficial Owner** | ** ** | ** **  | ** ** | **Number of  Shares** | ** ** | **%** | ** ** |
|---------------------------------------------|------------|-------------|------------|----------------------------|------------|-------|------------|
| Igor V. Zyuzin(1)                           | ** ** | 284,166,481 |       | 68.3                       | %          |
| Free float(2)(3)                            |       | 132,104,264 |       | 31.7                       | %          |
| Total                                       |       | 416,270,745 |       | 100                        | %          |

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(1)          Mr. Zyuzin is ourChief Executive Officer and a member of our board of directors. See “Item 6—Directors,Senior Management and Employees—Directors and Executive Officers.” His businessaddress is Krasnoarmeyskaya Street 1, Moscow 125993, Russian Federation. Of theshares beneficially owned by Mr. Zyuzin, 73,134,804 shares (including inthe form of GDSs) are owned by Calridge Limited, a company wholly owned byMr. Zyuzin. Calridge Limited has pledged 20,454,543 shares in the form ofGDSs to UBS AG (London Branch) in connection with its Mandatory ExchangeableNotes due 2009, and has transferred 14,161,347 of these shares in the form ofGDSs to UBS Limited pursuant to a Stock Lending Agreement. Mr. Zyuzin’sownership interest in Mechel as set forth in this document excludes the14,161,347 shares that Calridge Limited has transferred, as Calridge Limiteddoes not have voting or dispositive power with respect to such shares.

(2)          We believe our directorsand executive officers as a group, other than Mr. Zyuzin, own less than 1%of our shares.

(3)          Includes sharesunderlying our ADSs and GDSs. As of June 27, 2007, 35,752,167 ADSs and12,750,421 GDSs were outstanding. 

None of our shareholders have voting rights differentfrom any other holders of our shares. Based on our share register, we believewe are not directly or indirectly owned or controlled by another corporation orgovernment, and that there are no arrangements the operation of which mayresult in a change of control. 

In February 2006,Messrs. Zyuzin and Iorich reached an agreement pursuant to whichMr. Zyuzin agreed to purchase Mr. Iorich’s stake in Mechel over thecourse of a year. In March-December 2006, in a series of transactions,Mr. Zyuzin purchased 27.4% of Mr. Iorich’s stake, thereby increasinghis stake in Mechel to 68.3%. Of Mr. Iorich’s remaining stake, 11.5% wassold to investors in the form of GDSs in March 2006, and 3.4% was sold toMr. Zyuzin, who subsequently transferred this stake to UBS Limited 

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pursuantto a Stock Lending Agreement. As a result, Mr. Iorich disposed of hisentire 42.2% stake in Mechel. Prior to these transactions, Messrs. Zyuzinand Iorich had held equal stakes of 42.2%. Upon Mr. Iorich’s disposal ofhis stake, the Ownership, Control and Voting Agreement dated as ofAugust 1, 1995 between Mr. Zyuzin and Mr. Iorich, pursuant towhich they acted in concert and were required to vote the same way since 1995,was terminated as of December 21, 2006. 

**Related PartyTransactions**

See note 10 to ourconsolidated financial statements.

***Item8.***                          FinancialInformation

See “Item 18. FinancialStatements”

**Litigation**

Other than the legal proceedings described below, weare not involved in any legal proceedings that we believe to be material. 

In May 2007, Izhstalfiled a claim against the tax authorities seeking the invalidation of a taxassessment issued by the tax authorities for the period from January 1,2003 until April 30, 2006 in the total amount of $2.9 million, includinginterest and penalties. The case is pending in court.

In April 2007, SouthernUrals Nickel Plant filed a claim against the tax authorities seeking theinvalidation of a tax assessment issued by the tax authorities for the periodof 2004-2005 in the total amount of $3.2 million, including interest andpenalties. The case is pending in court. 

In 2006, Korshunov Mining Plant lost its challenge incourt to a claim from the tax inspectorate in the amount of approximately $9.4million related to mineral extraction taxes for 2005, including fines andpenalties. In addition to the foregoing amount, based on this precedent,Korshunov Mining Plant is further liable for the payment of mineral extractiontax, penalty and interest for the years 2002-2004 totaling $11.1 million,as well as mineral extraction tax and penalty for 2006 in the amount of nearly$8.1 million. The foregoing amounts were accrued in our financial statements,including $27.3 million as a management estimation of probable outflow ofresources and $1.3 million as an accepted claim.

In 2006, several claimswere brought against us in Russian courts by a group of minority shareholders.In three of them, minority shareholders are seeking payment by us of damages toour subsidiary Southern Kuzbass Coal Company in the amount of $264.4 million,allegedly caused to the subsidiaries of Southern Kuzbass Coal Company as aresult of losses of such subsidiaries in 2005 through first half of 2006. Inanother case, a minority shareholder of Mechel is seeking Mechel’s transfer of626,913 shares of Southern Kuzbass Coal Company amounting to $18 million, whichit claims it did not receive as a result of conversion of shares due to amerger of Southern Kuzbass Coal Company and one of its subsidiaries,Olzherassky Pit. The aforementioned cases are pending in court. We expectadditional similar claims to be filed against us by the same minorityshareholders. In the event that the foregoing lawsuits are resolved against us,our financial condition and results of operations could be materially adverselyaffected. See “Item 3. Key Information—Risk Factors—In the event certainminority shareholder lawsuits are resolved against us, our financial conditionand results of operations could be materially adversely affected.”

**DividendDistribution Policy**

As announced in March 2006, our dividend policyis to declare and pay an annual dividend equal to at least 50% of our annualnet income, as determined under U.S. GAAP, subject to any applicable Russianlegal restrictions. See “Item 10. Additional Information—Charter and CertainRequirements of Russian Legislation—Description of Capital Stock—Dividends.”

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The decision to paydividends and the amount thereof must be recommended by our board of directorsand approved by our shareholders. The amount of dividends, if any, approved bythe shareholders may not be higher than the amount proposed by the board ofdirectors. In particular, dividends may be declared and paid only out of netprofits calculated under Russian accounting standards and as long as thefollowing conditions have been met:

·       ourcharter capital has been paid in full;

·       thevalue of our net assets, calculated under Russian accounting standards, is notless (and would not become less as a result of the proposed dividend payment)than the sum of our charter capital, our reserve fund and the differencebetween the liquidation value and the par value of our issued and outstandingpreferred shares;

·       wehave repurchased all shares from shareholders having the right to demandrepurchase; and

·       weare not, and would not become as the result of the proposed dividend payment,insolvent.

For a further description, please refer to “Item 10.Additional Information—Charter and Certain Requirements of Russian Legislation—Descriptionof Capital Stock—Dividends.”

We anticipate that anydividends we may pay in the future on the common shares represented by the ADSswill be declared and paid to the depositary in rubles and will be convertedinto U.S. dollars by the depositary and distributed to holders of ADSs, net ofthe depositary’s fees and expenses. Accordingly, the value of dividendsreceived by holders of ADSs will be subject to fluctuations in the exchangerate between the ruble and the U.S. dollar.

**Significant Changes**

Other than as described inthis document, no significant change in our business has occurred sinceDecember 31, 2006.

***Item9.***                          TheOffer and Listing

Our ADSs have been listed on the New York StockExchange under the symbol “MTL” since October 2004. Our common shares havelisted on the RTS under the symbol “MTLR” since July 2004. 

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Thefollowing table sets forth the high and low closing prices per ADS and commonshare for (i) the most recent six months, (ii) the most recent sevenquarters and (iii) the three most recent years following our initialpublic offering in 2004.

| ** **           | ** ** | **ADSs** | ** ** | **Common Shares** | ** ** |
|----------------------|------------|----------|------------|------------------------|------------|
| ** **           | ** ** | **High** | ** ** | **Low**                | ** ** | **High** | ** ** | **Low** | ** ** |
| May 2007        |       | $        | 37.42      |                   | $          | 33.11 |   | $ | 11.80 |   | $ | 10.90 |   |
| April 2007      |       | $        | 35.27      |                   | $          | 31.99 |   | $ | 11.45 |   | $ | 10.90 |   |
| March 2007      |       | $        | 33.25      |                   | $          | 28.94 |   | $ | 11.30 |   | $ | 9.80 |   |
| February 2007   |       | $        | 33.80      |                   | $          | 28.63 |   | $ | 11.3   |   | $ | 9.53 |   |
| January 2007    |       | $        | 28.30      |                   | $          | 23.73 |   | $ | 9.10 |   | $ | 8.30 |   |
| December 2006   |       | $        | 26.40      |                   | $          | 24.67 |   | $ | 8.60 |   | $ | 8.30 |   |
| First Quarter 2007   |       | $        | 33.80      |                   | $          | 23.73 |   | $ | 11.30 |   | $ | 8.30 |   |
| Fourth Quarter  2006 |       | $        | 26.40      |                   | $          | 20.00 |   | $ | 8.60 |   | $ | 6.65 |   |
| Third Quarter  2006  |       | $        | 23.25      |                   | $          | 19.30 |   | $ | 7.80 |   | $ | 6.45 |   |
| Second Quarter  2006 |       | $        | 28.55      |                   | $          | 19.01 |   | $ | 9.30 |   | $ | 6.25 |   |
| First Quarter  2006  |       | $        | 30.95      |                   | $          | 23.86 |   | $ | 10.20 |   | $ | 8.40 |   |
| Fourth Quarter 2005  |       | $        | 34.88      |                   | $          | 23.47 |   | $ | 9.90 |   | $ | 7.75 |   |
| Third Quarter  2005  |       | $        | 36.51      |                   | $          | 24.89 |   | $ | 10.97 |   | $ | 8.25 |   |
| Second Quarter  2005 |       | $        | 33.70      |                   | $          | 24.03 |   | $ | 11.20 |   | $ | 8.25 |   |
| First Quarter  2005  |       | $        | 32.10      |                   | $          | 21.05 |   | $ | 11.15 |   | $ | 7.90 |   |
| 2006                 |       | $        | 30.95      |                   | $          | 19.01 |   | $ | 10.20 |   | $ | 6.25 |   |
| 2005                 |       | $        | 36.51      |                   | $          | 21.05 |   | $ | 11.20 |   | $ | 7.75 |   |
| 2004                 |       | $        | 22.45      |                   | $          | 15.79 |   | $ | 17.00 |   | $ | 0.36 |   |

 

***Item10.***                   AdditionalInformation

**Charter and CertainRequirements of Russian Legislation**

We describe below ourregistered common shares, the material provisions of our charter in effect onthe date of this document and certain requirements of Russian legislation. Inaddition to this description, we urge you to review our charter, which isincluded as an exhibit to this document, to learn its complete terms.

**Our Purpose**

Article 4.1 of ourcharter provides that our primary purpose is to earn profit, as well as toprovide the highest-quality products services for our customers.

**Description ofCapital Stock**

***General***

Pursuant to our charter, as amended, we have the rightto issue registered common shares, preferred shares and other securitiesprovided for by the legislation of the Russian Federation with respect tosecurities. Our capital stock currently consists of 416,270,745 common shares,each with a nominal value of 10 rubles, all of which are fully paid, issued andoutstanding. Under Russian legislation, charter capital refers to the aggregatenominal value of the issued and outstanding shares. We are authorized to issuean additional 81,698,341 common shares with a nominal value of 10 rubles each.No preferred shares are authorized or outstanding. Preferred shares may only beissued if amendments have been made to our charter pursuant to a resolution ofthe general meeting of shareholders. None of our capital stock is under optionor agreed conditionally or unconditionally to be put under option. The JointStock Companies Law 

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requires us to dispose ofany of our shares that we acquire within one year of their acquisition or,failing that, reduce our charter capital. We refer to such shares as treasuryshares for purposes hereof. Russian legislation does not allow for the votingof such treasury shares. Any of our shares that are owned by our subsidiariesare not considered treasury shares under Russian law (*i.e.*,they are considered outstanding shares), and we are able to vote such sharesand dispose of such shares without any further corporate actions by ourshareholders or board of directors, provided that such disposals are not majoror interested party transactions.

Currently, we have fewerthan 1,000 holders of voting shares, which determines the applicability ofcertain provisions of the Joint Stock Companies Law, as described below. Thedepositary is considered under Russian law as the single holder of all of theshares underlying our ADSs.

***Rights attaching to common shares***

Holders of ourcommon shares have the right to vote at all shareholder meetings. As requiredby the Joint Stock Companies Law and our charter, all of our common shares havethe same nominal value and grant to their holders identical rights. Each fullypaid common share, except for treasury shares, gives its holder the right to:

·       freelytransfer the shares without the consent of other shareholders;

·       receivedividends in accordance with our charter and current legislation;

·       participatein shareholders’ meetings and vote on all matters of shareholders’ competence;

·       transfervoting rights to its representative on the basis of a power of attorney;

·       electand be elected to the governing and controlling bodies of the company;

·       ifholding, alone or with other holders, 2% or more of the voting stock, within30 days after the end of our fiscal year, make proposals to the agenda ofthe annual shareholders’ meeting and nominate candidates to the board ofdirectors, review commission and counting commission;

·       ifholding, alone or with other holders, 10% or more of the voting stock, demandfrom the board of directors the calling of an extraordinary shareholders’meeting or an unscheduled audit by the review commission or an independentauditor;

·       demand,under the following circumstances, the repurchase by us of all or some of theshares owned by it, as long as such holder voted against or did not participatein the voting on the decision approving the following:

·        ourreorganization;

·        conclusionof a major transaction, as defined under Russian law; and

·        amendmentof our charter or approval of a new version of our charter that restricts theholder’s rights

·       uponliquidation, receive a proportionate amount of our property after ourobligations to our creditors are fulfilled;

·       haveaccess to certain company documents, receive copies for a reasonable fee and,if holding alone or with other holders, 25% or more of the voting stock, havefree access to accounting documents; and

·       exercise other rights of ashareholder provided by our charter, Russian legislation and decisions ofshareholders’ meetings approved in accordance with its competence.

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***Preemptive rights***

The Joint Stock CompaniesLaw and our charter provide existing shareholders with a preemptive right topurchase shares or securities convertible into shares in an amountproportionate to their existing shareholding. In addition, the Joint StockCompanies Law provides shareholders with a preemptive right to purchase sharesor securities convertible into shares during a closed subscription if theshareholders voted against or did not participate in the voting on the decisionapproving such subscription. The preemptive right does not apply to a closedsubscription to existing shareholders provided that such shareholders may eachacquire a whole number of shares or securities convertible into shares beingplaced in an amount proportionate to their existing holdings. We must provideshareholders with written notice of the proposed sale of shares at least 45days prior to the offering, during which time shareholders may exercise theirpreemptive rights.

***Dividends***

The Joint Stock Companies Law and our charter setforth the procedure for determining the dividends that we distribute to ourshareholders. Shareholders may decide on whether or not to pay the dividendsupon results of a financial quarter, half a year, nine months and/or year.Dividends are recommended to a shareholders’ meeting by the board of directors,and approved by the shareholders’ meeting by a majority vote. A decision onquarterly dividends must be taken within three months of the end of therespective quarter; a decision on annual dividends must be taken at the annualgeneral shareholders’ meeting. The dividend approved at the shareholders’meeting may not be more than the amount recommended by the board of directors.Dividends are distributed to holders of our shares as of the record date forthe shareholders’ meeting approving the dividends. See “—General Meetings ofShareholders—Notice and Participation.” Dividends are not paid on treasuryshares.

The Joint StockCompanies Law allows dividends to be declared only out of net profitscalculated under Russian accounting standards and as long as the followingconditions have been met:

·       thecharter capital of the company has been paid in full;

·       thevalue of the company’s net assets is not less (and would not become less as aresult of the proposed dividend payment) than the sum of the company’s chartercapital, the company’s reserve fund and the difference between the liquidationvalue and the par value of the issued and outstanding preferred shares of thecompany;

·       thecompany has repurchased all shares from shareholders having the right to demandrepurchase; and

·       the company is not, andwould not become, insolvent as the result of the proposed dividend payment.

***Distributions to shareholders onliquidation***

Under Russianlegislation, liquidation of a company results in its termination without thetransfer of rights and obligations to other persons as legal successors. TheJoint Stock Companies Law and our charter allows us to be liquidated:

·       bya three-quarters majority vote of a shareholders’ meeting; or

·       bya court order.

Following a decision to liquidate the company, theright to manage our affairs would pass to the liquidation commission which, inthe case of voluntary liquidation, is appointed by a shareholders’ meeting and,in an involuntary liquidation, is appointed by the court. Creditors may fileclaims within a period to be 

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determined by theliquidation commission, but which may not be less than two months from the dateof publication of notice of liquidation by the liquidation commission.

The Civil Codegives creditors the following order of priority during liquidation:

(1)         individuals owedcompensation for injuries or deaths;

(2)         employees;

(3)         federal and localgovernmental entities claiming taxes and similar payments to the budgets andnon-budgetary funds; and

(4)         other creditors inaccordance with Russian legislation.

Claims of creditors in obligations secured by a pledgeof the company’s property (“secured claims”) are satisfied out of the proceedsof sale of the pledged property prior to claims of any other creditors exceptfor the creditors of the first and second priorities described above, providedthat claims of such creditors arose before the pledge agreements in respect ofthe company’s property were made. To the extent that the proceeds of sale ofthe pledged property are not sufficient to satisfy secured claims, the latterare satisfied simultaneously with claims of the fourth priority creditors asdescribed above.

The Federal Law onInsolvency (Bankruptcy), however, provides for a different order of priorityfor creditors’ claims in the event of bankruptcy. The remaining assets of acompany are distributed among shareholders in the following order of priority:

·       paymentsto repurchase shares from shareholders having the right to demand repurchase;

·       paymentsof declared but unpaid dividends on preferred shares and the liquidation valueof the preferred shares determined by the company’s charter, if any; and

·       payments to holders ofcommon and preferred shares.

***Liability of shareholders***

The Civil Code andthe Joint Stock Companies Law generally provide that shareholders in a Russianjoint stock company are not liable for the obligations of a joint stock companyand bear only the risk of loss of their investment. This may not be the case,however, when one entity is capable of determining decisions made by anotherentity. The entity capable of determining such decisions is called an“effective parent.” The entity whose decisions are capable of being sodetermined is called an “effective subsidiary.” The effective parent bearsjoint and several responsibility for transactions concluded by the effectivesubsidiary in carrying out these decisions if

·       thisdecision-making capability is provided for in the charter of the effectivesubsidiary or in a contract between such persons; and

·       theeffective parent gives binding instructions to the effective subsidiary.

Thus, a shareholder of an effective parent is notitself liable for the debts of the effective parent’s effective subsidiary,unless that shareholder is itself an effective parent of the effective parent.Accordingly, a shareholder will not be personally liable for our debts or thoseof our effective subsidiaries unless such shareholder controls our business andthe conditions set forth above are met.

In addition, an effective parent is secondarily liablefor an effective subsidiary’s debts if an effective subsidiary becomesinsolvent or bankrupt resulting from the fault of an effective parent only whenthe effective parent has used the right to give binding instructions, knowingthat the consequence of carrying out this action would be insolvency of thiseffective subsidiary. Shareholders of the effective subsidiary may claimcompensation for the effective subsidiary’s losses from the effective parentthat caused the effective 

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subsidiary to take anyaction or fail to take any action knowing that such action or failure to takeaction would result in losses.

Russian law also providesfor other cases in which shareholders may be held liable to us.

***Share capital increase***

We may increase ourcharter capital by

·       issuingnew shares, or

·       increasingthe nominal value of already issued shares using the company’s net income.

A decision on any issuance of shares or securitiesconvertible into shares by closed subscription, or an issuance by opensubscription of common shares or securities convertible into common sharesconstituting more than 25% of the number of issued common shares, requires athree quarters majority vote of a shareholders’ meeting. A decision to increasethe charter capital by increasing the nominal value of issued shares requires amajority vote of a shareholders’ meeting. In addition, the issuance of sharesabove the number of authorized and non-issued shares provided in our charternecessitates a charter amendment, which requires a three-quartersmajority vote of a shareholders’ meeting.

The Joint Stock Companies Law requires that the valueof newly issued shares be determined by the board of directors based on theirmarket value but not less than their nominal value, except in limitedcircumstances where (1) existing shareholders exercise a preemptive rightto purchase shares at not less than 90% of the price paid by third parties, or(2) fees of up to 10% are paid to intermediaries, in which case the feespaid may be deducted from the price. The price may not be set at less than thenominal value of the shares. The board of directors shall value any in-kindcontributions for new shares, based on the appraisal report of an independentappraiser.

Russian securitiesregulations set out detailed procedures for the issuance and registration ofshares of a joint stock company. These procedures require

·       takinga decision on share placement and approving the resolution on share issuance;

·       priorregistration of a share issuance with the FSFM;

·       followingthe placement of the shares, registration and public disclosure of the resultsof the placement of shares; and

·       public disclosure ofinformation relating to the share issuance.

***Capital decrease; share buy-backs***

The Joint Stock Companies Law does not allow a companyto reduce its charter capital below the minimum charter capital required bylaw, which is 100,000 rubles for an open joint stock company. Our charterrequires that any decision to reduce our charter capital, whether through arepurchase and cancellation of shares or a reduction in the nominal value ofthe shares, be made by a majority vote of a shareholders’ meeting.Additionally, within 30 days of a decision to reduce our charter capital,we must issue written notice to our creditors and publish this decision. Ourcreditors would then have the right to demand, within 30 days ofpublication or sending by us of a notice, repayment of all amounts due to them,as well as compensation for damages.

The Joint Stock Companies Law allows our shareholdersor our board of directors to authorize the repurchase of up to 10% of ourshares in exchange for cash. The repurchased shares must be resold at a valuenot less than a market value within one year of their repurchase or, failingthat, the shareholders 

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must decide to cancel suchshares and decrease the charter capital. Repurchased shares do not bear votingrights.

The Joint StockCompanies Law allows us to repurchase our shares only if:

·       ourcharter capital is paid in full;

·       weare not and would not become, insolvent as a result of the repurchase;

·       thevalue of our net assets is not less (and would not become less, as a result ofthe proposed repurchase) than the sum of our charter capital, the reserve fundand the difference between the liquidation value and par value of our issuedand outstanding preferred shares; and

·       wehave repurchased all shares from shareholders having the right to demandrepurchase of their shares in accordance with Russian law, as describedimmediately below.

The Joint StockCompanies Law and our charter provide that our shareholders may demandrepurchase of all or some of their shares so long as the shareholder demandingrepurchase voted against or did not participate in the voting on the decisionapproving any of the following actions:

·       reorganization;

·       conclusionof a major transaction, as defined under Russian law; or

·       amendmentof our charter or approval of a restated version of our charter in a mannerwhich restricts shareholders’ rights.

We may spend up to 10% ofour net assets calculated under Russian accounting standards on the date of theadoption of the decision which gives rise for a share redemption demanded bythe shareholders. If the value of shares in respect of which shareholders haveexercised their right to demand repurchase exceeds 10% of our net assets, wewill repurchase shares from each such shareholder on a pro-rata basis.

***Registration and transfer of shares***

Russian legislation requires that a joint stockcompany maintain a register of its shareholders. Ownership of our registeredcommon shares is evidenced solely by entries made in such register. Any of ourshareholders may obtain an extract from our register certifying the number ofshares that such shareholder holds. Open Joint Stock Company “RegionalIndependent Registrar” currently maintains our shareholder register. InMarch 2006, our Board of Directors decided to transfer our shareholderregister from NIKoil to Open Joint Stock Company “Regional IndependentRegistrar,” which became effective in July 2006.

The purchase, sale orother transfer of shares is accomplished through the registration of thetransfer in the shareholder register, or the registration of the transfer witha depositary if shares are held by a depositary. The registrar or depositarymay not require any documents in addition to those required by Russianlegislation in order to transfer shares in the register. Refusal to registerthe shares in the name of the transferee or, upon request of the beneficialholder, in the name of a nominee holder, is not allowed except in certaininstances provided for by Russian legislation, and may be challenged in court.

***Reserve fund***

Russian legislationrequires that each joint stock company establish a reserve fund to be used onlyto cover the company’s losses, redeem the company’s bonds and repurchase thecompany’s shares in cases when other funds are not available. Our charterprovides for a reserve fund of 5% of our charter capital, funded throughmandatory annual transfers of at least 5% of our statutory net profits untilthe reserve fund has reached the 5% requirement.

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**Disclosure ofInformation**

Russian securitiesregulations require us to make the following periodic public disclosures andfilings:

·       filingquarterly reports with the Federal Service for the Financial Markets, or theFSFM, and RTS containing information about us, our shareholders anddepositary, the structure of our management bodies, the members of the board ofdirectors, our branches and representative offices, our shares, bank accountsand auditors, important developments during the reporting quarter, and otherinformation about our financial and business activity;

·       disclosureof the aforementioned quarterly reports in the newswire of authorizedinformation agencies and on our website at www.mechel.ru;

·       filingwith the FSFM and RTS and publishing any information concerning material factsand changes in our financial and business activity, including ourreorganization, certain changes in the amount of our assets, decisions on shareissuances, certain changes in ownership and shareholding as well as shareholderresolutions;

·       disclosure of the aforementioned informationconcerning material facts in the newswire of authorized information agenciesand on our website at www.mechel.ru;

·       disclosinginformation on various stages of share placement, issuance and registrationthrough publication of certain data as required by the securities regulationsby means of publishing it in the newswire of authorized information agenciesand on our website at www.mechel.ru, as well as by filing it with the RTS;

·       disclosing our charter andinternal corporate governance documents on our website and filing them with theRTS;

·       disclosingour annual report and annual financial statements prepared in accordance withRussian accounting standards;

·       filingwith the FSFM and RTS on a quarterly basis a list of our affiliated companiesand individuals and disclosing such list on our website at www.mechel.ru; and

·       other information asrequired by applicable Russian securities legislation.

**General Meetings ofShareholders**

***Procedure***

The powers of ashareholders’ meeting are set forth in the Joint Stock Companies Law and in ourcharter. A shareholders’ meeting may not decide issues that are not included inthe list of its competence by the Joint Stock Companies Law and our charter.Among the issues which the shareholders have the exclusive power to decide are:

·       charteramendments;

·       reorganizationor liquidation;

·       electionand early removal of the members of the board of directors;

·       determinationof the number, nominal value and type of authorized shares and rights grantedby such shares;

·       changesin the company’s charter capital;

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·       appointmentand early removal of the members of our review commission and countingcommission;

·       approvalof our external auditor;

·       approvalof certain interested party transactions and major transactions;

·       distributionof profits and losses, including approval of dividends;

·       decisionon our participation in commercial or industrial groups, or other associationsof commercial entities;

·       redemptionby the company of issued shares in cases provided for by the Joint StockCompanies Law;

·       approvalof certain internal documents regulating the activity of our governing bodies;and

·       otherissues, as provided for the by the Joint Stock Companies Law and our charter.

Voting at ashareholders’ meeting is generally on the principle of one vote per commonshare, with the exception of the election of the board of directors, which isdone through cumulative voting. Decisions are generally passed by a majorityvote of the voting stock present at a shareholders’ meeting. However, Russianlaw requires a three-quarters majority vote of the voting stock presentat a shareholders’ meeting to approve the following:

·       charteramendments;

·       reorganizationor liquidation;

·       majortransactions involving assets in excess of 50% of the balance sheet value ofthe company’s assets;

·       determinationof the number, nominal value and category (type) of authorized shares and therights granted by such shares;

·       repurchaseby the company of its issued shares;

·       anyissuance of shares or securities convertible into common shares by closed subscription;or

·       issuanceby open subscription of common shares or securities convertible into commonshares, in each case, constituting 25% or more of the number of issued andoutstanding common shares.

The quorum requirement for our shareholders meeting ismet if shareholders (or their representatives) accounting for more than 50% ofthe issued voting shares are present. If the over 50% quorum requirement is notmet, another shareholders’ meeting with the same agenda may (and, in the caseof an annual meeting, must) be scheduled and the quorum requirement issatisfied if shareholders (or their representatives) accounting for at least30% of the issued voting shares are present at that meeting.

The annualshareholders meeting must be convened by the board of directors betweenMarch 1 and June 30 of each year, and the agenda must include thefollowing items:

·       electionof the members of the board of directors and review commission;

·       approvalof the annual report and annual financial statements, including the balancesheet and profit and loss statement;

·       approvalof distribution of profits, including approval of annual dividends and losses,if any; and

·       appointmentof an independent auditor.

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A shareholder or group of shareholders owning in theaggregate at least 2% of the issued voting shares may introduce proposals forthe agenda of the annual shareholders’ meeting and may nominate candidates tothe board of directors, general director, the review commission and countingcommission. Any agenda proposals or nominations must be provided to the companyno later than 30 days after the preceding financial year ends.

Extraordinary shareholders’ meetings may be called bythe board of directors on its own initiative, or at the request of the reviewcommission, the independent auditor of the statutory accounts or a shareholderor group of shareholders owning in the aggregate at least 10% of the issuedvoting shares as of the date of the request.

A general meeting of shareholders may be held in aform of a meeting or by absentee ballot. The form of a meeting contemplates theadoption of resolutions by the general meeting of shareholders through theattendance of the shareholders or their authorized representatives for thepurpose of discussing and voting on issues of the agenda, provided that if aballot is mailed to shareholders for participation at a meeting convened insuch form, the shareholders may complete and mail the ballot back to thecompany without personally attending the meeting. A general meeting of the shareholdersby absentee ballot contemplates the determination of shareholders’ opinions onissues on the agenda by means of a written poll.

The followingissues cannot be decided by a shareholders’ meeting by absentee ballot:

·       electionof directors;

·       electionof the review commission;

·       approvalof a company’s independent auditor for statutory accounts; and

·       approval of the annualreport and annual financial statements, including balance sheet, profit andloss statement and any distribution of profits and losses, including approvalof annual dividends, if any.

***Notice and participation***

All shareholders entitled to participate in a generalshareholders’ meeting must be notified of the meeting, whether the meeting isto be held in direct form or by absentee ballot, no less than 30 daysprior to the date of the meeting, and such notification shall specify theagenda for the meeting. However, if it is an extraordinary shareholders’meeting to elect the board of directors, shareholders must be notified at least70 days prior to the date of the meeting. Under our charter, we can eitherprovide notice by mail to the shareholders or publish a notice in the“Rossiyskaya Gazeta”, a Russian language newspaper. Only those items that wereset out in the agenda may be voted upon at a general shareholders’ meeting.

The list of shareholders entitled to participate in ageneral shareholders’ meeting is compiled on the basis of data in ourshareholder register on the date established by the board of directors, whichdate may neither be earlier than the date of adoption of the board resolutionto hold a general shareholders’ meeting nor more than 50 days before thedate of the meeting (or, in the case of an extraordinary shareholders’ meetingto elect the board of directors, not more than 65 days before the date ofthe meeting).

The right toparticipate in a general meeting of shareholders may be exercised by ashareholder as follows:

·       bypersonally participating in the discussion of agenda items and voting thereon;

·       bysending an authorized representative to participate in the discussion of agendaitems and to vote thereon;

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·       byabsentee ballot; or

·       by delegating the right tofill out the absentee ballot to an authorized representative.

**Board of Directors**

The Joint Stock CompaniesLaw and our charter provides that our entire board of directors is up forelection at each annual general shareholders’ meeting and that our board ofdirectors is elected through cumulative voting. Under cumulative voting, eachshareholder may cast an aggregate number of votes equal to the number of votingshares held by such shareholder multiplied by the number of persons to beelected to our board of directors, and the shareholder may give all such votesto one candidate or spread them between two or more candidates. Before theexpiration of their term, the directors may be removed as a group at any timewithout cause by a majority vote of a shareholders’ meeting.

The Joint Stock CompaniesLaw requires at least a five-member board of directors for all joint stockcompanies, at least a seven-member board of directors for a joint stockcompany with more than 1,000 holders of voting shares, and at least anine-member board of directors for a joint stock company with more than 10,000holders of voting shares. Only natural persons (as opposed to legal entities)are entitled to sit on the board. Members of the board of directors are notrequired to be shareholders of the company. The actual number of directors isdetermined by the company’s charter or decision of the shareholders’ meeting.Our charter provides that our board of directors shall consist of nine members,and the majority of our directors shall be independent.

TheJoint Stock Companies Law generally prohibits the board of directors fromacting on issues that fall within the exclusive competence of the generalshareholders’ meeting. Our board of directors has the power to direct thegeneral management of the company, and to decide the following issues:

·       determinationof our business priorities;

·       conveningannual and extraordinary shareholders’ meetings, except in certaincircumstances specified in the Joint Stock Companies Law;

·       approvalof the agenda of the shareholders’ meeting and determination of the record datefor shareholders entitled to participate in a shareholders’ meeting;

·       placementof our bonds and other securities, except in certain circumstances specified inthe Joint Stock Companies Law and our charter;

·       determinationof the price of our property and of our securities to be placed or repurchased,as provided for by the Joint Stock Companies Law;

·       repurchaseof our shares, bonds and other securities in certain cases provided for by theJoint Stock Companies Law;

·       formationof our executive bodies, including appointment of the general director, andearly termination of their powers and the establishment of their compensation;

·       recommendationon the amount of a dividend and the payment procedure thereof;

·       recommendationon the amount of remuneration and compensation to be paid to the members of ourreview commission and on the fees payable for the services of an independentauditor;

·       theuse of our reserve fund and other funds;

·       thecreation and liquidation of branches and representative offices;

·       approvalof internal documents, except for those documents whose approval fall withinthe competence of the company’s shareholders or general director;

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·       approvalof major and interested party transactions in the cases provided for by theJoint Stock Companies Law;

·       increasingour charter capital by issuing additional shares within the limits of theauthorized charter capital, except in certain circumstance specified in ourcharter;

·       approvalof decisions on share issuances and of the prospectus relating to such shareissuances, as well as of reports on the results of such share issuances;

·       approvalof our share registrar; and

·       otherissues, as provided for by the Joint Stock Companies Law and our charter.

Our charter generallyrequires a majority vote of the directors present for an action to pass, withthe exception of actions for which Russian legislation requires a unanimousvote or a majority vote of the disinterested and independent directors, asdescribed herein. A board meeting is considered duly assembled and legallycompetent to act when at least five directors, including at least oneindependent director, are present. In addition, our charter requires thepresence of at least three quarters of the total number of directors, includingat least one third of the total number of independent directors, for boardmeetings convened to make decisions on certain matters specified in ourcharter.

**Interested PartyTransactions**

Under the JointStock Companies Law, certain transactions defined as “interested partytransactions” require approval by disinterested directors or shareholders ofthe company. “Interested party transactions” include transactions involving amember of the board of directors or member of any executive body of thecompany, any person that owns, together with any affiliates, at least 20% of acompany’s issued voting stock or any person who is able to direct the actionsof the company, if that person, or that person’s spouse, parents, children,adoptive parents or children, brothers or sisters or affiliates, is:

·       aparty to, or beneficiary of, a transaction with the company, whether directlyor as a representative or intermediary;

·       theowner of at least 20% of the issued voting shares of a legal entity that is aparty to, or beneficiary of, a transaction with the company, whether directlyor as a representative or intermediary; or

·       amember of the board of directors or a member of any management body of acompany that is a party to, or beneficiary of, a transaction with the company,whether directly or as a representative or intermediary.

The Joint Stock Companies Law requires that aninterested party transaction by a company with more than 1,000 shareholders beapproved by a majority vote of the independent directors of the company who arenot interested in the transaction. An “independent director” is a person who isnot, and within the year preceding the decision was not, the general director,a member of any executive body or an affiliate of the company. Additionally,such person’s spouse, parents, children, adoptive parents or children, brothersor sisters may not occupy positions in the executive bodies of the company. Forcompanies with 1,000 or fewer shareholders, an interested party transactionmust be approved by a majority vote of the directors who are not interested inthe transaction if the number of these directors is sufficient to constitute aquorum.

Approval by amajority of shareholders who are not interested in the transaction is requiredif:

·       thevalue of such transaction or a number of interrelated transactions is 2% ormore of the balance sheet value of the company’s assets determined underRussian accounting standards;

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·       thetransaction or a number of interrelated transactions involves the issuance, bysubscription, of voting shares or securities convertible into voting shares, orsecondary market sale of such securities, in an amount exceeding 2% of thecompany’s issued voting stock;

·       thenumber of directors who are not interested in the transaction is not sufficientto constitute a quorum; or

·       allthe members of the board of directors of the company are interested parties, ornone of them is an independent director.

Approval by a majority of shareholders who are notinterested in the transaction may not be required for an interested partytransaction if such transaction is substantially similar to transactionsconcluded by the company and the interested party in the ordinary course ofbusiness before such party became an interested party with respect to thetransaction.

The approval ofinterested party transactions is not required in the following instances:

·       thecompany has only one shareholder that simultaneously performs the functions ofthe executive body of the company;

·       allshareholders of the company are deemed interested in such transactions;

·       thetransactions arise from the shareholders executing their preemptive rights topurchase newly issued shares of the company;

·       thetransactions arise from the repurchase, whether mandatory or not, by thecompany of the issued shares; or

·       the company is merging withanother company, when the latter owns more than three-fourths of thevoting capital stock of the company.

**Major Transactions**

The Joint Stock CompaniesLaw defines a “major transaction” as a transaction, or a number of relatedtransactions, involving the acquisition or disposal, or a possibility ofdisposal (whether directly or indirectly), of property having a value of 25% ormore of the balance sheet value of the assets of a company as determined underRussian accounting standards as of the latest reporting date preceding thetransaction, with the exception of transactions completed in the ordinarycourse of business or transactions involving the placement of common shares orsecurities convertible into common shares by means of subscription (disposal).Major transactions involving assets ranging from 25% to 50% of the balancesheet value of the assets of a company require unanimous approval by allmembers of the board of directors or, failing to receive such approval, asimple majority vote of a shareholders’ meeting. Major transactions involvingassets in excess of 50% of the balance sheet value of the assets of a companyrequire a three-quarters majority vote of a shareholders’ meeting.

**Change in Control**

***Anti-takeover protection***

Russian legislationrequires the following:

·       Aperson intending to acquire 30% or more of an open joint stock company’sordinary shares and voting preferred shares (including, for such purposes,shares already owned by such person and its affiliates), will be entitled tomake a public tender offer to other holders of such shares or securitiesconvertible into such shares.

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·       Aperson that has acquired 30% or more of the totality of an open joint-stockcompany’s ordinary shares and voting preferred shares (including, for suchpurposes, shares already owned by such person and its affiliates, but excludingshares that were acquired pursuant to previous voluntary or mandatory offers)will generally be required to make, within 35 days of acquiring such shares, apublic tender offer for other shares of the same class and for securitiesconvertible into such shares, atthe price which is not less than the price determined based on aweighted market price of the shares for the previous six months, or on a pricenot less than the market price which must be determined by an independentappraiser if the shares have no or insufficient trading history. From themoment of acquisition of 30% or more of the shares until the moment of sendingof an offer to the security holders, the person making an offer and itsaffiliates will be able to register for quorum and vote only 30% of the sharesof the company (regardless of the size of their actual holdings). Theserules are also applied (or reapplied) to acquisitions resulting in aperson or a group of persons owning more than 50% and 75% of a company’soutstanding shares.

·       Aperson that as a result of such an offer becomes (individually or with itsaffiliates) the owner of more than 95% of the company’s ordinary shares andvoting preferred shares, must buy out the remaining shares of the company aswell as other securities convertible into such shares upon request of theholders of such shares or other securities, and may require such holders tosell such shares and other securities, at a price based on the prices of thepreceding acquisition by the offeror.

·       Anoffer of the kind described in either of the preceding three paragraphs must beaccompanied by a bank guarantee of payment. If the company is publicly traded,prior notice of the offer must be filed with the FSFM; otherwise, notice mustbe filed with the FSFM no later than the date of the offer. The FSFM may orderamendments to the terms of the offer (including price) in order to bring theminto compliance with the rules.

·       Oncesuch an offer has been made, competing offers for the same securities can bemade by third parties and, in certain circumstances, acceptance of the initialoffer may be withdrawn by the security holders who choose to accept suchcompeting offer. From the making of such an offer until 20 days after itsexpiry (which period may in certain cases exceed 100 days) the company’sshareholders meeting will have the sole power to make decisions on chartercapital increase, issuance of securities, approval of certain majortransactions, and on certain other significant matters.

The above rules maybe supplemented through rulemaking by the FSFM, which may result in a wider,narrower or more specific interpretation of these rules by the governmentand judicial authorities, as well as by market participants.

***Approvalof the Russian Federal Antimonopoly Service***

Pursuant to the FederalLaw on Competition, acquisitions of voting stock capital of a joint stockcompany, involving companies with a combined value of assets or annualrevenues, exceeding a certain threshold under Russian Accounting Standards, orcompanies registered as having more than a 35% share of a certain commoditymarket, and which would result in a shareholder (or a group of shareholdersdefined under Russian law) holding more than 25%, 50% or 75% of the votingcapital stock of such company, or in a transfer between such companies ofassets or rights to assets, the value of which exceeds a certain amount, ortransfer of powers of the chief executive officer to a management company incertain instances must be approved in advance by the Federal AntimonopolyService.

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***Notificationof Foreign Ownership***

Foreign persons registeredas individual entrepreneurs in Russia who acquire shares in a Russian jointstock company and foreign companies that acquire shares in a Russian jointstock company may need to notify the Russian tax authorities within one monthfollowing such acquisition. However, the procedure of notifying the Russian taxauthorities by foreign companies that are not registered with such taxauthorities at the time of their share acquisitions remain unclear.

**Material Contracts**

None.

**Exchange Controls**

The Federal Law onCurrency Regulation and Currency Control which came into effect as ofJune 18, 2004, sets forth certain restrictions on settlements betweenresidents of Russia with respect to transactions involving foreign securities(including ADRs), including requirements for settlement in Russian rubles.

**Repatriation of Export Proceeds**

Russian companies mustrepatriate 100% of their receivables from the export of goods and services(with a limited number of exceptions concerning, in particular, certain typesof secured financing) within seven days of the date on which they were received(also with a limited number of exceptions).

**Restrictions on the remittance of dividends, interestor other payments to non-residents**

The Federal Law on ForeignInvestments in the Russian Federation of July 9, 1999, specificallyguarantees foreign investors the right to repatriate their earnings fromRussian investments. However, the evolving Russian exchange control regime mayaffect your ability to do so. Ruble dividends on common shares may be paid tothe depositary or its nominee and converted into U.S. dollars by the depositaryfor distribution to owners of ADSs without restriction. Also, ADSs may be soldby non-residents of Russia for U.S. dollars outside Russia without regard toRussian currency control laws as long as the buyer is not a Russian residentfor currency control purposes. However, the ability to convert rubles into U.S.dollars is also subject to the availability of U.S. dollars in Russia’scurrency markets. Although there is an existing market within Russia for theconversion of rubles into U.S. dollars, including the interbank currencyexchange and over-the-counter and currency futures markets, the furtherdevelopment of this market is uncertain. At present, there is no market for theconversion of rubles into foreign currencies outside of Russia and a limitedemerging market in which to hedge ruble and ruble-denominatedinvestments.

**Taxation**

The following discussiondescribes the material U.S. federal and Russian income and withholding taxconsequences to a beneficial owner of common shares or ADSs that is a “UnitedStates person,” as defined in the United States Internal Revenue Code of 1986,as amended. No opinion of counsel will be issued with respect to the followingdiscussion and, therefore, such discussion is not based on an opinion ofcounsel. A resident of the United States for purposes of the Convention betweenthe United States of America and the Russian Federation for the Avoidance ofDouble Taxation and the Prevention of Fiscal Evasion with respect to Taxes onIncome and Capital (the “United States—Russia income tax treaty”) that is fullyeligible for benefits under the United States-Russia income tax treaty isreferred to herein as a “U.S. holder.” Subject to certain provisions of theUnited States-Russia income tax treaty relating to 

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limitationson benefits, you generally will be a resident of the United States for treatypurposes and entitled to treaty benefits if you are:

·       liable,under the laws of the United States, for U.S. federal income tax (other thantaxes in respect only of income from sources in the United States or capitalsituated therein) by reason of your domicile, residence, citizenship, place ofincorporation, or any other similar criterion (and, for income derived by apartnership, trust or estate, residence is determined in accordance with theresidence of the person liable to tax with respect to such income); and

·       notalso a resident of the Russian Federation for purposes of the UnitedStates-Russia income tax treaty.

The benefits under the United States-Russiaincome tax treaty discussed in this document generally are not available toU.S. persons who hold ADSs or common shares in connection with the conduct of abusiness in the Russian Federation through a permanent establishment as definedin the United States-Russia income tax treaty. Subject to certainexceptions, a U.S. person’s permanent establishment under the United States-Russiaincome tax treaty is a fixed place of business through which such personcarries on business activities in the Russian Federation (generally including,but not limited to, a place of management, a branch, an office and a factory).Under certain circumstances, a U.S. person may be deemed to have a permanentestablishment in the Russian Federation as a result of activities carried on inthe Russian Federation through agents of the U.S. person. This summary does notaddress the treatment of those holders.

The followingdiscussion is based on:

·       theUnited States Internal Revenue Code of 1986, as amended, the Treasuryregulations promulgated thereunder and judicial and administrativeinterpretations thereof;

·       Russianlegislation; and

·       theUnited States-Russia income tax treaty (and judicial and administrativeinterpretations thereof);

all as in effect on the date of this document. All ofthe foregoing are subject to change, possibly on a retroactive basis, after thedate of this document. This discussion is also based, in part, onrepresentations of the depositary, and assumes that each obligation in thedeposit agreement and any related agreements will be performed in accordancewith its terms. The discussion with respect to Russian legislation is based onour understanding of current Russian law and Russian tax rules, which aresubject to frequent change and varying interpretations. See “Item 3. KeyInformation—Risk Factors—Risks Relating to the Russian Federation—Legal Risksand Uncertainties—Weaknesses relating to the legal system and legislationcreate an uncertain environment for investment and business activity” and “Item3. Key Information—Risk Factors—Risks Relating to the Russian Federation—LegalRisks and Uncertainties—Characteristics of and changes in the Russian taxsystem could materially adversely affect our business, financial condition,results of operations and prospects and the value of the shares and ADSs.”

We believe, and the following discussion assumes, thatfor U.S. federal income tax purposes, we were not a passive foreign investmentcompany for the taxable year ending in 2006, we will not be a passive foreigninvestment company for the current taxable year and we will not become apassive foreign investment company in the future. However, passive foreigninvestment company, determinations are made annually and may involve facts thatare not within our control. If we were a passive foreign investment company,materially adverse United States federal income tax consequences could resultfor investors who are “United States persons” as defined in the United StatesInternal Revenue Code of 1986.

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The following discussionis not intended as tax advice to any particular investor. It is also not acomplete analysis or listing of all potential U.S. federal or Russian incomeand withholding tax consequences to you of ownership of common shares or ADSs.We urge you to consult your own tax adviser regarding the specific U.S.federal, state and local and Russian tax consequences of the ownership anddisposition of the common shares or ADSs under your own particular factualcircumstances.

**Russian Income andWithholding Tax Considerations**

The Russian tax rules applicable to U.S. holdersare characterized by significant uncertainties and by an absence of interpretiveguidance. Russian tax authorities have not provided any guidance regarding thetreatment of ADS arrangements, and there can be no certainty as to how theRussian tax authorities will ultimately treat those arrangements. Inparticular, it is unclear whether Russian tax authorities will treat U.S.holders as the beneficial owners of the underlying shares for the purposes ofthe United States-Russia income tax treaty. If the Russian taxauthorities were not to treat U.S. holders as the beneficial owners of theunderlying shares, then the benefits discussed below regarding the UnitedStates-Russia income tax treaty would not be available to U.S. holders.See “Item 3. Key Information—Risk Factors—Risks Relating to Our Shares and ADSsand the Trading Market—ADS holders may not be able to benefit from the UnitedStates-Russia income tax treaty.”

Russian tax law and procedures are also not welldeveloped, and the process, implementation and systematization of acomprehensive Russian tax regime is not yet finalized. Local tax inspectorshave considerable autonomy and often interpret tax rules without regard tothe rule of law. Both the substantive provisions of Russian tax law andthe interpretation and application of those provisions by the Russian tax authoritiesmay be subject to more rapid and unpredictable change than in jurisdictionswith more developed capital markets.

The first part of the Tax Code of the RussianFederation, or the Tax Code, came into effect as of January 1, 1999, andit defines the general principles of taxation in Russia, including the legalstatus of taxpayers and tax agencies, the general rules of tax filings andtax control, as well as procedures for challenging tax and appealing claims andassessments of the tax authorities and their actions (or failure to act).

The second part of the TaxCode came into effect as of January 1, 2001, and it sets forth thespecific tax categories and rules for imposing taxes.

***Taxation of dividends***

Dividends paid to U.S. holders generally will besubject to Russian withholding tax at a 15% rate to 30% rate for individualholders. This tax may be reduced to 5% to 10% under the United States-Russiaincome tax treaty for U.S. holders; a 10% rate applies to dividends paid toU.S. holders owning less than 10% of the entity’s outstanding shares and 5% forU.S. holders, which is a legal entity, owning 10% or more of the entity’soutstanding shares. Given the depositary’s status as the legal owner of all theshares underlying our ADSs, it is possible that the depositary may claimentitlement to a reduced withholding tax rate of 5%. Under current regulations,authorization from the Russian tax authorities is not required to allow us towithhold at reduced rates under applicable double tax treaties provided thatall of the numerous administrative requirements are met. See “—United States-Russiaincome tax treaty procedures.”

If the appropriatedocumentation has not been provided to us before the dividend payment date, weare required to withhold tax at the full rate, and U.S. holders qualifying fora reduced rate under the United States-Russia income tax treaty thenwould be required to file claims for refund within three years with the Russiantax authorities. There is significant uncertainty regarding the availabilityand timing of such refunds.

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***Taxation of capital gains***

U.S. holders generally should not be subject to anyRussian income or withholding taxes in connection with the sale, exchange, orother disposition of ADSs or common shares outside of Russia if the shares orADSs are not sold to a Russian resident. Sales or other dispositions of ADSs orcommon shares to Russian residents, however, may be subject to Russian incomeor withholding taxes, and for such a sale by a U.S. holder, the Russianresident purchaser may be required to withhold 20% to 30% of any gain realizedon the sale. However, there is no mechanism by which a Russian purchaser wouldbe able to effect this withholding upon purchasing ADSs from a U.S. holder inconnection with the sale of ADSs on the New York Stock Exchange.

U.S. holders may be able to claim the benefits of areduced rate of withholding under the United States-Russia income taxtreaty on the disposition of common shares or ADSs to Russian residents, orobtain a refund of any withheld amounts at rates different from those providedin the treaty, by relying on the United Sates-Russia income tax treatyand complying with the appropriate procedures described below.

Regardless of theresidence of the purchaser, a U.S. holder which is a legal entity should not besubject to any Russian income or withholding taxes in connection with the sale,exchange or other disposition of ADSs if immovable property constitutes 50% orless of our assets or if ADSs are sold via foreign exchanges where they arelegally circulated.

***United States-Russia income taxtreaty procedures***

Under current rules, to claim the benefit of a reducedrate of withholding under the United States-Russia income tax treaty, anon-resident generally must provide official certification from the U.S. taxauthorities of eligibility for the treaty benefits in the manner required byRussian law.

A U.S. holder may obtain the appropriate certificationby mailing completed forms, together with the holder’s name, taxpayeridentification number, the tax period for which certification is required, andother applicable information, to the United States Internal Revenue Service.The procedures for obtaining certification are described in greater detail inthe instructions to Internal Revenue Service Form 8802. As obtaining therequired certification from the Internal Revenue Service may take at least sixto eight weeks, U.S. holders should apply for such certification as soon aspossible.

If tax is withheld by a Russian resident on dividendsor other amounts at the rate different from provided in the tax treaty, a U.S.holder may apply for a tax refund by filing a package of documents with theRussian local tax inspectorate to which the withholding tax was remitted withinthree years from the withholding date for U.S. holders which are legalentities, and within one year from the withholding date for individual U.S.holders. The package should include confirmations of residence of the foreignholder (IRS Form 6166), a copy of the agreement or other documentssubstantiating the payment of income, documents confirming the beneficialownership of the dividends recipient and the transfer of tax to the budget.Under the provisions of the Tax Code the refund of the tax should be effectedwithin one month after the submission of the documents. However, procedures forprocessing such claims have not been clearly established, and there issignificant uncertainty regarding the availability and timing of such refunds.

Neither the depositary norus will have any obligation to assist an ADS holder with the completion andfiling of any tax forms.

**United StatesFederal Income Tax Considerations**

The following is ageneral description of the material U.S. federal income tax consequences thatapply to you if you are, for U.S. federal income tax purposes, a beneficialowner of ADSs or common shares who 

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is acitizen or resident of the United States, a corporation (including any entitytreated as a corporation for U.S. federal income tax purposes) created ororganized in or under the laws of the United States, any state thereof or theDistrict of Columbia, an estate the income of which is subject to U.S. taxregardless of its source, or a trust, if a U.S. court can exercise primarysupervision over the administration of the trust and one or more U.S. personscan control all substantial trust decisions, or if the trust was in existenceon August 20, 1996 and has properly elected to continue to be treated as aU.S. person. If a partnership (including any entity treated as a partnershipfor U.S. federal income tax purposes) is a beneficial owner of ADSs or commonshares, the U.S. federal income tax treatment of a partner in the partnershipwill generally depend on the status of the partner and the activities of thepartnership. Since your U.S. federal income and withholding tax treatment mayvary depending upon your particular situation, you may be subject to specialrules not discussed below. Special rules will apply, for example, ifyou are:

·       aninsurance company;

·       atax-exempt organization;

·       afinancial institution;

·       aperson subject to the alternative minimum tax;

·       aperson who is a broker-dealer in securities;

·       anS corporation;

·       anexpatriate subject to Section 877 of the United States Internal RevenueCode;

·       anowner of, directly, indirectly or by attribution, 10% or more of ouroutstanding common shares; or

·       anowner holding ADSs or common shares as part of a hedge, straddle, syntheticsecurity or conversion transaction.

In addition, this summary is generally limited topersons holding common shares or ADSs as “capital assets” within the meaning ofSection 1221 of the United States Internal Revenue Code and whosefunctional currency is the U.S. dollar. The discussion below also does notaddress the effect of any U.S. state or local tax law or foreign tax law.

For purposes of applyingUnited States federal income and withholding tax law, a holder of an ADS shouldbe treated as the owner of the underlying common shares represented by thatADS.

***Taxation of dividends on commonshares or ADSs***

For U.S. federal income tax purposes, the gross amountof a distribution, including any Russian withholding taxes, with respect tocommon shares or ADSs will be treated as a taxable dividend to the extent ofour current and accumulated earnings and profits, computed in accordance withUnited States federal income tax principles. For taxable years beginning beforeJanuary 1, 2011, if you are a non-corporate taxpayer, such dividends maybe taxed at the lower applicable capital gains rate provided (1) certainholding period requirements are satisfied, (2) either (a) in the caseof ADSs, our ADSs continue to be listed on the New York Stock Exchange (orother national securities exchange that is registered under section 6 ofthe Securities Exchange Act of 1934, as amended, or the Nasdaq Stock Market) or(b) we are eligible for the benefits of the United States-Russiaincome tax treaty, and (3) we are not, for the taxable year in which thedividend was paid, or in the preceding taxable year, a “passive foreigninvestment company.” Non-corporate U.S. holders are strongly urged to consulttheir own tax advisors as to the applicability of the lower capital gains rateto dividends received with respect to ADSs or common shares. Distributions inexcess of our current and accumulated earnings and profits will be appliedagainst and will reduce your tax basis in common shares or ADSs and, to theextent in excess of 

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such tax basis, will betreated as gain from a sale or exchange of such common shares or ADSs. Youshould be aware that we do not intend to calculate our earnings and profits forU.S. federal income tax purposes and, unless we make such calculations, youshould assume that any distributions with respect to common shares or ADSsgenerally will be treated as a dividend, even if that distribution wouldotherwise be treated as a return of capital or as a capital gain pursuant tothe rules described above. If you are a corporation, you will not beallowed a deduction for dividends received in respect of distributions oncommon shares or ADSs, which is generally available for dividends paid by U.S.corporations.

If a dividend distribution is paid in rubles, theamount includible in income will be the U.S. dollar value of the dividend,calculated using the exchange rate in effect on the date the dividend isincludible in income by you, regardless of whether the payment is actuallyconverted into U.S. dollars. Any gain or loss resulting from currency exchangerate fluctuations during the period from the date the dividend is includible inyour income to the date the rubles are converted into U.S. dollars will betreated as ordinary income or loss. You may be required to recognize foreigncurrency gain or loss on the receipt of a refund of Russian withholding taxpursuant to the United States-Russia income tax treaty to the extent theU.S. dollar value of the refund differs from the U.S. dollar equivalent ofthat amount on the date of receipt of the underlying dividend.

Russian withholding tax at the rate applicable to youunder the United States-Russia income tax treaty should be treated as aforeign income tax that, subject to generally applicable limitations andconditions, is eligible for credit against your U.S. federal income taxliability or, at your election, may be deducted in computing taxable income.If, however, the holder of an ADS is not treated as the owner of the underlyingcommon shares represented by the ADS for U.S. federal income tax purposes, thenRussian withholding tax would not be treated as a foreign income tax eligiblefor credit as described in the preceding sentence. If Russian tax is withheldat a rate in excess of the rate applicable to you under the United States-Russiaincome tax treaty, you may not be entitled to credits for the excess amount,even though the procedures for claiming refunds and the practical likelihoodthat refunds will be made available in a timely fashion are uncertain.

For United States foreigntax credit purposes, a dividend distribution will be treated as foreign sourceincome and will generally be classified as “passive category income” but could,in the case of certain U.S. holders, constitute “general category income”for taxable years beginning after December 31, 2006. Therules relating to the determination of the foreign tax credit, ordeduction in lieu of the foreign tax credit, are complex and you should consultyour own tax advisors with respect to those rules.

***Taxation on sale or exchange ofcommon shares or ADSs***

The sale of common shares or ADSs will generallyresult in the recognition of gain or loss in an amount equal to the differencebetween the amount realized on the sale and your adjusted basis in such commonshares or ADSs. That gain or loss will be capital gain or loss if the commonshares or ADSs are capital assets in your hands and will be long-term capitalgain or loss if the common shares or ADSs have been held for more than oneyear. If you are an individual, such realized long-term capital gain isgenerally subject to a reduced rate of U.S. federal income tax. Limitations mayapply to your ability to offset capital losses against ordinary income.

Deposits and withdrawals of common shares by you inexchange for ADSs will not result in the realization of gain or loss for U.S.federal income tax purposes.

Gain realized on the saleof common shares or ADSs will generally be treated as U.S. source income andtherefore the use of foreign tax credits relating to any Russian taxes imposedupon such sale may be limited. You are strongly urged to consult your own taxadvisors as to the availability of tax credits for any Russian taxes withheldon the sale of common shares or ADSs.

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***Information reporting and backupwithholding***

Dividends and proceedsfrom the sale or other disposition of common shares or ADSs that are paid inthe United States or by a U.S.-related financial intermediary will besubject to U.S. information reporting rules and U.S. backup withholdingtax, unless you are a corporation or other exempt recipient. In addition, youwill not be subject to backup withholding if you provide your taxpayeridentification number and certify that no loss of exemption from backup withholdinghas occurred. Holders that are not U.S. persons generally are not subject toinformation reporting or backup withholding, but such holders may be requiredto provide certification as to their non-U.S. status.

**Documents onDisplay**

The documents that are exhibits to or incorporated byreference in this document can be read at the SEC’s Public ReferenceRoom at 100 F Street, NE, Washington, DC 20549. You can obtain informationon the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.These filings are also available at the website maintained by the SEC athttp://www.sec.gov.

You can also inspect someof our reports and other information at the offices of the NYSE at20 Broad Street, New York, New York 10005.

***Item 11.****                  **Quantitative and QualitativeDisclosures about Market Risk*

In the normal course of business, our financialposition is routinely subject to a variety of risks. We are exposed to marketrisks associated with foreign currency exchange rates, interest rates andcommodity and equity prices. We are also subject to the risks associated withthe business environment in which we operate, including the collectibility ofaccounts receivable.

Except for hedging foreign currency exchange ratesrisk as more fully discussed below, we do not enter into hedge transactions tomanage the risks specified above.

We do not hold or issuederivative financial instruments for trading purposes.

**Currency risk**

The functional currencies for our Russian and Romaniansubsidiaries are the ruble and lei, respectively. The U.S. dollar is thefunctional currency of our other international operations. Our reportingcurrency is the U.S. dollar.

As the economies of Russia and Romania were consideredhighly inflationary through December 31, 2002 and September 30, 2004,respectively, transactions and balances of respective domestic operations notalready measured in U.S. dollars were remeasured as if the functional currencywere the U.S. dollar, in accordance with the relevant provisions of SFAS No. 52,“Foreign Currency Translation.” The objective of this remeasurement process isto produce the same results that would have been reported if the accountingrecords had been kept in U.S. dollars. Under this method, monetary assets andliabilities are translated using the exchange rate as of the balance sheetdates. Non-monetary assets and liabilities, including non-current non-monetaryassets, liabilities and shareholders’ equity, are stated at their actual U.S.dollar cost or are restated from their historic cost, by applying thehistorical exchange rate as at the date of the original transaction. Income andexpenses are restated by applying the annual average exchange rates. Items inthe statement of cash flows are translated at the annual average exchange ratesand where applicable at the exchange rates on the dates of the transactions.Foreign currency differences arising from remeasurement of the local currenciesto U.S. dollars are included in the consolidated income statement as “Foreignexchange gain (loss).”

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Effective January 1, 2003 and October 1,2004, Russia and Romania, respectively, no longer meet the criteria for highlyinflationary economies for purposes of applying SFAS No. 52. Accordingly,for the periods starting January 1, 2003 and October 1, 2004,respectively, the translation adjustments resulting from the process oftranslating financial statements from the functional currency into thereporting currency are included in determining other comprehensive income.

The initial implementation of this change had theeffect of decreasing the U.S. dollar value of the combined net assets of ourRussian subsidiaries by $30.9 million and increasing the accumulated othercomprehensive income by the same amount. The impact of the change was to record$30.9 million of income for the year ended December 31, 2003, as acomponent of accumulated net other comprehensive income in the shareholders’equity section of the consolidated balance sheet. The impact of the changerelated to Romania in 2004 was not significant.

The Russian ruble and the Romanian lei are generallynot convertible outside Russia and Romania, respectively, so our ability tohedge against further devaluation by converting to other currencies issignificantly limited. Further, our ability to convert Russian rubles andRomanian leis into other currencies in Russia and Romania, respectively, issubject to rules that restrict the purposes for which conversion and thepayment in foreign currencies are allowed.

We at times enter into forward transactions to buyU.S. dollars for euros to hedge our exposure to movements in foreign currencyexchange rates arising on euro-denominated accounts receivable of Mechel TradingAG and Mechel Metal Supply, our Swiss and Liechtenstein wholly ownedsubsidiaries. This derivative was not designated as a hedge for accountingpurposes. Such forward transactions amounted to $10.4 million during theyear ended December 31, 2006. As of December 31, 2006, we did nothave outstanding any forward transactions.

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We areexposed to movements in the ruble and euro exchange rates relative to the U.S.dollar, our reporting currency. The following table sets forth our monetaryassets and liabilities by currency at December 31, 2006.

| **Balance as of December 31, 2006**           | ** ** | ** **                                             | ** **   | **U.S. Dollar** | ** ** | **Ruble**    | ** ** | **Euro**    | ** ** | **Lei**     | ** ** | **Other**   | ** ** | **Total**    | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------------|--------------|----------------------|------------|--------------|------------|-------------|------------|-------------|------------|-------------|------------|--------------|------------|
| ** **                                                             | ** ** | **(in thousands of U.S. dollars)** | ** **   |
| **Current Assets:**                                                    | ** ** |                                                   | ** **   | ** **           |       | ** **   | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** **   | ** ** |
| Cash and cash  equivalents                                             |       |                                                   | 35,021       |                 |       | 112,069      |       | 20,521      |       | 1,109       |       | 3,894       |       | 172,614      |       |
| Trade  receivables, net                                                |       |                                                   | 25,499       |                 |       | 92,285       |       | 36,343      |       | 32,474      |       | 4,571       |       | 191,172      |       |
| Due from related  parties                                              |       |                                                   | 127          |                 |       | 407          |       | 11          |       | —      |       | —      |       | 545          |       |
| Deferred income  taxes                                                 |       |                                                   | 26           |                 |       | 8,124        |       | —      |       | (323        | )          | 95          |       | 7,922        |       |
| Current assets on  discontinued operations                             |       |                                                   |         |                 |       |         |       |        |       |        |       | 9           |       | 9            |       |
| Prepayments and  other current assets                                  |       |                                                   | 9,347        |                 |       | 579,680      |       | 3,863       |       | 1,410       |       | 1,264       |       | 595,564      |       |
| **Total current assets**                                               |       |                                                   | **70,020**   | ** **           | ** ** | **792,565**  | ** ** | **60,738**  | ** ** | **34,670**  | ** ** | **9,833**   | ** ** | **967,826**  | ** ** |
| **Current Liabilities:**                                               | ** ** |                                                   | ** **   | ** **           |       | ** **   | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** **   | ** ** |
| Short-term  borrowings and current maturities of long-term debt        |       |                                                   | (63,144      | )                    |       | (32,078      | )          | (52,146     | )          | (17,836     | )          | (1,313      | )          | (166,517     | )          |
| Accounts payable and  accrued  expenses:                               |       |                                                   |         |                 |       |         |       |        |       |        |       |        |       |         |       |
| Advances received                                                      |       |                                                   | (20,457      | )                    |       | (66,883      | )          | (237        | )          | (655        | )          | (45         | )          | (88,278      | )          |
| Accrued expenses  and other current liabilities                        |       |                                                   | (3,825       | )                    |       | (76,937      | )          | (168        | )          | (2,778      | )          | (924        | )          | (84,632      | )          |
| Pension obligations, current portion                                   |       |                                                   | —       |                 |       | (9,697       | )          | —      |       | (1,347      | )          | —      |       | (11,044      | )          |
| Current liabilities of discontinued operations                         |       |                                                   | —       |                 |       | —       |       | —      |       | —      |       | (508        | )          | (508         | )          |
| Taxes and social charges payable                                       |       |                                                   | (4,391       | )                    |       | (111,858     | )          | —      |       | (5,129      | )          | (21,658     | )          | (143,037     | )          |
| Trade payables to  vendors of goods and services                       |       |                                                   | 2,152        |                 |       | (141,019     | )          | (14,765     | )          | (23,082     | )          | (6,771      | )          | (183,485     | )          |
| Due to related  parties                                                |       |                                                   | (482         | )                    |       | (1,871       | )          | —      |       | —      |       | —      |       | (2,353       | )          |
| Asset retirement  obligation                                           |       |                                                   | —       |                 |       | (2,443       | )          | —      |       | (1,001      | )          | —      |       | (3,444       | )          |
| Deferred income  taxes                                                 |       |                                                   | (2,778       | )                    |       | (56,042      | )          | —      |       | —      |       | —      |       | (58,820      | )          |
| Finance lease  liabilities                                             |       |                                                   | —       |                 |       | (5,579       | )          | —      |       | —      |       | (487        | )          | (6,066       | )          |
| Deferred revenue                                                       |       |                                                   | (7,156       | )                    |       | (28          | )          | —      |       | —      |       | —      |       | (7,183       | )          |
| **Total current liabilities**                                          |       |                                                   | **(100,081** | **)**                | ** ** | **(504,437** | **)**      | **(67,315** | **)**      | **(51,829** | **)**      | **(31,704** | **)**      | **(761,919** | **)**      |
| **Long-term Liabilities:**                                             | ** ** |                                                   | ** **   | ** **           |       | ** **   | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** **   | ** ** |
| Restructured  taxes and social charges payable, net of current portion |       |                                                   | —       |                 |       | (6,552       | )          | —      |       | (1,230      | )          | —      |       | (7,782       | )          |
| Long-term  debt, net of current portion                                |       |                                                   | (59          | )                    |       | (318,650     | )          | —      |       | (3,894      | )          | —      |       | (322,604     | )          |
| Pension  obligations, net of current portion                           |       |                                                   | —       |                 |       | (56,596      | )          | —      |       | (2,573      | )          | —      |       | (59,170      | )          |
| Asset retirement  obligation, net of current portion                   |       |                                                   | —       |                 |       | (85,632      | )          | —      |       | (3,283      | )          | —      |       | (88,914      | )          |
| Due to related  parties                                                |       |                                                   | —       |                 |       | —       |       | —      |       | —      |       | —      |       | —       |       |
| Deferred income  tax                                                   |       |                                                   | (17,230      | )                    |       | (107,700     | )          | —      |       | (11,989     | )          | —      |       | (136,920     | )          |
| Finance lease liabilities                                              |       |                                                   | —       |                 |       | (49,838      | )          | —      |       | —      |       | (1,230      | )          | (51,068      | )          |
| Other long-term  liabilities                                           |       |                                                   | —       |                 |       | —       |       | —      |       | —      |       | —      |       | —       |       |
| **Total long-term liabilities**                                        |       |                                                   | **(17,290**  | **)**                | ** ** | **(624,203** | **)**      | **—**  | ** ** | **(22,980** | **)**      | **(1,230**  | **)**      | **(665,692** | **)**      |
| Minority interest                                                      |       |                                                   | —       |                 |       | (138,264     | )          | —      |       | (24,772     | )          | —      |       | (163,036     | )          |
| **Net monetary assets  (liabilities)**                                 |       |                                                   | **(47,350**  | **)**                | ** ** | **(475,102** | **)**      | **(6,576**  | **)**      | **(64,899** | **)**      | **(23,108** | **)**      | **(617,038** | **)**      |

 

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Thetable below summarizes our debt position by currency and rate method as of December 31,2006.

| ** **            | ** ** | **U.S. Dollar**                                   | ** ** | **Ruble** | ** ** | **Euro** | ** ** | **Lei**  | ** ** | **Lit** | ** ** | **Total** | ** ** |
|-----------------------|------------|--------------------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|---------|------------|-----------|------------|
| ** **            | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| Total debt  including |       |                                                   | (83,267    | )         |       | (272,867 | )          | (115,335 | )          | (17,652 | )          |      | —     |   |   | (489,121 | ) |
| Fixed-rate debt       |       |                                                   | (59        | )         |       | (262,141 | )          | (64,020  | )          | —  |       |      | —     |   |   | (326,220 | ) |
| Variable-rate  debt   |       |                                                   | (83,208    | )         |       | (10,726  | )          | (51,315  | )          | (17,652 | )          |      | —     |   |   | (162,901 | ) |

 

**Interest rate risk**

Our interest rate exposure results mainly from debtobligations. At December 31, 2006, we had $326.2 million infixed-rate borrowings and $162.9 million in variable-rate borrowings.

We have not entered into transactions designed tohedge against interest rate risks, which may exist under our current, or futureindebtedness. We monitor the market and assess our options for hedging interestrate risks and may enter into such arrangements.

Thetable below presents the principle cash flows and related range of interestrates, by expected maturity dates, of our fixed-rate debt obligations as of December 31,2006. 

| ** **                        | ** ** | ** **                                             | ** ** | **Expected maturity date as of December 31,** | ** ** | ** ** | ** ** | **Annual  Interest  rate  (Actual at  December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|------------|----------------------------------------------------------------|------------|
| ** **                        | ** ** | **Currency**                                           | ** ** | **2007**                                                                    | ** ** | **2008**   | ** ** | **2009**                                                       | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **2006** | ** ** |
| ** **                        | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| **Fixed-rate  U.S. dollar debt:** | ** ** | ** **                                             | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** **                                                     | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Astroga Trading                   |       | U.S.  dollar                                           |       | —                                                                      |       | —     |       | —                                                         |       |   | — | ** ** |   |   | 59 | ** ** |   | 59 |   | 12 | % |
| Total                             |       |                                                   |       | —                                                                      |       | —     |       | —                                                         |       |   | — | ** ** |   |   | 59 | ** ** |   | 59 |   |   |   |
| **Fixed-rate euro debt:**         | ** ** | ** **                                             | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** **                                                     | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Gazprombank                       |       | Euro                                                   |       | —                                                                      |       | 31,870     |       | 31,870                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 63,740 |   | 6.50 | % |
| STEIERMÄRKISCHE              |       | Euro                                                   |       | 280                                                                         |       | —     |       | —                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 280 |   | 6.00 | % |
| Total                             |       |                                                   |       | 280                                                                         |       | 31,870     |       | 31,870                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 64,020 |   |   |   |
| **Fixed-rate ruble debt:**        | ** ** | ** **                                             | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** **                                                     | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Gazprombank                       |       | Ruble                                                  |       | 42,017                                                                      |       | —     |       | —                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 42,017 |   | 6.60-6.70 | % |
| Sberbank                          |       | Ruble                                                  |       | 7,596                                                                       |       | —     |       | —                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 7,596 |   | 7.80 | % |
| Uralsib                           |       | Ruble                                                  |       | 11,393                                                                      |       | —     |       | —                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 11,393 |   | 6.00 | % |
| Bonds                             |       | Ruble                                                  |       | 2,071                                                                       |       | —     |       |                                                           |       |   | — | ** ** |   |   | — | ** ** |   | 2,071 |   | 5.50 | % |
| Bonds                             |       | Ruble                                                  |       | —                                                                      |       | —     |       | 7,320                                                          |       |   | — | ** ** |   |   | — | ** ** |   | 7,320 |   | 5.50 | % |
| Bonds                             |       | Ruble                                                  |       | —                                                                      |       | —     |       | —                                                         |       |   | — | ** ** |   |   | 188,983 | ** ** |   | 188,983 |   | 8.40 | % |
| Promissory notes                  |       | Ruble                                                  |       | —                                                                      |       | 2,457      |       | —                                                         |       |   | 106 | ** ** |   |   | 107 | ** ** |   | 2,671 |   | 7.49 | % |
| Other                             |       | Ruble                                                  |       | 91                                                                          |       | —     |       | —                                                         |       |   | — | ** ** |   |   | — | ** ** |   | 91 |   | 0.00-11.00 | % |
| Total                             |       |                                                   |       | 63,167                                                                      |       | 2,457      |       | 7,320                                                          |       |   | 106 | ** ** |   |   | 189,090 | ** ** |   | 262,141 |   |   |   |
| Total debt:                       |       |                                                   |       | 63,448                                                                      |       | 34,327     |       | 39,190                                                         |       |   | 106 | ** ** |   |   | 189,149 | ** ** |   | 326,220 |   |   |   |

 

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Thetable below presents the principal cash flows and related range of interestrates, by expected maturity dates, of our variable-rate debt obligations as of December 31,2006. 

| ** **                           | ** ** | ** **                                             | ** ** | **Expected maturity date as of December 31,** | ** ** | ** ** | ** ** | **Average  annual  Interest  rate  (Actual at  December 31** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Currency**                                           | ** ** | **2007**                                                                    | ** ** | **2008**   | ** ** | **2009**                                                               | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **2006** | ** ** |
| ** **                           | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| **Variable-rate  U.S. dollar debt:** | ** ** | ** **                                             | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** **                                                             | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** |
| Vneshtorgbank                        |       | U.S.  dollar                                           |       | —                                                                      |       | 17,160     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 17,160 |   | 10.94 | % |
| Raiffeisenbank                       |       | U.S.  dollar                                           |       | 4,699                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 4,699 |   | 6.00-8.50 | % |
| BNP Paribas                          |       | U.S.  dollar                                           |       | 41,956                                                                      |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 41,956 |   | 7.20 | % |
| Hypo Vereinsbank                     |       | U.S.  dollar                                           |       | 4,332                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 4,332 |   | 7.67 | % |
| Fortis Bank                          |       | U.S.  dollar                                           |       | 3,070                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 3,070 |   | 9.45 | % |
| Commerzbank                          |       | U.S.  dollar                                           |       | —                                                                      |       | —     |       | 3,184                                                                  |       |   | — | ** ** |   |   | — | ** ** |   | 3,184 |   | 7.50 | % |
| ING Bank                             |       | U.S.  dollar                                           |       | 6,694                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 6,694 |   | 6.88 | % |
| Erste Bank Vienna                    |       | U.S.  dollar                                           |       | 574                                                                         |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 574 |   | 8.50 | % |
| Natexis                              |       | U.S.  dollar                                           |       | 1,539                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 1,539 |   | 6 | % |
| Total                                |       |                                                   |       | 62,864                                                                      |       | 17,160     |       | 3,184                                                                  |       |   | — | ** ** |   |   | — | ** ** |   | 83,208 |   |   |   |
| **Variable-rate  euro debt:**        |       | Euro                                                   |       |                                                                        |       |       |       |                                                                   |       |   |   | ** ** |   |   |   | ** ** |   |   |   |   |   |
| Commerzbank                          |       | Euro                                                   |       | —                                                                      |       | —     |       | 32,943                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 32,943 |   | 5.96 | % |
| Bank SEB Vilniaus                    |       | Euro                                                   |       | 1,312                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 1,312 |   | 4.00 | % |
| Raiffeisenbank                       |       | Euro                                                   |       | 3,730                                                                       |       | 3,894      |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 7,624 |   | 6.25-7.75 | % |
| BCR                                  |       | Euro                                                   |       | 1,294                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 1,294 |   | 6.50 | % |
| Fortis Bank                          |       | Euro                                                   |       | 5,593                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 5,593 |   | 4.95 | % |
| BNP Paribas                          |       | Euro                                                   |       | 1,179                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 1,179 |   | 4.89-7.45 | % |
| Erste Bank Vienna                    |       | Euro                                                   |       | 1,057                                                                       |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 1,057 |   | 7.45 | % |
| BCP                                  |       | Euro                                                   |       | 313                                                                         |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 313 |   | 4.95 | % |
| Total                                |       |                                                   |       | 14,478                                                                      |       | 3,894      |       | 32,943                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 51,315 |   |   |   |
| **Variable-rate ruble debt:**        |       |                                                   |       |                                                                        |       |       |       |                                                                   |       |   |   | ** ** |   |   |   | ** ** |   |   |   |   |   |
| Commerzbank                          |       | Ruble                                                  |       | —                                                                      |       | —     |       | 5,606                                                                  |       |   | — | ** ** |   |   | — | ** ** |   | 5,606 |   | 7.92 | % |
| IMB                                  |       | Ruble                                                  |       | —                                                                      |       | —     |       | 5,120                                                                  |       |   | — | ** ** |   |   | — | ** ** |   | 5,120 |   | 7.97 | % |
| Total                                |       |                                                   |       | —                                                                      |       | —     |       | 10,726                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 10,726 |   |   |   |
| **Variable-rate lei debt:**          |       |                                                   |       |                                                                        |       |       |       |                                                                   |       |   |   | ** ** |   |   |   | ** ** |   |   |   |   |   |
| Raiffeisenbank                       |       | Lei                                                    |       | 17,652                                                                      |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 17,652 |   | 9.70-10.80 | % |
| Total                                |       |                                                   |       | 17,652                                                                      |       | —     |       | —                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 17,652 |   |   |   |
| Total debt:                          |       |                                                   |       | 94,994                                                                      |       | 21,054     |       | 46,853                                                                 |       |   | — | ** ** |   |   | — | ** ** |   | 162,901 |   |   |   |

 

The carrying amounts ofshort-term loans approximate their fair values due to their short maturity. Webelieve that the carrying value of our long-term debt approximates its fairvalue.

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**Commodity pricerisk**

In the normal course of our business, we are primarilyexposed to market risk of price fluctuations related to the purchase,production and sale of steel products, and to a lesser extent, to the purchase,production and sale of coal, coke and other products.

We do not use commodity derivatives or long-term salesor supply agreements to manage our commodity price risks.

Under certain of our steelproducts sales agreements we grant a third-party reseller a sales priceconcession under which the selling price, which is typically prepaid by thereseller, is subject to adjustment based upon the level of market prices of theLondon Metals Exchange. Historically,these selling price adjustments occur within a one month periodfrom the date the products are delivered to the reseller. We had 942 tonnes ofour nickel products as of December 31, 2006 in the distribution channelfor which we received prepayments in the amount of $7.2 million. See “Item 5.Operating and Financial Review and Prospects—Critical Accounting Policies andEstimates—Revenue recognition.”

**Equity price risk**

As of December 31, 2006, we had certainmarketable securities of various Russian public companies. These investmentsare exposed to market risk of fluctuations in equity prices. Our investments inequity of various Russian companies increased in September 2006 followingour acquisition of Moscow Coke Gas Plant, which had such investments. Most ofthe shares which were held by Moscow Coke Gas Plant were publicly traded on theRTS. These shares are revalued at market prices of the RTS as of each reportingperiod. Shares were acquired by Moscow Coke Gas Plant for resale purposes.

We also have minor investments in shares of Russiancompanies that are not publicly traded and, accordingly, their market valuesare not available. Currently, it is not practicable for us to estimate the fairvalues of these investments because we have not yet obtained or developed thevaluation models necessary to make the estimates, and the cost of obtaining anindependent valuation is believed by the management to be excessive consideringthe significance of the investments. Therefore, these investments are omittedfrom quantitative risk information disclosure presented herein.

Yakutugol experienced losses of $54.5 million in 2006.As Yakutugol shares are not publicly traded, their market value is not readilyavailable. Management evaluated the carrying amount of Yakutugol for potentialimpairment as of December 31, 2006 using valuation techniques andassumptions that a market participant would employ to value Yakutugol, andbased on these techniques, concluded that no impairment was necessary.Nevertheless, the majority shareholder of Yakutugol, plans to sell its holding,75% minus 1 share, at a public auction in August 2007. The results of thisauction may adversely affect the carrying amount of Yakutugol.

We do not use derivativeinstruments or any other arrangements to manage our equity price risks.

***Item 12.***                   Descriptionof Securities Other than Equity Securities

Not applicable.

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**PART II**

***Item13.***                   Defaults,Dividend Arrearages and Delinquencies

None.

***Item14.***                   MaterialModifications to the Rights of Security Holders and Use of Proceeds

Not applicable.

***Item15.***                   Controlsand Procedures

*(a)*     Disclosure Controls andProcedures

As required by Rules 13a-15 and 15d-15under the Securities Exchange Act of 1934, management has evaluated, with theparticipation of our chief executive officer and chief financial officer, theeffectiveness of our disclosure controls and procedures as of the end of theperiod covered by this report. Disclosure controls and procedures refer tocontrols and other procedures designed to ensure that information required tobe disclosed in the reports we file or submit under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the rules and forms of the Securities and Exchange Commission.Disclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed by usin our reports that we file or submit under the Exchange Act is accumulated andcommunicated to management, including our chief executive officer and chieffinancial officer, as appropriate to allow timely decisions regarding our requireddisclosure. In designing and evaluating our disclosure controls and procedures,management recognizes that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management was required to apply its judgmentin evaluating and implementing possible controls and procedures.

As described below, ninematerial weaknesses were identified in our internal control over financialreporting. The Public Company Accounting Oversight Board’s Auditing StandardNo. 2 defines a material weakness as a significant deficiency, orcombination of significant deficiencies, that results in more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected. As a result of the materialweaknesses, our chief executive officer and chief financial officer haveconcluded that, as of December 31, 2006, the end of the period covered bythis report, our disclosure controls and procedures were not effective at areasonable assurance level.

*(b)*    Management’s Annual Report onInternal Control Over Financial Reporting 

Management is responsible for establishing andmaintaining adequate internal control over financial reporting.

Internal controlover financial reporting refers to a process designed by, or under thesupervision of, our chief executive officer and chief financial officer andeffected by our board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles and includes those policies andprocedures that:

·       pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of our assets;

·       providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that our receipts and expenditures are being madeonly in accordance with authorizations of our management and members of ourboard of directors; and

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·       providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of our assets that could have a materialeffect on our financial statements.

Internal control over financial reporting cannotprovide absolute assurance of achieving financial reporting objectives becauseof its inherent limitations. Internal control over financial reporting is aprocess that involves human diligence and compliance and is subject to lapsesin judgment and breakdowns resulting from human failures. Internal control overfinancial reporting also can be circumvented by collusion or improper override.Because of such limitations, there is a risk that material misstatements maynot be prevented or detected on a timely basis by internal control overfinancial reporting. However, these inherent limitations are known features ofthe financial reporting process, and it is possible to design into the processsafeguards to reduce, though not eliminate, this risk.

Our management evaluated the effectiveness of ourinternal control over financial reporting as of December 31, 2006 usingthe framework set forth in the report of the Treadway Commission’s Committee ofSponsoring Organizations (COSO), “Internal Control—Integrated Framework.” Thescope of management’s evaluation excluded the Moscow Coke and Gas Plant, whichwe acquired in September 2006, as described in Frequently Asked QuestionNo. 3 (Oct. 6, 2004) regarding Release No. 34 47986,“Management’s Report on Internal Control Over Financial Reporting andCertification of Disclosure in Exchange Act Periodic Reports” (June 5,2003). Accordingly, management’s assessment of our internal control overfinancial reporting does not include internal control over financial reportingof Moscow Coke and Gas Plant, which represented 9.4% of our total assets and12.3% of our net assets at December 31, 2006, and generated 1.0% of ourtotal revenue and 7.0% of our net income during the year then ended.

As a result ofmanagement’s evaluation of our internal control over financial reporting,management  identified nine materialweaknesses in our internal control. These material weaknesses are describedbelow:

·       Wedid not maintain an effective monitoring function due to the lack of aneffective Internal Audit function;

·       Wedid not maintain effective controls over the segregation of duties at most ofour subsidiaries because we failed to complete the required analysis anddocumentation and at some of our foreign subsidiaries, certain personnel hadincompatible duties;

·       Wedid not have sufficient personnel with technical accounting and financialreporting expertise to sufficiently address relatively complex transactionsand/or accounting and financial reporting issues that arise from time to timein the course of our operations, as well as to meet periodic reportingrequirements;

·       Wedo not have an adequate system of internal controls over period-end financialreporting to ensure that the reporting packages received by the subsidiariesare properly reviewed at the subsidiary and corporate level, and that the U.S.GAAP transformation schedules and relatively complex and non-routine processesare properly completed and reviewed;

·       Wedid not maintain effective controls over the completeness and accuracy of thetax provision and deferred income tax balances in accordance with U.S. GAAP;

·       Wedid not properly establish, describe and test controls over the process ofidentification and evaluation based on applicable accounting literature oftax-related contingencies, including income taxes, mineral extraction tax andall relevant taxes levied by local and federal governmental authorities;

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·       Wedid not properly establish, document and test controls over the impairment ofgoodwill, other long-lived assets (*e.g*., property,plant and equipment and mineral reserves, among others) and equity investees;

·       Wedid not properly establish, document and test controls over the calculation ofasset retirement obligations; and

·       We did not establish,document and test controls over accounting for business acquisitions.

As a result of these material weaknesses, managementhas concluded that our internal control over financial reporting wasineffective as of December 31, 2006.

Management’s assessment ofthe effectiveness of our internal controls over financial reporting as ofDecember 31, 2006 has been audited by Ernst & Young LLC, anindependent registered public accounting firm, as stated in their report whichappears in this Annual Report on Form 20-F.

*AdditionalInformation Regarding the Material Weaknesses and Remediation Activities *

1)              *We did notmaintain an effective monitoring function due to the lack of an effectiveInternal Audit function.*

An effective monitoring function is one of theelements of the Entity Level Controls based on criteria established by the COSOframework. Although the Internal Audit function was established in late 2006,it did not operate during the year. This material weakness contributed to othermaterial weaknesses described below.

We have taken andcontinue to take steps to correct this material weakness. For example, weestablished the Internal Audit Department in 2006 and, in the beginning of2007, we hired and continue to seek and hire qualified personnel to work in ourInternal Audit Department. In 2007, our Audit Committee approved an Internal AuditPlan establishing the implementation of internal audits to be conducted duringthe year.

2)              *We did notmaintain effective controls over the segregation of duties at most of oursubsidiaries because we failed to complete the required analysis and documentationand at some of our foreign subsidiaries, certain personnel had incompatibleduties.*

In some of our foreign subsidiaries, certain personnelhad incompatible duties that allowed them to work independently of each otherwithout effective oversight, initiate and record transactions, prepare andreview financial data that was not subsequently reviewed. This materialweakness did not result in material adjustments to our consolidated financialstatements; however, it could result in material misstatements to ourconsolidated financial statements that would not be prevented or detected bythe existing system of internal controls.

In 2007, we plan toundertake and complete a full analysis of and document the segregation ofduties at all our subsidiaries. In addition, we plan to revise the reportingstructure and establish clear roles, responsibilities and accountability withineach of our subsidiaries in accordance with the Segregation of DutiesRegulations and COSO “InternalControl—Integrated Framework.”

3)              *We did nothave sufficient personnel with technical accounting and financial reportingexpertise to sufficiently address relatively complex transactions and/oraccounting and financial reporting issues that arise from time to time in thecourse of our operations, as well as to meet periodic reporting requirements.*

The lack of adequate accounting resources andexpertise was exacerbated by the additional demands placed upon our accountingand finance personnel as they worked to establish and maintain the internalcontrol over financial reporting requirements under Section 404 of theSarbanes-Oxley Act of 2002.

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We have taken andcontinue to take steps to correct this material weakness. We plan to increasestaffing in our International Reporting and Accounting Departments of oursubsidiaries with qualified personnel to address more effectively our complexaccounting and financial reporting requirements. In addition, inApril 2006, we began implementing an automated system designed totransform our statutory financial statements into U.S. GAAP financialstatements. An automated system will reduce time needed for routine tasks andwill allow overloaded personnel to pay more attention to complex accountingissues. This automated system is currently being tested, and we anticipate thatit will be fully implemented by the end of 2007.

4)              *We do nothave an adequate system of internal controls over period-end financialreporting to ensure that the reporting packages received by the subsidiariesare properly reviewed at the subsidiary and corporate level, and that the U.S.GAAP transformation schedules and relatively complex and non-routine processesare properly completed and reviewed.*

The inadequate system of internal controls overperiod-end financial reporting was aggravated by the lack of a unifiedautomated consolidation accounting and reporting system, and our lack ofeffective controls over the completeness, accuracy, validity and restrictedaccess over accounting software applications and spreadsheets supporting significantaccounting balances. As a result, numerous audit adjustments to theconsolidated financial statements were identified resulting from errors in theunderlying data or misapplication of accounting principles. The areas thatresulted in material adjustments are included elsewhere as separate materialweaknesses in this Item 15(b). Although the remaining adjustments were notmaterial, this material weakness could result in material misstatements to ourconsolidated financial statements that would not be prevented or detected byour existing system of internal controls.

As described above,we plan to put in place an automated process to support the transformation ofstatutory financial statements into U.S. GAAP financial statements by the endof 2007. In addition, we plan to improve the period-end financial reportingprocess by requiring all significant non-routine transactions to be reviewed byqualified accounting personnel to ensure that account reconciliations andanalyses for significant financial statement accounts are reviewed forcompleteness and accuracy. We also expect to implement a process that ensuresthe timely review and approval of complex accounting estimates by qualifiedaccounting personnel and subject matter experts, where appropriate, and todevelop better monitoring controls at the subsidiary and corporate levels.

5)              *We did notmaintain effective controls over the completeness and accuracy of the taxprovision and deferred income tax balances in accordance with U.S. GAAP.*

We do not have adequate controls over the review ofour subsidiaries’ tax registers and the manner by which the information fromthese registers is reported in our reporting packages. Reporting packages arestandard forms and spreadsheets submitted to our International ReportingDepartment by our subsidiaries and used for the preparation of U.S. GAAPconsolidated financial statements. We also have inadequate controls withrespect to the calculation of our deferred taxes, including, for example, theclassification of the difference between book and tax basis as temporary ornon-temporary, as well as the classification between deductible andnon-deductible expenses. In addition, we did not establish, describe and testcontrols related to the valuation of our deferred tax assets and, as a result,there were numerous audit adjustments involving our deferred taxes. Theseadjustments were not material either individually or in the aggregate.Nevertheless, this material weakness could result in material misstatements toour consolidated financial statements that would not be prevented or detectedby our existing system of internal controls.

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Management plans toscrutinize the process of calculating deferred taxes and intends to address allrelevant risks and controls with respect thereto. In addition, we aim toestablish a more robust review and approval process of our subsidiaries’ taxregisters.

6)              *We did notproperly establish, describe and test controls over the process ofidentification and evaluation based on applicable accounting literature oftax-related contingencies, including income taxes, mineral extraction tax andall relevant taxes levied by local and federal governmental authorities.*

This material weakness resulted in several adjustmentsto our consolidated financial statements, as well as to amounts and disclosuresof possible tax risks. Although these adjustments were not material eitherindividually or in the aggregate, this material weakness could result inmaterial misstatements to our consolidated financial statements, includingrequired disclosures, which would not be prevented or detected by our existingsystem of internal controls.

We have alreadystarted the process of identification and evaluation based on applicableaccounting literature of income tax-related contingencies. In addition, weintend to:

a)               implement newpolicies and procedures with respect to information gathering, identificationand evaluation of tax-related contingencies; and

b)              implementdescriptions and test controls over the identification and evaluation processbased on applicable accounting literature of tax-related contingencies.

7)              *We did notproperly establish, document and test controls over the impairment of goodwill,other long-lived assets (e.g., property, plant and equipment and mineralreserves, among others) and equity investees.*

The lack of these controls resulted in the untimelyidentification of assets to be tested for impairment. In addition, the analyseswe performed were not properly reviewed and contained numerous errors, resultingeither from the use of erroneous data or improper assumptions. This materialweakness did not result in material adjustments to our consolidated financialstatements. Nevertheless, this material weakness could result in materialmisstatements that would not be prevented or detected by our existing system ofinternal controls.

To correct thismaterial weakness, we plan to implement additional policies and procedures toensure the completeness and accuracy of incoming data used for the testing ofgoodwill, other long-lived assets (property, plant and equipment and mineralreserves, among others) and equity investees, for impairment. We also plan toimprove controls over the accuracy of impairment tests by reviewing theanalysis for completeness and accuracy by qualified personnel and experts,where appropriate, and developing better monitoring controls at the subsidiaryand corporate levels.

8)              *We did notproperly establish, document and test controls over the calculation of assetretirement obligations.*

The lack of relevant controls resulted in materialadjustments to the consolidated financial statements, involving an increase toour asset retirement obligations and respective property, plant and equipmentas of December 31, 2006, and the related expense for the year then ended.

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To correct thismaterial weakness, we plan to implement additional policies and procedures toensure the completeness and accuracy of incoming data used for calculatingasset retirement obligations and respective property, plant and equipmentamounts. We also plan to improve controls over the accuracy of asset retirementobligation and respective property, plant and equipment calculations byreviewing the appraiser’s report for completeness and accuracy by qualifiedpersonnel and experts, where appropriate, and developing better monitoringcontrols at the subsidiary and corporate levels.

9)              *We did notestablish, document and test controls over accounting for businessacquisitions.*

The lack of relevant controls resulted in materialadjustments to the consolidated financial statements related to deferred taxesarising from business combinations. We also made material adjustments to thevaluation amounts of such transactions not involving the exchange of cash, andto the date of one such business combination that occurred in 2006.

In order to remedythis material weakness, we intend to:

a)               formalize the duediligence process for major transactions, including, without limitation, thetax and legal due diligence process, and follow up our due diligence effortswith a formal accounting of the purchase price allocation;

b)              develop anaccounting checklist to ensure that we properly identify the effective date ofa business combination, the purchase price consideration and the relevant assetsacquired and liabilities assumed in a manner consistent with the requirement ofSFAS 141, “Business Combinations.” We also aim to develop effective andconsistent valuation methods and techniques to account for such businesscombinations; and

c)               establish a formalreview of the purchase price allocation to be performed by a person notinvolved in its preparation.

The material weaknesses identified by management inour internal control have been reported in the year ended December 31,2006. Notwithstanding the steps we have taken and continue to take that aredesigned to remedy each material weakness identified above, we may not besuccessful in remediating these material weaknesses in the near or long termand we may not be able to prevent other material weaknesses in the future. Inaddition, we performed additional analysis and other post-closing procedures toensure that the consolidated financial statements were prepared in accordancewith generally accepted accounting principles. Accordingly, our managementbelieves that the financial statements included in this report fairly presentin all material respects our financial position, results of operations and cashflows for the periods presented.

Ernst & YoungLLC, our independent registered public accounting firm, has issued anattestation report on management’s assessment of our internal control overfinancial reporting.

*(c)*     Report of IndependentRegistered Public Accounting Firm

Shareholders and the Board of Directors

Mechel OAO

We have audited management’s assessment, included inthe company’s Management’s Annual Report on Internal Control Over FinancialReporting, that Mechel OAO, an open joint stock company, and subsidiaries(hereinafter referred to as the “Group”) did not maintain effective internal controlover financial reporting as of December 31, 2006, because of the effect ofmaterial weaknesses in internal controls discussed below, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (the COSO criteria). TheGroup’s management is responsible for maintaining effective internal controlover financial reporting and 

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for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Group’s internal control over financial reporting based onour audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

A material weaknessis a control deficiency, or combination of control deficiencies, that resultsin more than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. The followingmaterial weaknesses have been identified and included in management’sassessment as of December 31, 2006:

1)     The Groupdid not maintain effective monitoring function, one of the elements of theEntity Level Controls, based on the criteria established by the COSO framework,because it lacked an effective Internal Audit function. The Internal Auditfunction was established late in 2006 and did not operate during the year. Thismaterial weakness contributed to other material weaknesses described below.

2)     The Groupdid not maintain effective controls over the segregation of duties, because itdid not complete its analysis and documentation over the segregation of dutiesat most subsidiaries. In some of the Group’s foreign subsidiaries, certainpersonnel had incompatible duties that allowed them to initiate and recordtransactions, prepare and review financial data without undergoing a subsequentreview or having effective oversight. This material weakness did not result inmaterial adjustments to the Group’s consolidated financial statements, however,this material weakness could result in material misstatements that would not beprevented or detected by the Group’s internal controls.

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3)     The Groupdid not have sufficient personnel with technical accounting and financialreporting expertise within its accounting function to sufficiently addressrelatively complex transactions and/or accounting and financial reportingissues that arise from time to time in the course of its operations, as well asmeet periodic reporting requirements. This situation was exacerbated by theadditional demands placed upon the Group’s accounting and finance personnel asit worked to meet the internal control testing and reporting requirements underSection 404 of the Sarbanes-Oxley Act of 2002.

4)     The Groupdoes not have an adequate system of internal controls over period end financialreporting to ensure that the reporting packages received by the subsidiaries areproperly reviewed at the subsidiary and Group level, and that the US GAAPtransformation schedules, and relatively complex and non-routine processes areproperly completed and reviewed. The situation was aggravated by the lack of aunified automated consolidation accounting and reporting system, and theGroup’s lack of effective controls over the completeness, accuracy, validityand restricted access over accounting software applications and spreadsheetssupporting significant accounting balances. As a result, numerous auditadjustments to the consolidated financial statements were identified resultingfrom errors in the underlying data or misapplication of accounting principles.The areas that resulted in material adjustments have been identified as separatematerial weaknesses in this audit opinion. The remaining adjustments were notmaterial, nevertheless, this material weakness could result in materialmisstatements to the Group’s consolidated financial statements that would notbe prevented or detected by the existing system of internal controls.

5)     The Groupdid not maintain effective controls over the completeness and accuracy of thetax provision and deferred income tax balances in accordance with accountingprinciples generally accepted in the United States. Specifically, the Groupdoes not have adequate controls over the review of subsidiaries’ tax registersand the manner by which the information from these registers is reported in theGroup’s reporting packages. Inadequate controls were also noted within thecalculation of deferred taxes, for example classification of differencesbetween book and tax basis as temporary and non-temporary, and classificationbetween deductible and non-deductible expenses. Finally, the Group did notestablish, describe and test controls related to the valuation of its deferredtax assets. As a result there were numerous audit adjustments in the area ofdeferred taxes. These adjustments were not material either individually or inaggregate, nevertheless, this material weakness could result in materialmisstatements to the Group’s consolidated financial statements that would notbe prevented or detected by the existing system of internal controls.

6)     The Groupdid not properly establish, describe and test controls over the process ofidentification and evaluation based on applicable accounting literature of taxrelated contingencies, including income taxes, mineral extraction tax, and allrelevant taxes levied by local and federal governmental authorities. Thismaterial weakness resulted in several adjustments in the Group’s consolidatedfinancial statements as well as to adjustments of amounts and disclosures ofpossible tax risks. These adjustments were not material either individually orin aggregate, nevertheless, this material weakness could result in materialmisstatements to the Group’s consolidated financial statements, includingrequired disclosures, which would not be prevented or detected by the existingsystem of internal controls.

7)     The Groupdid not properly establish, document and test controls over impairment ofgoodwill, other long-lived assets (property, plant and equipment, mineralreserves, and other), and equity investees. Lack of these controls resulted inuntimely identification of assets to be tested for impairment; analysesperformed contained numerous errors, resulting either from erroneous data usedor improper assumptions, and were not properly reviewed. This material weaknessdid not result in material adjustments to the Group’s consolidated financialstatements, however, this material weakness could result in materialmisstatements that would not be prevented or detected by the Group’s internalcontrols.

163

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8)     The Groupdid not properly establish, document and test controls over the calculation of assetretirement obligations. Lack of relevant controls resulted in materialadjustments to the consolidated financial statements to increase the Group’sasset retirement obligations and respective property, plant and equipment as ofDecember 31, 2006 and the related expense for the year then ended.

9)     The Groupdid not establish, document and test controls over accounting for the businessacquisition process. Lack of relevant controls resulted in material adjustmentsto the consolidated financial statements related to deferred taxes arising frombusiness combinations, the valuation of transactions not involving exchange ofcash, and determination of the appropriate date of the business combinationwhich incurred in 2006.

The material weaknesses above were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the fiscal year 2006 consolidated financial statements of the Group, andthis report does not affect our report dated June 27, 2007, on thoseconsolidated financial statements.

As indicated in the Group’s Management’s Annual Reporton Internal Control Over Financial Reporting, management’s assessment of andconclusion on the effectiveness of internal control over financial reportingdid not include the internal controls of Moscow Coke and Gas Plant, which wasacquired in September 2006 and is included in the 2006 consolidatedfinancial statements of the Group and constituted, $416,325,000 and$352,372,000 of total and net assets, respectively, as of December 31, 2006and $44,792,000 and $42,168,000 of revenues and net income, respectively, forthe year then ended. Our audit of internal control over financial reporting ofthe Group also did not include an evaluation of the internal control overfinancial reporting of Moscow Coke and Gas Plant.

In our opinion,management’s assessment that the Group did not maintain effective internalcontrol over financial reporting as of December 31, 2006, is fairlystated, in all material respects, based on the COSO criteria. Also, in ouropinion, because of the effect of the material weaknesses described above onthe achievement of the objectives of the control criteria, the Group has notmaintained effective internal control over financial reporting as ofDecember 31, 2006 based on the COSO criteria.

/s/ ERNST & YOUNG LLCJune 27, 2007Moscow, Russia

*(d)*    Changes in Internal Controlover Financial Reporting

Management has evaluated,with the participation of our chief executive officer and chief financialofficer, whether any changes in our internal control over financial reportingthat occurred during the period covered by this annual report have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting. Based on the evaluation we conducted, management hasconcluded that no such changes have occurred. However, management believes themeasures that have been implemented to remediate the material weaknesses havehad a material impact on our internal control over financial reporting sinceDecember 31, 2006, and anticipates that these measures and other ongoingenhancements will continue to have a material impact on our internal controlover financial reporting in future periods.

***Item16A.***           AuditCommittee Financial Expert

Our Board of Directors hasdetermined that Roger Gale, chairman of our audit committee, is an “auditcommittee financial expert.” Mr. Gale is independent in accordance withSEC Rule 10A-3.

164

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***Item16B.***           Codeof Ethics

We have adopted a code ofbusiness conduct and ethics that applies to our directors, officers andemployees. It is available at www.mechel.com and www.mechel.ru.

***Item16C.***          PrincipalAccountant Fees and Services

Ernst &Young LLC has served as our independent registered public accountants for eachof the fiscal years in the three-year period ended December 31, 2006, forwhich audited financial statements appear in this Annual Report on Form 20-F.The following table presents the aggregate fees for professional services andother services rendered by Ernst & Young LLC in 2006 and 2005,respectively.

| ** **          | ** ** | **Year ended  December 31,**            | ** ** |
|---------------------|------------|---------------------------------------------------|------------|
| ** **          | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **          | ** ** | **(in thousand of  U.S. dollars)** | ** ** |
| Audit Fees          |       | $                                                 | 5,026.3    |   | $ | 4,693.3 |   |
| Audit-Related  Fees |       | $                                                 | 2,750.0    |   | — |   |
| Tax Fees            |       | —                                            |       | — |   |
| All Other Fees      |       | $                                                 | 310.0      |   | $ | 7.1 |   |
| Total               |       | $                                                 | 8,086.3    |   | $ | 4,700.4 |   |

 

**Audit fees**

The amount of audit feesincludes fees necessary to perform an audit or interim review in accordancewith the standards of the Public Company Accounting Oversight Board (UnitedStates) and services that generally only the independent auditor can reasonablyprovide, such as comfort letters, statutory audits, attest services, consentsand assistance with, and review of, documents filed with the SEC.

**Audit-relatedfees**

This category includesassurance and related services that are typically performed by the independentauditor. More specifically, these services included, among others, employeebenefit plan audits, accounting assistance in connection with proposed orconsummated transactions and consultation concerning financial accounting andreporting standards. Audit-related fees charged to us in 2006 related to aninternal control audit.

**Tax fees**

Tax services include,among others, tax consultation related to proposed and consummatedtransactions, restructuring, personal taxation and general tax consultation.

**Other fees**

Other fees include, amongother things, fees for the allowable assistance with implementingSection 404 and performing ongoing quality assurance of the accounting andreporting system implementation project, and internal staff training fees inconnection with the first time adoption and application of FIN 48.

**Audit CommitteePre-Approval Policies and Procedures**

The Sarbanes-OxleyAct of 2002 required that we implement a pre-approval process for allengagements with our independent public accountants. In compliance withSarbanes-Oxley requirements pertaining to auditor independence, our AuditCommittee pre-approves the engagement terms and fees of 

165

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Ernst &Young LLC for all audit and non-audit services, including tax services.All audit and tax services rendered by Ernst & Young LLC in 2006 wereapproved by the Audit Committee before Ernst & Young LLC was engagedfor such services. No services of any kind were approved pursuant to a waiverpermitted pursuant to 17 CFR 210.2-01(c)(7)(i)(C).

***Item16D.****         *Exemptionsfrom the Listing Standards for Audit Committees

None.

***Item16E.***          Purchasesof Equity Securities by the Issuer and Affiliated Purchasers

We did not repurchase any shares or ADSs in 2006.

166

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**PART III**

***Item17.***                   FinancialStatements

See instead “Item 18.Financial Statements.”

***Item18.***                   FinancialStatements

Thefollowing financial statements, together with the report of Ernst &Young LLC, are filed as part of this annual report on Form 20-F.
| Index to Consolidated  Financial Statements                                                                                 |   | F-1 |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-----|
| Report of Independent  Registered Public Accounting Firm                                                                    |   | F-2 |
| Consolidated Balance Sheets as of  December 31, 2006 and 2005                                                          |   | F-3 |
| Consolidated Income Statements  for the years ended December 31, 2006, 2005 and 2004                                   |   | F-4 |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2006, 2005 and 2004                            |   | F-5 |
| Consolidated Statements of  Changes in Shareholders’ Equity for the years ended December 31, 2006,  2005 and 2004 |   | F-7 |
| Notes to the  Consolidated Financial Statements                                                                             |   | F-8 |

 

***Item 19.***                   Exhibits
| Exhibit No. | ** ** | ** **                                                                                                                                                        | **Description** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|
| 1.1              |       | Charter of Mechel OAO (new version) registered on  February 20, 2007                                                                                         |
| 8.1              |       | Subsidiaries of Mechel                                                                                                                                            |
| 12.1             |       | Certification by the Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                      |
| 12.2             |       | Certification by the Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                      |
| 13.1             |       | Certification of the Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |
| 13.2             |       | Certification of the Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

167

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**SIGNATURES**

Theregistrant hereby certifies that it meets all of the requirements for filing onForm 20-F and that it has duly caused and authorized the undersignedto sign this annual report on its behalf.
|                         | MECHEL  OAO |
|-------------------------|-------------|
|                    | By:         | /s/ IGOR V. ZYUZIN |
|                    | Name:       | Igor V. Zyuzin |
|                    | Title:      | *Chief Executive Officer* |
| Date: July 2, 2007 | * *    |

 

168

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**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

| **REPORT  OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING  FIRM**                                                                     |   | F-2 |
|------------------------------------------------------------------------------------------------------------------------------------|--------|-----|
| **CONSOLIDATED BALANCE SHEETS  AS  OF DECEMBER 31,  2006 AND 2005**                                                           |   | F-3 |
| **CONSOLIDATED INCOME STATEMENTS  FOR  THE YEARS ENDED DECEMBER 31,  2006,  2005 AND 2004**                              |   | F-4 |
| **CONSOLIDATED STATEMENTS  OF CASH FLOWS  FOR  THE  YEARS ENDED DECEMBER 31,  2006, 2005 AND 2004**                 |   | F-5 |
| **CONSOLIDATED STATEMENTS  OF CHANGES  IN SHAREHOLDERS’ EQUITY  FOR  THE YEARS  ENDED DECEMBER 31, 2006, 2005 AND 2004** |   | F-7 |
| **NOTES  TO  THE CONSOLIDATED FINANCIAL  STATEMENTS**                                                                              |   | F-8 |

 

F-1

----

| **** | ** ** | **** |
|------|------------|------|

 

**Report ofIndependent Registered Public Accounting**Firm

Shareholders and the Board of DirectorsMechel OAO

We have audited the accompanying consolidated balancesheets of Mechel OAO, an open joint stock company, and subsidiaries(hereinafter referred to as the “Group”) as of December 31, 2006 and 2005,and the related consolidated statements of income, shareholders’ equity, andcash flows for each of the three years in the period ended December 31,2006. These financial statements are the responsibility of the Group’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

As more fully described in Note 3(g) to theconsolidated financial statements, the value of property, plant, and equipmentpertaining to non-controlling shareholders in the accounting for minorityinterests resulting from acquisitions of various subsidiaries has been recordedat appraised values rather than at historical cost as required by accountingprinciples generally accepted in the United States.

In our opinion, except for the effects of the matterdiscussed in the preceding paragraph, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of the Group at December 31, 2006 and 2005, and the consolidatedresults of its operations and its cash flows for each of the three years in theperiod ended December 31,2006, in conformity with accounting principles generally accepted in the UnitedStates.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of the Group’s internal controls overfinancial reporting as of December 31, 2006, based on criteria establishedin Internal Control-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated June 27, 2007expressed an unqualified opinion on management’s assessment, and an adverseopinion on the effectiveness of internal control over financial reporting.
| /s/ Ernst & Young |
|----------------------------|

June 27, 2007Moscow, Russia

F-2

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**MECHEL OAO (formerly Mechel Steel Group OAO)**CONSOLIDATED BALANCESHEETS (in thousands of U.S. dollars,except share amounts)

| ** **                                                                                                                                                                                             | ** ** | **Notes**  | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** **    |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|---------------|
| **ASSETS**                                                                                                                                                                                             |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                             | ** ** | ** ** | **4**      | ** **                  | ** ** | ** **                  | **$**         | **172,614** |   |   |   | $ | 311,775 |   |   |
| Trading securities                                                                                                                                                                                     | ** ** | ** ** | **8**      |                        | ** ** | ** **                  | **270,964**   |   |   |   | — |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $19,592 in 2006 and  $17,509 in 2005                                                                                              | ** ** | ** ** | **5**      |                        | ** ** | ** **                  | **191,172**   |   |   |   | 140,649 |   |   |
| Due from related  parties                                                                                                                                                                              | ** ** | ** ** | **10**     |                        | ** ** | ** **                  | **545**       |   |   |   | 4,455 |   |   |
| Inventories                                                                                                                                                                                            | ** ** | ** ** | **6**      |                        | ** ** | ** **                  | **653,079**   |   |   |   | 496,658 |   |   |
| Deferred cost of  inventory in transit                                                                                                                                                                 | ** ** | ** ** | **3**      | **(r)**                     | ** ** | ** **                  | **14,125**    |   |   |   | 49,893 |   |   |
| Current assets of  discontinued operations                                                                                                                                                             | ** ** | ** ** | **2**      | **(k)**                     | ** ** | ** **                  | **9**         |   |   |   | 88 |   |   |
| Deferred income  taxes                                                                                                                                                                                 | ** ** | ** ** | **20**     |                        | ** ** | ** **                  | **7,922**     |   |   |   | 8,965 |   |   |
| Prepayments and  other current assets                                                                                                                                                                  | ** ** | ** ** | **7**      |                        | ** ** | ** **                  | **324,600**   |   |   |   | 347,000 |   |   |
| Total current  assets                                                                                                                                                                                  |       |       |       |                        | ** ** | ** **                  | **1,635,030** |   |   |   | 1,359,483 |   |   |
| Long-term  investments in related parties                                                                                                                                                              | ** ** | ** ** | **9**      |                        | ** ** | ** **                  | **429,206**   |   |   |   | 408,708 |   |   |
| Other long-term  investments                                                                                                                                                                           | ** ** | ** ** | **9**      |                        | ** ** | ** **                  | **44,392**    |   |   |   | 16,148 |   |   |
| Non-current assets  of discontinued operations                                                                                                                                                         | ** ** | ** ** | **2**      | **(k)**                     | ** ** | ** **                  | **108**       |   |   |   | 97 |   |   |
| Intangible assets,  net                                                                                                                                                                                | ** ** | ** ** | **11**     |                        | ** ** | ** **                  | **4,746**     |   |   |   | 7,590 |   |   |
| Property, plant  and equipment, net                                                                                                                                                                    | ** ** | ** ** | **12**     |                        | ** ** | ** **                  | **2,012,828** |   |   |   | 1,508,984 |   |   |
| Mineral licenses,  net                                                                                                                                                                                 | ** ** | ** ** | **13**     |                        | ** ** | ** **                  | **269,851**   |   |   |   | 242,006 |   |   |
| Deferred income  taxes                                                                                                                                                                                 | ** ** | ** ** | **20**     |                        | ** ** | ** **                  | **6,983**     |   |   |   | 17,487 |   |   |
| Goodwill                                                                                                                                                                                               | ** ** | ** ** | **2**      | **(l)**                     | ** ** | ** **                  | **45,914**    |   |   |   | 39,580 |   |   |
| **Total  assets**                                                                                                                                                                                      |       |       |       | ** **                  | ** ** | ** **                  | **$**         | **4,449,058** |   |   |   | $ | 3,600,083 |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                          |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Short-term  borrowings and current portion of long-term debt                                                                                                                                           | ** ** | ** ** | **14**     | ** **                  | ** ** | ** **                  | **$**         | **166,517** |   |   |   | $ | 389,411 |   |   |
| Accounts payable and accrued expenses:                                                                                                                                                                 |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Advances received                                                                                                                                                                                      |       |       |       |                        | ** ** | ** **                  | **88,278**    |   |   |   | 47,369 |   |   |
| Accrued expenses  and other current liabilities                                                                                                                                                        |       |       |       |                        | ** ** | ** **                  | **84,632**    |   |   |   | 79,405 |   |   |
| Taxes and social  charges payable                                                                                                                                                                      | ** ** | ** ** | **15**     |                        | ** ** | ** **                  | **143,037**   |   |   |   | 144,715 |   |   |
| Trade payable to  vendors of goods and services                                                                                                                                                        |       |       |       |                        | ** ** | ** **                  | **183,485**   |   |   |   | 210,228 |   |   |
| Due to related  parties                                                                                                                                                                                | ** ** | ** ** | **10**     |                        | ** ** | ** **                  | **2,353**     |   |   |   | 2,935 |   |   |
| Current  liabilities of discontinued operations                                                                                                                                                        | ** ** | ** ** | **2**      | **(k)**                     | ** ** | ** **                  | **508**       |   |   |   | 109 |   |   |
| Asset retirement  obligation, current portion                                                                                                                                                          | ** ** | ** ** | **16**     |                        | ** ** | ** **                  | **3,444**     |   |   |   | 4,236 |   |   |
| Deferred income  taxes                                                                                                                                                                                 | ** ** | ** ** | **20**     |                        | ** ** | ** **                  | **58,820**    |   |   |   | 26,557 |   |   |
| Deferred revenue                                                                                                                                                                                       | ** ** | ** ** | **3**      | **(r)**                     | ** ** | ** **                  | **7,183**     |   |   |   | 55,267 |   |   |
| Pension  obligations, current portion                                                                                                                                                                  | ** ** | ** ** | **17**     |                        | ** ** | ** **                  | **11,044**    |   |   |   | 8,189 |   |   |
| Finance lease  liabilities, current portion                                                                                                                                                            | ** ** | ** ** | **18**     |                        | ** ** | ** **                  | **6,066**     |   |   |   | 887 |   |   |
| Total current  liabilities                                                                                                                                                                             |       |       |       |                        | ** ** | ** **                  | **755,367**   |   |   |   | 969,308 |   |   |
| Long-term debt,  net of current portion                                                                                                                                                                | ** ** | ** ** | **14**     |                        | ** ** | ** **                  | **322,604**   |   |   |   | 45,615 |   |   |
| Restructured taxes  and social charges payable, net of current portion                                                                                                                                 | ** ** | ** ** | **15**     |                        | ** ** | ** **                  | **7,782**     |   |   |   | 33,866 |   |   |
| Asset retirement  obligations, net of current portion                                                                                                                                                  | ** ** | ** ** | **16**     |                        | ** ** | ** **                  | **88,914**    |   |   |   | 54,816 |   |   |
| Pension  obligations, net of current portion                                                                                                                                                           | ** ** | ** ** | **17**     |                        | ** ** | ** **                  | **59,170**    |   |   |   | 43,510 |   |   |
| Deferred income  taxes                                                                                                                                                                                 | ** ** | ** ** | **20**     |                        | ** ** | ** **                  | **136,154**   |   |   |   | 105,481 |   |   |
| Finance lease  liabilities, net of current portion                                                                                                                                                     | ** ** | ** ** | **18**     |                        | ** ** | ** **                  | **51,068**    |   |   |   | 9,179 |   |   |
| Commitments and  contingencies                                                                                                                                                                         | ** ** | ** ** | **25**     |                        |       |                        |          |   |   |   |   |   |   |
| Minority interests                                                                                                                                                                                     | ** ** | ** ** | **2**      | **(m)**                     | ** ** | ** **                  | **163,036**   |   |   |   | 127,834 |   |   |
| **SHAREHOLDERS’ EQUITY**                                                                                                                                                                          |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Common shares (10  Russian rubles par value; 497,969,086 shares authorized, 416,270,745 shares issued and  416,270,745 and 403,118,680 shares outstanding as of December 31, 2006 and  2005) | ** ** | ** ** | **19**     |                        | ** ** | ** **                  | **133,507**   |   |   |   | 133,507 |   |   |
| Treasury shares,  at cost (13,152,065 common shares as of December 31, 2005)                                                                                                                      |       |       |       |                        | ** ** | ** **                  | **—**    |   |   |   | (4,187 | ) |   |
| Additional paid-in  capital                                                                                                                                                                            |       |       |       |                        | ** ** | ** **                  | **412,327**   |   |   |   | 321,864 |   |   |
| Accumulated other  comprehensive income                                                                                                                                                                |       |       |       |                        | ** ** | ** **                  | **188,218**   |   |   |   | 42,046 |   |   |
| Retained earnings                                                                                                                                                                                      |       |       |       |                        | ** ** | ** **                  | **2,130,911** |   |   |   | 1,717,244 |   |   |
| Total  shareholders’ equity                                                                                                                                                                       |       |       |       |                        | ** ** | ** **                  | **2,864,963** |   |   |   | 2,210,474 |   |   |
| **Total  liabilities and shareholders’ equity**                                                                                                                                                   |       |       |       | ** **                  | ** ** | ** **                  | **$**         | **4,449,058** |   |   |   | $ | 3,600,083 |   |   |

 

See accompanying notes to consolidated financial statements

F-3

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**MECHEL OAO (formerly Mechel Steel Group OAO)** CONSOLIDATED INCOME STATEMENTS (in thousands of U.S. dollars,except share and per share amounts)

| ** **                                                                                                                      | ** ** | ** ** | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                      | ** ** | **Notes**  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue, net (including related party amounts of  $66,998, $65,431 and $68,806 during 2006, 2005 and 2004, respectively)   | ** ** |       | ** ** | ** **                                 |       | **$** | **4,397,811** | ** ** | $ | 3,804,995 |   | $ | 3,635,955 |   |
| Cost of goods sold (including related party amounts  of $142,959, $73,829 and $12,334 during 2006, 2005 and 2004, respectively) | ** ** |       | ** ** | ** **                                 |       | **(2,868,564** | **)** | (2,469,134 | ) | (2,225,088 | ) |
| Gross profit                                                                                                                    | ** ** |       | ** ** | ** **                                 |       | **1,529,247** |   | 1,335,861 |   | 1,410,867 |   |
| Selling,  distribution and operating expenses:                                                                                  |       |       | ** ** | ** **                                 |       |   |   |   |   |   |   |
| Selling and distribution expenses                                                                                               | ** ** |       | ** ** | ** **                                 |       | **(418,901** | **)** | (450,238 | ) | (367,514 | ) |
| Taxes other than income tax                                                                                                     | ** ** |       | **21**     | ** **                                 |       | **(82,140** | **)** | (90,683 | ) | (69,285 | ) |
| Accretion expense                                                                                                               | ** ** |       | **16**     | ** **                                 |       | **(7,433** | **)** | (3,248 | ) | (2,081 | ) |
| Loss on write-off of property, plant and equipment                                                                              | ** ** |       | **3**      | **(l)**                                    |       | **(2,418** | **)** | (12,667 | ) | — |   |
| (Provision for) recovery of doubtful accounts                                                                                   | ** ** |       | **5**      | ** **                                 |       | **(2,722** | **)** | (3,569 | ) | 7,859 |   |
| General, administrative and other operating expenses                                                                            | ** ** |       | **22**     | ** **                                 |       | **(289,935** | **)** | (259,728 | ) | (229,039 | ) |
| Total selling, distribution and operating expenses                                                                              | ** ** |       | ** ** | ** **                                 |       | **(803,549** | **)** | (820,133 | ) | (660,060 | ) |
| Operating income                                                                                                                | ** ** |       | ** ** | ** **                                 |       | **725,698** |   | 515,728 |   | 750,807 |   |
| *Other  income and (expense):*                                                                                                  |       |       | ** ** | ** **                                 |       |   |   |   |   |   |   |
| (Loss) income from equity investments                                                                                           | ** ** |       | **9**      | ** **                                 |       | **(9,858** | **)** | 12,426 |   | 4,621 |   |
| Interest income                                                                                                                 | ** ** |       | ** ** | ** **                                 |       | **8,314** |   | 10,049 |   | 2,375 |   |
| Interest expense                                                                                                                | ** ** |       | ** ** | ** **                                 |       | **(38,183** | **)** | (40,829 | ) | (51,409 | ) |
| Gain on revaluation of trading securities                                                                                       | ** ** |       | ** ** | ** **                                 |       | **50,688** |   | — |   | — |   |
| Other income, net                                                                                                               | ** ** |       | **23**     | ** **                                 |       | **69,401** |   | 65,920 |   | 836,817 |   |
| Foreign exchange gain (loss)                                                                                                    | ** ** |       | ** ** | ** **                                 |       | **58,773** |   | (37,435 | ) | 1,884 |   |
| Total other income and (expense), net                                                                                           | ** ** |       | ** ** | ** **                                 |       | **139,135** |   | 10,131 |   | 794,288 |   |
| Income before income tax, minority interest,  discontinued operations and extraordinary gain                               | ** ** |       | ** ** | ** **                                 |       | **864,833** |   | 525,859 |   | 1,545,095 |   |
| Income tax expense                                                                                                              | ** ** |       | **20**     | ** **                                 |       | **(230,599** | **)** | (136,643 | ) | (175,776 | ) |
| Minority interest in income of subsidiaries                                                                                     | ** ** |       | **2**      | **(m)**                                    |       | **(31,528** | **)** | (6,879 | ) | (11,673 | ) |
| Income from continuing operations                                                                                               | ** ** |       | ** ** | ** **                                 |       | **602,706** |   | 382,337 |   | 1,357,646 |   |
| Income (loss) from discontinued operations, net of  tax                                                                         | ** ** |       | **2**      | **(k)**                                    |       | **543** |   | (1,157 | ) | (15,211 | ) |
| Extraordinary gain, net of tax                                                                                                  | ** ** |       | **2**      | **(m)**                                    |       | **—** |   | — |   | 271 |   |
| **Net income**                                                                                                                  | ** ** |       | ** ** | ** **                                 |       | **$** | **603,249** |   | $ | 381,180 |   | $ | 1,342,706 |   |
| Currency translation adjustment                                                                                                 | ** ** |       | ** ** | ** **                                 |       | **148,920** |   | (53,822 | ) | 49,116 |   |
| Adjustment of available-for-sale securities                                                                                     | ** ** |       | ** ** | ** **                                 |       | **11,203** |   | 2,181 |   | (2,350 | ) |
| Additional minimum pension liability                                                                                            | ** ** |       | **17**     | ** **                                 |       | **(4,669** | **)** | — |   | — |   |
| **Comprehensive income**                                                                                                        | ** ** |       | ** ** | ** **                                 |       | **$** | **758,703** |   | $ | 329,539 |   | $ | 1,389,472 |   |
| Basic and diluted earnings per share:                                                                                           | ** ** |       | **19**     | ** **                                 |       | ** ** |   |   |   |   |   |
| Earnings per share from continuing operations                                                                                   | ** ** |       | ** ** | ** **                                 |       | **$** | **1.48** |   | $ | 0.95 |   | $ | 3.63 |   |
| Loss per share effect of discontinued operations                                                                                | ** ** |       | ** ** | ** **                                 |       | **(0.00** | **)** | (0.00 | ) | (0.04 | ) |
| Earnings per share effect of extraordinary gain                                                                                 | ** ** |       | ** ** | ** **                                 |       | **0.00** |   | 0.00 |   | 0.00 |   |
| **Net income per share**                                                                                                        | ** ** |       | ** ** | ** **                                 |       | **$** | **1.48** |   | $ | 0.95 |   | $ | 3.59 |   |
| **Weighted  average number of shares outstanding**                                                                              | ** ** |       | ** ** | ** **                                 |       | **$** | **408,979,356** |   | $ | 403,118,680 |   | $ | 373,971,312 |   |

 

See accompanying notes to consolidated financial statements

F-4

----

**MECHEL OAO (formerly Mechel Steel Group OAO)Consolidated Statements of Cash Flows (in thousands of U.S. dollars)**

| ** **                                                                                     | ** ** | ** ** | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                                                                     | ** ** | **Notes**  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ***Cash Flows from Operating  Activities***                                                    | ** ** |       | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                     |       |       | ** ** | ** **                                 | ** ** | **$** | **603,249** | ** ** | $ | 381,180 |   | $ | 1,342,706 |   |
| *Adjustments to reconcile net income to net cash  provided  by operating activities:*          |       |       | ** ** | ** **                                 | ** ** | ** ** | ** ** |   |   |   |   |
| Depreciation                                                                                   |       |       | ** ** | ** **                                 | ** ** | **177,303** | ** ** | 147,117 |   | 120,444 |   |
| Depletion and  amortization                                                                    |       |       | ** ** | ** **                                 | ** ** | **18,924** | ** ** | 20,483 |   | 17,376 |   |
| Foreign exchange (gain)  loss                                                                  |       |       | ** ** | ** **                                 | ** ** | **(58,773** | **)** | 37,435 |   | (1,884 | ) |
| Deferred income taxes                                                                          |       |       | ** ** | ** **                                 | ** ** | **22,299** | ** ** | (12,535 | ) | (11,217 | ) |
| Provision for (recovery  of) doubtful accounts                                                 |       |       | ** ** | ** **                                 | ** ** | **2,722** | ** ** | 3,569 |   | (7,859 | ) |
| Inventory write-down                                                                           |       |       | ** ** | ** **                                 | ** ** | **525** | ** ** | 5,938 |   | 2,183 |   |
| Accretion expense                                                                              |       |       | ** ** | ** **                                 | ** ** | **7,433** | ** ** | 3,248 |   | 2,081 |   |
| Loss on write-off of  property, plant and equipment                                            |       |       | ** ** | ** **                                 | ** ** | **2,418** | ** ** | 12,667 |   | — |   |
| Minority interest                                                                              |       |       | ** ** | ** **                                 | ** ** | **31,528** | ** ** | 6,879 |   | 11,673 |   |
| Gain on revaluation of  trading securities                                                     |       |       | ** ** | ** **                                 | ** ** | **(50,688** | **)** | — |   | — |   |
| Change in undistributed  earnings of equity investments                                        |       |       | ** ** | ** **                                 | ** ** | **17,426** | ** ** | (10,426 | ) | (4,621 | ) |
| Non-cash interest on  long-term tax and pension liabilities                                    |       |       | ** ** | ** **                                 | ** ** | **6,173** | ** ** | 13,749 |   | 11,425 |   |
| Loss on sale of  property, plant and equipment                                                 |       |       | ** ** | ** **                                 | ** ** | **1,320** | ** ** | 1,801 |   | 5,736 |   |
| Loss (gain) on sale of  long-term investments                                                  |       |       | ** ** | ** **                                 | ** ** | **5,047** | ** ** | (2,743 | ) | (803,405 | ) |
| Gain on discharged asset  retirement obligations                                               |       |       | ** ** | ** **                                 | ** ** | **(2,112** | **)** | — |   | — |   |
| (Income) loss from  discontinued operations                                                    |       |       | ** ** | ** **                                 | ** ** | **(543** | **)** | 1,157 |   | 15,211 |   |
| Gain on accounts payable  with expired legal term                                              | ** ** |       | **23**     | ** **                                 | ** ** | **(843** | **)** | (23,347 | ) | (1,250 | ) |
| Gain on forgiveness of  fines and penalties                                                    | ** ** |       | **23**     | ** **                                 | ** ** | **(69,767** | **)** | (38,383 | ) | (18,296 | ) |
| Stock-based compensation  expense                                                              |       |       | ** ** | ** **                                 | ** ** | **260** | ** ** | — |   | 1,400 |   |
| Amortization of  capitalized costs on bonds issue                                              |       |       | ** ** | ** **                                 | ** ** | **673** | ** ** | 1,553 |   | 1,525 |   |
| Pension service cost and  amortization of prior year  service cost                             |       |       | ** ** | ** **                                 | ** ** | **3,510** | ** ** | 2,511 |   | 2,187 |   |
| Extraordinary gain                                                                             |       |       | ** ** | ** **                                 | ** ** | **—** | ** ** | — |   | (271 | ) |
| Net change before changes in working capital                                                   |       |       | ** ** | ** **                                 | ** ** | **718,084** | ** ** | 551,853 |   | 685,144 |   |
| *Changes in working capital items, net of effects  from acquisition of new subsidiaries:* |       |       | ** ** | ** **                                 | ** ** | ** ** | ** ** |   |   |   |   |
| Accounts receivable                                                                            |       |       | ** ** | ** **                                 | ** ** | **(9,004** | **)** | 23,602 |   | (2,831 | ) |
| Inventories                                                                                    |       |       | ** ** | ** **                                 | ** ** | **(159,103** | **)** | 14,614 |   | (170,726 | ) |
| Trade payable to vendors  of goods and services                                                |       |       | ** ** | ** **                                 | ** ** | **(47,940** | **)** | 60,087 |   | (1,305 | ) |
| Advances received                                                                              |       |       | ** ** | ** **                                 | ** ** | **35,128** | ** ** | (46,269 | ) | 4,902 |   |
| Accrued taxes and other  liabilities                                                           |       |       | ** ** | ** **                                 | ** ** | **24,715** | ** ** | 14,868 |   | 4,176 |   |
| Settlements with related  parties                                                              |       |       | ** ** | ** **                                 | ** ** | **3,430** | ** ** | 12,658 |   | 1,253 |   |
| Current assets and  liabilities of discontinued operations                                     |       |       | ** ** | ** **                                 | ** ** | **(187** | **)** | 57 |   | (4,134 | ) |
| Deferred revenue and  cost of inventory in transit, net                                        |       |       | ** ** | ** **                                 | ** ** | **(12,316** | **)** | 4,624 |   | (22,607 | ) |
| Other current assets                                                                           |       |       | ** ** | ** **                                 | ** ** | **2,116** | ** ** | (15,219 | ) | (197,735 | ) |
| Net cash provided by  operating activities                                                     |       |       | ** ** | ** **                                 | ** ** | **554,923** | ** ** | 620,875 |   | 296,137 |   |
|                                                                                                |            |            |            |                                            |            |  |  |  |  |  |  |  |  |  |

 

F-5

----

**MECHEL OAO (formerly Mechel Steel Group OAO)Consolidated Statements of Cash Flows(Continued) (in thousands of U.S. dollars, exceptshare amounts)**

| ** **                                                                                                        | ** **   | ** **   | ** **   | **Year ended December 31,** | ** **   |
|-------------------------------------------------------------------------------------------------------------------|--------------|--------------|--------------|--------------------------------------------|--------------|
| ** **                                                                                                        | ** **   | **Notes**    | ** **   | **2006**                                   | ** **   | **2005** | ** ** | **2004** | ** ** |
| ***Cash Flows from Investing  Activities***                                                                       |         |         | ** **   | ** **                                 | ** **   | ** ** | ** ** |   |   |   |   |
| Acquisition of  subsidiaries, less cash acquired                                                                  |         |         | ** **   | ** **                                 | ** **   | **(2,153** | **)** | (3,497 | ) | — |   |
| Acquisition of minority  interest in subsidiaries                                                                 | ** **   |         | **2**        | **(m)**                                    | ** **   | **(4,016** | **)** | (73,936 | ) | (37,021 | ) |
| Acquisition of Moscow  Coke and Gas Plant                                                                         | ** **   |         | **2**        | **(j)**                                    | ** **   | **(156,474** | **)** | — |   | — |   |
| Investment in Yakutugol                                                                                           | ** **   |         | **2**        | **(f)**                                    | ** **   | **—** | ** ** | (411,182 | ) | — |   |
| Acquisition of Izhstal                                                                                            |         |         | ** **   | ** **                                 | ** **   | **—** | ** ** | — |   | (22,742 | ) |
| Acquisition of Port  Posiet                                                                                       |         |         | ** **   | ** **                                 | ** **   | **—** | ** ** | — |   | (29,966 | ) |
| Acquisition of Kaslinsky  Architectural Casting Plant                                                             |         |         | ** **   | ** **                                 | ** **   | **—** | ** ** | — |   | (996 | ) |
| Investments in other  marketable securities                                                                       |         |         | ** **   | ** **                                 | ** **   | **(2,016** | **)** | (7,554 | ) | (29,762 | ) |
| Proceeds from disposal of  non-marketable equity securities                                                       |         |         | ** **   | ** **                                 | ** **   | **6,507** | ** ** | 19,388 |   | 875,967 |   |
| Proceeds from disposals  of property, plant and   equipment                                                       |         |         | ** **   | ** **                                 | ** **   | **3,456** | ** ** | 2,628 |   | 3,647 |   |
| Purchases of mineral  licenses                                                                                    |         |         | ** **   | ** **                                 | ** **   | **(6,382** | **)** | (93,033 | ) | — |   |
| Purchases of property,  plant and equipment                                                                       |         |         | ** **   | ** **                                 | ** **   | **(391,460** | **)** | (427,521 | ) | (303,411 | ) |
| Net cash (used in)  provided by investing activities                                                              |         |         | ** **   | ** **                                 | ** **   | **(552,538** | **)** | (994,707 | ) | 455,716 |   |
| ***Cash Flows from Financing  Activities***                                                                       |         |         | ** **   | ** **                                 | ** **   | ** ** | ** ** |   |   |   |   |
| Proceeds from short-term  borrowings                                                                              |         |         | ** **   | ** **                                 | ** **   | **883,307** | ** ** | 1,577,984 |   | 954,733 |   |
| Repayment of short-term  borrowings                                                                               |         |         | ** **   | ** **                                 | ** **   | **(1,116,762** | **)** | (1,686,578 | ) | (941,340 | ) |
| Dividends paid                                                                                                    |         |         | ** **   | ** **                                 | ** **   | **(189,583** | **)** | (194,154 | ) | (5,145 | ) |
| Proceeds from issuance of  common stock                                                                           | ** **   | ** **   | **19**       | ** **                                 | ** **   | **—** | ** ** | — |   | 220,873 |   |
| Purchase of treasury  stock                                                                                       |         |         | ** **   | ** **                                 | ** **   | **(36,449** | **)** | — |   | — |   |
| Proceeds from disposal of  treasury stock                                                                         |         |         | ** **   | ** **                                 | ** **   | **1,248** | ** ** | — |   | — |   |
| Proceeds from long-term  debt                                                                                     |         |         | ** **   | ** **                                 | ** **   | **415,345** | ** ** | 14,815 |   | 75,241 |   |
| Repayment of long-term  debt                                                                                      |         |         | ** **   | ** **                                 | ** **   | **(110,840** | **)** | (20,180 | ) | (52,093 | ) |
| Repayment of obligations  under finance lease                                                                     |         |         | ** **   | ** **                                 | ** **   | **(9,048** | **)** | (757 | ) | — |   |
| Net cash (used in)  provided by financing activities                                                              |         |         | ** **   | ** **                                 | ** **   | **(162,782** | **)** | (308,870 | ) | 252,269 |   |
| Effect of exchange rate  changes on cash and cash equivalents                                                     |         |         | ** **   | ** **                                 | ** **   | **21,236** | ** ** | (30,284 | ) | 1,360 |   |
| Net (decrease) increase  in cash and cash equivalents                                                             |         |         | ** **   | ** **                                 | ** **   | **(139,161** | **)** | (712,986 | ) | 1,005,482 |   |
| Cash and cash equivalents  at beginning of year                                                                   |         |         | ** **   | ** **                                 | ** **   | **311,775** | ** ** | 1,024,761 |   | 19,279 |   |
| Cash and cash equivalents  at end of year                                                                         |         |         | ** **   | ** **                                 | ** **   | **$** | **172,614** | ** ** | $ | 311,775 |   | $ | 1,024,761 |   |
| ***Supplementary cash flow  information:***                                                                       |         |         | ** **   | ** **                                 | ** **   | ** ** | ** ** |   |   |   |   |
| Interest paid, net of  amount capitalized                                                                         |         |         | ** **   | ** **                                 | ** **   | **$** | **(38,882** | **)** | $ | (43,354 | ) | $ | (62,835 | ) |
| Income taxes paid                                                                                                 |         |         | ** **   | ** **                                 | ** **   | **$** | **(196,913** | **)** | $ | (171,774 | ) | $ | (136,473 | ) |
| ***Non-cash Activities:***                                                                                        | *** *** | *** *** | *** *** | *** ***                               | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Net assets of  subsidiaries contributed by minority shareholders in exchange for shares  issued by   subsidiaries | ** **   | ** **   | **19**       | ** **                                 | ** **   | **$** | **9,641** | ** ** | $ | 17,460 |   | $ | 340 |   |
| Acquisition of  plant and equipment in exchange for goods                                                         |         |         | ** **   | ** **                                 | ** **   | **$** | **—** | ** ** | $ | — |   | $ | 3,071 |   |
| Acquisition of  equipment under finance lease                                                                     | ** **   | ** **   | **18**       | ** **                                 | ** **   | **$** | **46,855** | ** ** | $ | 10,291 |   | $ | — |   |
| Conversion of debt  into shares of subsidiaries                                                                   |         |         | ** **   | ** **                                 | ** **   | **$** | **20,482** | ** ** | $ | 25,595 |   | $ | — |   |
| Treasury shares  issued to acquire subsidiary                                                                     | ** **   | ** **   | **19**       | ** **                                 | ** **   | **$** | **119,950** | ** ** | $ | — |   | $ | 9,723 |   |

 

See accompanying notes to consolidated financial statements

F-6

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY(in thousands of U.S. dollars, exceptshare amounts)

|                                                                           | ** ** | ** **             | ** ** | ** **               | ** **  | ** **     | ** **      | ** **                                                        | ** ** | ** **          | ** ** | **Accumulated other** | ** ** | ** **                 | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|--------------------------|-------------|----------------|-----------------|-------------------------------------------------------------------|------------|---------------------|------------|----------------------------|------------|----------------------------|------------|------------|------------|
| ** **                                                                | ** ** | **Common shares** | ** ** | **Treasury shares** | ** **  | **Additional** | ** **      | **    comprehensive    ** | ** ** | ** **          | ** ** | ** **                 | ** ** |
| ** **                                                                | ** ** | **Shares**             | ** ** | **Amount**               | ** **  | **Shares**     | ** **      | **Amount**                                                        | ** ** | **paid-in-capital** | ** ** | **income**                 | ** ** | **Retained earnings** | ** ** | **Total**  | ** ** |
| **Balances as of  December 31, 2003**                                | ** ** | **382,969,086**        | ** ** | **$**                    | **121,935** | ** **     | **(16,790,271** | **)**                                                             | **$**      | **(5  ,346)**       | ** ** |                       | **$**      | **92,659**                 | ** ** |       |       | **$** | **46,921** | ** ** |   |   | **$** | **192,657** | ** ** |   | **$** | **448,826** | ** ** |
| Issue of shares (Note 19)                                                 |       | 33,301,659             |       | 11,572                   |        | —         |            | —                                                            | ** ** |                | 201,781    | ** **                 |       |                       | —     |       |       |   | — |   |   | 213,353 |   |
| Net income                                                                |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | —     |       |       |   | 1,342,706 |   |   | 1,342,706 |   |
| Dividends                                                                 |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | —     |       |       |   | (5,145 | ) |   | (5,145 | ) |
| Cumulative translation adjustment for  2004                               |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | 49,116     |       |       |   | — |   |   | 49,116 |   |
| Adjustment of available-for-sale securities                               |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | (2,350     | )          |       |   | — |   |   | (2,350 | ) |
| Stock-based compensation (Note 19)                                        |       | —                 |       | —                   |        | 2,297,815      |            | 732                                                               | ** ** |                | 668        | ** **                 |       |                       | —     |       |       |   | — |   |   | 1,400 |   |
| Stock issued for acquisition of minority interest  (Note 19)              |       | —                 |       | —                   |        | 1,340,391      |            | 427                                                               | ** ** |                | 9,296      | ** **                 |       |                       | —     |       |       |   | — |   |   | 9,723 |   |
| **Balances as of  December 31, 2004**                                |       | **416,270,745**        |       | **$**                    | **133,507** |           | **(13,152,065** | **)**                                                             | **$**      | **(4  ,187**        | **)**      |                       | **$**      | **304,404**                | ** ** |       |       | **$** | **93,687** |   |   |   | **$** | **1,530,218** |   |   | **$** | **2,057,629** |   |
|                                                                           |       |                   |       |                     |        |           |            |                                                              | ** ** |                |       | ** **                 |       |                       |       |       |       |   |   |   |   |   |   |
| Net income                                                                |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | —     |       |       |   | 381,180 |   |   | 381,180 |   |
| Dividends                                                                 |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | —     |       |       |   | (194,154 | ) |   | (194,154 | ) |
| Cumulative translation adjustment for 2005                                |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | (53,822    | )          |       |   | — |   |   | (53,822 | ) |
| Adjustment of available-for-sale  securities                              |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | 2,181      |       |       |   | — |   |   | 2,181 |   |
| Additional capital arising on acquisition of minority  interest (Note 19) |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | 17,460     | ** **                 |       |                       | —     |       |       |   | — |   |   | 17,460 |   |
| **Balances as of  December 31, 2005**                                | ** ** | **416,270,745**        | ** ** | **$**                    | **133,507** | ** **     | **(13,152,065** | **)**                                                             | **$**      | **(4  ,187**        | **)**      |                       | **$**      | **321,864**                | ** ** |       |       | **$** | **42,046** | ** ** |   |   | **$** | **1,717,244** | ** ** |   | **$** | **2,210,474** | ** ** |
|                                                                           |       |                   |       |                     |        |           |            |                                                              | ** ** |                |       | ** **                 |       |                       |       |       |       |   |   |   |   |   |   |
| Net income                                                                |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | —     |       |       |   | 603,249 |   |   | 603,249 |   |
| Dividends                                                                 |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | —     |       |       |   | (189,582 | ) |   | (189,582 | ) |
| Cumulative translation adjustment for 2006                                |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | 148,920    |       |       |   | — |   |   | 148,920 |   |
| Additional minimum pension liability  (Note 17)                           |       |                   |       |                     |        |           |            | ** **                                                        | ** ** |                |       | ** **                 |       |                       | (4,669     | )          |       |   |   |   |   | (4,669 | ) |
| Adjustment of available-for-sale securities                               |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | 11,203     |       |       |   | — |   |   | 11,203 |   |
| Effect of SFAS No. 158 adoption  (Note 17)                           |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | —     | ** **                 |       |                       | (9,282     | )          |       |   | — |   |   | (9,282 | ) |
| Purchase of treasury stock from a related party (Note  19)                |       | —                 |       | —                   |        | (5,648,850     | )               | (36,449                                                           | **)**      |                | —     | ** **                 |       |                       | —     |       |       |   | — |   |   | (36,449 | ) |
| Stock-based compensation (Note 19)                                        |       | —                 |       | —                   |        | 155,857        |            | 51                                                                | ** ** |                | 1,457      | ** **                 |       |                       | —     |       |       |   | — |   |   | 1,508 |   |
| Treasury shares used for acquisition of subsidiaries (Note  19)           |       | —                 |       | —                   |        | 18,645,058     |            | 40,585                                                            | ** ** |                | 79,365     | ** **                 |       |                       | —     |       |       |   | — |   |   | 119,950 |   |
| Additional capital arising on  acquisition of minority interest (Note 19) |       | —                 |       | —                   |        | —         |            | —                                                            | ** ** |                | 9,641      | ** **                 |       |                       | —     |       |       |   | — |   |   | 9,641 |   |
| **Balances  as of December 31, 2006**                                | ** ** | **416,270,745**        | ** ** | **$**                    | **133,507** | ** **     | **—**      | ** **                                                        | **$**      | **—**          | ** ** |                       | **$**      | **412,327**                | ** ** |       |       | **$** | **188,218** | ** ** |   |   | **$** | **2,130,911** | ** ** |   | **$** | **2,864,963** | ** ** |
| ** **                                                                | ** ** | ** **             | ** ** | ** **               | ** **  | ** **     | ** **      | ** **                                                        | ** ** |                | ** ** | ** **                 |       |                       | ** ** | ** ** |       |   | ** ** | ** ** |   | ** ** | ** ** |

 

See accompanying notes to consolidated financial statements

F-7

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**1.**                 GENERAL

**(a)**          Formation

MechelOAO (“Mechel”, formerly—Mechel Steel Group OAO) was incorporated onMarch 19, 2003, under the laws of the Russian Federation in connectionwith a reorganization to serve as a holding company for various steel andmining companies owned by two individual shareholders (the “ControllingShareholders”). The Controlling Shareholders, directly or through theiraffiliates, either acquired existing companies or established new companies, atvarying dates from 1995 through March 19, 2003, which were contributed toMechel after its formation. Mechel and its subsidiaries****are collectively****referred to herein as the “Group”. Set forth below is asummary of the Group’s primary subsidiaries:

| ** **                                                                                    | ** ** | ** **    | ** ** | ** **             | ** ** | ** **             | ** ** | **Interest in voting stock held by** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------|------------|------------------------|------------|------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | ** **    | ** ** | ** **             | ** ** | **Date control**  | ** ** | **the Group at December 31,**             | ** ** |
| **Name of subsidiary**                                                              | ** ** | ** **    | ** ** | **Registered in** | ** ** | **Core business** | ** ** | **acquired(*)**                                               | ** ** | ** 2006 ** | ** ** | ** 2005 ** | ** ** | ** 2004 ** | ** ** |
| Mechel International  Holdings  AG (MIH)(1)                                              |       | Switzerland   |       | Holding  and trading   |       | July 1,  1995     |       |                                                          | 100.0      | % |   | 100.0 | % | 100.0 | % |
| Mechel Metal Supply AG (MMS)                                                                  |       | Liechtenstein |       | Trading                |       | Oct  30, 2000          |       |                                                          | 100.0      | % |   | 100.0 | % | 100.0 | % |
| Mechel Trading House (MTH)                                                               |       | Russia        |       | Holding  and trading   |       | June 23,  1997    |       |                                                          | 100.0      | % |   | 100.0 | % | 100.0 | % |
| Southern Kuzbass Coal Company (SKCC), including  its most significant subsidiaries: |       | Russia        |       | Holding  and trading   |       | Jan  21, 1999          |       |                                                          | 93.5       | % |   | 93.7 | % | 96.6 | % |
| Sibirginsk Open Pit Mine (SOPM)**                                                             |       | Russia        |       | Coal  mining           |       | Jan  21, 1999          |       |                                                          | —     |   |   | — |   | 90.4 | % |
| Krasnogorsk Open Pit Mine (KOPM)****                                                          |       | Russia        |       | Coal  mining           |       | Jan  21, 1999          |       |                                                          | —     |   |   | 88.9 | % | 87.4 | % |
| Tomusinsk Open Pit Mine  (TOPM)                                                          |       | Russia        |       | Coal  mining           |       | Jan  21, 1999          |       |                                                          | 74.4       | % |   | 74.4 | % | 74.4 | % |
| Olzherassk Open Pit Mine  (OOPM)                                                         |       | Russia        |       | Coal  mining           |       | Dec  28, 1999          |       |                                                          | 82.9       | % |   | 81.9 | % | 80.6 | % |
| Kuzbass Central Processing Plant (KCPP)**                                                     |       | Russia        |       | Coal  processing       |       | Dec  31, 2000          |       |                                                          | —     |   |   | — |   | 95.0 | % |
| Lenin Mine (LM)****                                                                           |       | Russia        |       | Coal  mining           |       | Dec  29, 2001          |       |                                                          | —     |   |   | 79.0 | % | 78.5 | % |
| Usinsk Mine (UM)***                                                                           |       | Russia        |       | Coal  mining           |       | Dec  29, 2001          |       |                                                          | —     |   |   | 80.2 | % | 78.6 | % |
|                                                                                               |            |               |            |                        |            |                        |            |                                                               |            |  |  |  |  |  |  |  |  |

F-8

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| Siberian Central Processing Plant (SCPP)**     |   | Russia      |   | Coal  processing            |   | Dec  22, 2000        |   |   | — |   |   | — |   | 90.8   | %      |
|------------------------------------------------|--------|-------------|--------|-----------------------------|--------|----------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Chelyabinsk Metallurgical Plant (CMP)          |   | Russia      |   | Steel  products             |   | Dec  27, 2001        |   |   | 93.7   | %      |   | 93.7   | %      | 86.9   | %      |
| Southern Urals Nickel Plant  (SUNP)       |   | Russia      |   | Nickel                      |   | Dec  27, 2001        |   |   | 79.9   | %      |   | 79.9   | %      | 79.3   | %      |
| Vyartsilya Metal Products Plant (VMPP)         |   | Russia      |   | Steel  products             |   | May 24,  2002   |   |   | 93.3   | %      |   | 93.3   | %      | 93.4   | %      |
| Beloretsk Metallurgical Plant (BMP)       |   | Russia      |   | Steel  products             |   | June 14,  2002  |   |   | 90.4   | %      |   | 90.3   | %      | 90.2   | %      |
| Mechel Targoviste  SA                          |   | Romania     |   | Steel  products             |   | Aug  28, 2002        |   |   | 86.6   | %      |   | 83.7   | %      | 81.0   | %      |
| Mechel Zeljezara  (MZ)                         |   | Croatia     |   | Steel  products             |   | March 17,  2003 |   |   | 100    | %      |   | 100.0  | %      | 100.0  | %      |
| Ural Stampings Plant (USP)                     |   | Russia      |   | Steel  products             |   | April 24,  2003 |   |   | 93.8   | %      |   | 93.8   | %      | 93.8   | %      |
| Korshunov Mining Plant (KMP)                   |   | Russia      |   | Iron  ore mining            |   | Oct  16, 2003        |   |   | 85.6   | %      |   | 85.5   | %      | 75.0   | %      |
| Mechel Campia Turzii SA                   |   | Romania     |   | Steel  products             |   | June 20,  2003  |   |   | 86.56  | %      |   | 84.9   | %      | 81.0   | %      |
| Mechel Nemunas (MN)                            |   | Lithuania   |   | Steel  products             |   | Oct  15, 2003        |   |   | 100.0  | %      |   | 100.0  | %      | 100.0  | %      |
| Mechel Coal Resources (MCR)               |   | Kazakhstan  |   | Coal mining  and processing |   | Dec  31, 2003        |   |   | — |   |   | — |   | 100.0  | %      |
| Mechel Energo                                  |   | Russia      |   | Energy  trading             |   | Feb  3, 2004         |   |   | 100.0  | %      |   | 100.0  | %      | 100.0  | %      |
| Port Posiet                                    |   | Russia      |   | Transportation              |   | Feb  11, 2004        |   |   | 96.93  | %      |   | 80.0   | %      | 80.0   | %      |
| Izhstal                                        |   | Russia      |   | Steel  products             |   | May 14,  2004   |   |   | 87.9   | %      |   | 87.7   | %      | 62.3   | %      |
| Port Kambarka                                  |   | Russia      |   | Transportation              |   | April 27,  2005 |   |   | 90.4   | %      |   | 90.4   | %      | — |   |
| Kaslinsky Architectural Art Casting Plant |   | Russia      |   | Steel  products             |   | April 14,  2004 |   |   | 100.0  | %      |   | 100.0  | %      | 100.0  | %      |
| Mechel Trading Ltd.                            |   | Switzerland |   | Trading                     |   | Dec. 20,  2005  |   |   | 100.0  | %      |   | 100.0  | %      | — |   |
| Metals Recycling  OOO                          |   | Russia      |   | Scrap  collecting           |   | March 14,  2006 |   |   | 100.0  | %      |   | — |   | — |   |
| Mechel Hardware OOO                            |   | Russia      |   | Trading                     |   | March 21,  2006 |   |   | 100.0  | %      |   | — |   | — |   |

F-9

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| Moscow Coke and  Gas Plant  (Moskoks) |   | Russia |   | Coke production |   | Oct 4, 2006 |   |   | 98.94 | % |   | — |   | — |   |
|--------------------------------------------|--------|--------|--------|-----------------|--------|-------------|--------|--------|-------|---|--------|--------|--------|--------|--------|

----

*                    Date when acontrol interest was acquired by either the Group or Controlling Shareholders.

**             Merged with SKCC inOctober – December 2005

***      Merged with Lenin Mine inMarch 2006

**** Merged with SKCC in October 2006

(1)          Formerly—MechelTrading AG (MT). Renamed on December 20, 2005

**(b)**          ControllingShareholders and Reorganization

From 1995 until December 2006, the ControllingShareholders have acted in concert pursuant to a written Ownership, Control andVoting Agreement, which requires them to vote all shares of Mechel’ssubsidiaries owned by them in the same manner. The establishment of the Groupin March 2003 involved the contribution of certain of the abovesubsidiaries, acquired before March 19, 2003, by the Controlling Shareholdersto Mechel in exchange for all the outstanding capital stock of Mechel, forminga new holding company via an exchange of shares.

As a result of this restructuring, the ControllingShareholders maintained their original equal ownership in the subsidiariesthrough Mechel and Mechel became a direct holder of the stock of thesubsidiaries.

Shareholders in each of Mechel’s subsidiaries beforethe restructuring who were not Controlling Shareholders did not contribute anyshares in these subsidiaries to Mechel in exchange for its shares and wereconsidered as outside the control group and these shareholders retained aminority interest in the subsidiaries. Thus, to the extent minority interestsexisted in the entities under common control prior to March 19, 2003, suchminority interests did not change as a result of the formation of Mechel andthe reorganization of the Group.

During 2006, one of theControlling Shareholders sold all his Mechel’s stock to the other ControllingShareholder, and Ownership, Control and Voting Agreement was terminated onDecember 21, 2006.

**(c)**           Basisof Presentation

The formation of Mecheland contribution of the subsidiaries’ shares into Mechel’s capital represents areorganization of entities under common control, and accordingly, has beenaccounted for in a manner akin to a pooling for the periods presented.

F-10

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(d)**          Business

The Group operates in twobusiness segments: steel (comprising steel and steel products) and mining(comprising coal, iron ore and nickel), and conducts operations in Russia,Lithuania and Central and Eastern Europe. The Group sells its products withinRussia and foreign markets. Through acquisitions, the Group has added variousbusinesses to explore new opportunities and build an integrated steel andmining group. The Group operates in a highly competitive and cyclical industry;any local or global downturn in the industries may have an adverse effect onthe Group’s results of operations and financial condition. The Group willrequire a significant amount of cash to fund capital improvement programs.While the Group will utilize funds from operations, it expects to continue torely on capital markets and other financing sources for its capital needs. Amore detailed description of activity is provided within individual notes oneach significant subsidiary acquisition.

**2.**                 ACQUISITIONS,INVESTMENTS AND DISPOSALS

As disclosed in thepreceding note, the Group experienced significant growth through acquisitions.The following describes business combinations between January 1, 2004 andDecember 31, 2006.

**(a)**          PortPosiet

On February 11, 2004, the Group acquired 80.04%of the common shares of Port Posiet, a cargo port located in Russia’s Far Easton the Sea of Japan, for $30,000 in cash. The primary reason for the acquisitionwas the Group’s intention to selectively expand its internal logisticscapabilities, currently centered on the Group’s railway freight and forwardingcompany. Through the acquisition of Port Posiet, located on the Sea of Japan,the Group tries to optimize its transportation expenses. The Group intends toship primarily its coking coal concentrate, as well as steel products, to Asiathrough this port. No sea ports were readily available on the market, due tothis fact and because most ports located in the Far East are controlled eitherby competitors or independent transportation companies, the Group had to pay apremium in order to acquire Port Posiet. The premium paid resulted in positivegoodwill, none of which will be deductible for income tax purposes. The PortPosiet is included in the mining segment as the majority of its activity relateto movement of coal and coking coal concentrate.

F-11

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Theacquisition of Port Posiet was accounted for using the purchase method ofaccounting. The results of operations of Port Posiet are included in theconsolidated financial statements from the date of acquisition of control,February 11, 2004. The following table summarizes the fair values of netassets acquired at the date of acquisition of control.

| ** **                           | ** ** | **February 11, 2004** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|
| Cash and cash  equivalents           |       |                            | 34         |   |   |
| Other current  assets                |       |                            | 530        |   |   |
| Property, plant  and equipment       |       |                            | 5,361      |   |   |
| Current  liabilities                 |       |                            | (377       | ) |   |
| Long-term  liabilities               |       |                            | (207       | ) |   |
| Deferred income  taxes               |       |                            | (1,010     | ) |   |
| Fair value of net assets acquired    |       |                            | 4,331      |   |   |
| Goodwill                             |       |                            | 26,534     |   |   |
| Minority’s share  in net assets |       |                            | (865       | ) |   |
| **Total  investment**                | ** ** | ** **                      | **30,000** |   |   |

 

**(b)**          KaslinskyArchitectural Art Casting Plant

On April 14, 2004,the Group acquired 100% of Kaslinsky Architectural Art Casting Plant, a smallmetal processing plant engaged in metal art product casting, located in Kasli,in Southern Urals, for $996 in cash. The acquisition is a small-scale corporateventure investment aimed at capitalizing on the recovery of a precedentlyrecognized brand in the value-added segment of the metal products market. Theacquisition of Kaslinsky Architectural Art Casting Plant was accounted forusing the purchase method of accounting and recorded in the consolidatedfinancial statements for the year ended December 31, 2004.

**(c)**           Izhstal

In January-February 2004, the Group acquired a15.35% interest in Izhstal, a producer of semi-finished steel products, carbonand specialty steel products and forgings, similar to those of the Group, onthe open market for $508 in cash. On May 14, 2004, the Group acquired anadditional 26.9% interest from the government for $17,264 in cash, and a 17.17%interest from the management of Izhstal for $5,671 in cash. DuringMay 2004, the Group acquired an additional 2.19% interest by buying shareson the open market for $1,694 in cash. Thus, by the end of May 2004, theGroup had accumulated 61.61% of Izhstal voting stock and had paid a total of$25,137 in cash.

F-12

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Theacquisition of Izhstal was accounted for using the purchase method ofaccounting. The excess of the fair value of the net assets acquired over thepurchase price has been allocated as a pro rata reduction of $75,040 of theamounts that otherwise would have been assigned to property, plant andequipment, in accordance with SFAS No. 141, “Business Combinations”. Theresults of operations of Izhstal are included in the consolidated financialstatements from the date of acquisition of control, May 14, 2004. Thefollowing table summarizes the fair values of net assets acquired at the dateof acquisition of control.

| ** **                           | ** ** | **May 14, 2004** | ** ** |
|--------------------------------------|------------|----------------------------|------------|
| Cash and cash  equivalents           |       |                       | 2,396      |   |   |
| Other current  assets                |       |                       | 35,134     |   |   |
| Property, plant  and equipment       |       |                       | 112,172    |   |   |
| Current  liabilities                 |       |                       | (47,661    | ) |   |
| Long-term  liabilities               |       |                       | (19,935    | ) |   |
| Deferred income  taxes               |       |                       | (10,122    | ) |   |
| Fair value of net assets acquired    |       |                       | 71,984     |   |   |
| Minority’s share  in net assets |       |                       | (46,847    | ) |   |
| **Total  investment**                | ** ** | ** **                 | **25,137** |   |   |

 

After the acquisition dateand prior to December 31, 2004, the Group acquired additional 0.71%interest for $230 in cash. In 2005, the Group acquired additional 25.14%interest of Izhstal for $15,999 in cash.

**(d)**          InvestCoal

On June 17, 2004, the Group acquired 100% ofInvest Coal for $3,275 in cash. Invest Coal owns licenses for mineral reservesextension, mostly in the area surrounding one of the Group’s coal mines. The acquisitionof Invest Coal facilitates the extraction of mineral reserves of that coalmine. The acquisition of Invest Coal was accounted for as an acquisitionof an asset as it did not constitute a business.

On December 29, 2005,Invest coal was merged with Olzherassk Open Pit Mine.

**(e)**           MechelEnergo

On February 3, 2004,the Group acquired the assets of REK Energosbyt, later renamed Mechel Energo,an emerging energy trader in Siberia and Eastern Russia, whose primary assetwas a license to operate in the wholesale segments of the Russian electricitymarket, for $2,005, including $1,735 paid with promissory notes and $270 incash. The acquisition of Mechel Energo was accounted for as an acquisition ofan asset as it did not constitute a business. The license was recorded as anintangible asset and is being amortized over five years.

F-13

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(f)**             Yakutugol

On January 24, 2005, the Group won the auctionwhere the Government of Republic Sakha (Yakutia) sold shares of Yakutugol, a leadingcoal producer in the northeast of Russia. The Group acquired 25% plus one sharefor $411,182 in cash. Yakutugol extracts predominantly coking coal, as well assteam coal in open and underground mines. The company sells most of the outputto the Asian Pacific region, primarily Japan, South Korea, and Taiwan, mostlyunder long-term contracts.

Thepurchase of Yakutugol shares was accounted for using the equity method ofaccounting and is included within long-term investments in related parties asof December 31, 2005. Property, plant and equipment and mineral licensesof Yakutugol were valued by independent appraisers as of December 31, 2004and were adjusted for depreciation and depletion through January 24, 2005.The Group’s share in results of operations of Yakutugol is included in theconsolidated financial statements from the date of acquisition of shares,January 24, 2005. The individual assets and liabilities of Yakutugol arenot included in the accompanying consolidated financial statements of the Groupas the Group accounts for Yakutugol as its equity-method investment. Thefollowing table summarizes the fair values of net assets of Yakutugol at thedate of acquisition of shares:

| ** **                                                    | ** ** | **January 24, 2005** | ** **  |
|---------------------------------------------------------------|------------|--------------------------------|-------------|
| Cash and cash  equivalents                                    |       |                           | 31,101      |   |   |
| Other current  assets                                         |       |                           | 99,593      |   |   |
| Property, plant  and equipment                                |       |                           | 330,057     |   |   |
| Mineral licenses                                              |       |                           | 1,592,491   |   |   |
| Current  liabilities                                          |       |                           | (74,980     | ) |   |
| Long-term  liabilities                                        |       |                           | (144,045    | ) |   |
| Deferred income  taxes                                        |       |                           | (405,368    | ) |   |
| Fair value of net assets of Yakutugol                         |       |                           | 1,428,849   |   |   |
| Share of  controlling shareholders in net assets of Yakutugol |       |                           | (1,071,637  | ) |   |
| Excess of  investment over fair value of net assets acquired  |       |                           | 53,970      |   |   |
| **Total  investment**                                         | ** ** | ** **                     | **411,182** |   |   |

 

Current mineral licenses of Yakutugol expire in 2013,but based on the provisions of the Russian Subsoil Law their extension throughthe end of the estimated proven and probable reserve depletion period isconsidered by management to be reasonably assured. Government of Republic Sakha(Yakutia) owns majority ownership interest in Yakutugol, therefore, the renewalof mineral licenses upon their expiration in 2013 is expected to be virtuallyautomatic. Consequently, the value assigned to mineral licenses includes suchreasonably assured license extensions of $505,418. Yakutugol’s mineral licensesare amortized using the units-of-production method through the end of theestimated proven and probable reserve depletion period (2031).

F-14

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

The Group’s share in theYakutugol’s net (loss) income for the years ended December 31, 2006 and2005 of ($13,628) and $9,353 includes the effect of depletion of minerallicenses. Yakutugol is included in the mining segment.

**(g)**           Chelyabenergo

FromApril through December 2004, the Group acquired 3.77% ofChelyabenergo. In February 2005, Chelyabenergo was re-organized intoseveral independent entities:

·       ChelyabenergoOAO E&E

·       ChelyabinskGenerating Holding Company

·       ChelyabinskEnergy Holding Company

·       Chelyabenergosbyt

·       SouthernUrals Hydroelectric Station.

Later in 2005, another company was set up—ChelyabinskPower Circuit. All holders of former Chelyabenergo shares received an equalnumber of shares in all new entities. After the split, the Group continuedacquisition of shares in these companies and spent $6,079 for these purposes.

In December 2005, the Group sold vast majority ofshares of Chelyabenergo OAO E&E, Chelyabinsk Generating Holding Company,Chelyabinsk Energy Holding Company and Southern Urals Hydroelectric Station(4.9%, 5.15%, 4.75% and 4.75% of each company, respectively), for the totalconsideration of $12,512, realizing a gain of $2,500 on such disposal. As ofDecember 31, 2005, the Group’s total investment in Chelyabenergo Groupentities was $4,792, the Group possessed between 0.6% and 15.05% share inChelyabenergo Group entities.

In 2006, Chelyabenergo OAOE&E, Chelyabinsk Generating Holding Company, Chelyabinsk Energy HoldingCompany and Southern Urals Hydroelectric Station merged to form WholesaleGenerating Company—3. During February–April 2006, the Group both purchasedand sold insignificant number of shares of Chelyabenergosbyt, Chelyabenergo OAOE&E, Chelyabinsk Power Circuit and Wholesale Generating Company—3,realizing a total gain of $1,714 on those operations. As of December 31,2006, the Group possessed between 0.1% and 15.73% share in Chelyabenergo Groupentities, and total investment therein was $15,681.

**(h)**          MechelCoal Resources

Mechel Coal Resourcesconsisted of the assets of Coal Washing Factory-38, a coal washing plant,and Gorbachev Mine, an underground coal mine primarily producing coking coal,which the Group acquired in December 2003 and May 2004, respectively.In August 2005, the Group made a decision to sell Mechel Coal Resources toCoal Trade Company, a Kazakh company not associated with the Group, for thetotal of $7,000. In addition, Coal Trade Company agreed to repay the $5,200long-term loan issued by Mechel International Holdings AG to Mechel CoalResources, which was included in the net assets of Mechel 

F-15

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

CoalResources of $4,964 as of the date of sale. The total gain on disposal ofMechel Coal Resources amounted to $2,036.

**(i)**             MetalsRecycling

On March 14, 2006, the Group acquired MetalsRecycling OOO (“Metals Recycling”), a full-scale metal collector and processor,for $4,824 in cash, $2,053 of which was payable as at June 30, 2006.Metals Recycling includes 8 operating scrap collecting facilities located inChelyabinsk Region, Russia, with the total capacity of 178 thousand tonnes ofscrap. As of the date of acquisition, Metals Recycling owned 51% in each of itssubsidiaries Ecomet+ OOO, VtorResurs-Yuzhny OOO, PKF Vtormet OOO, PromComplexOOO, which are all integrated into the Metals Recycling business process.

Theacquisition of Metals Recycling was accounted for using the purchase method ofaccounting. The results of operations of Metals Recycling are included in theconsolidated financial statements from the date of control, March 14,2006. The following table summarizes the fair values of net assets acquired atthe date of acquisition of control.

| ** **                         | ** ** | **March 14, 2006** | ** ** |
|------------------------------------|------------|------------------------------|------------|
| Cash and cash  equivalents         |       |                         | 618        |   |   |
| Other current  assets              |       |                         | 1,690      |   |   |
| Property, plant  and equipment     |       |                         | 3,443      |   |   |
| Current  liabilities               |       |                         | (3,533     | ) |   |
| Deferred income  taxes             |       |                         | (568       | ) |   |
| Fair value of net  assets acquired |       |                         | 1,650      |   |   |
| Goodwill                           |       |                         | 3,174      |   |   |
| **Total  investment**              | ** ** | ** **                   | **4,824**  |   |   |

 

**(j)**             MoscowCoke and Gas Plant

During July-September 2006, the Group acquiredshares of Moscow Coke and Gas Plant (Moskoks) and its subsidiaries. OnSeptember 25, 2006, the Group’s share in Moskoks reached 98.94%, acquiredpartially for $178,958 in cash, and through exchange of 18,645,058 shares ofMechel OAO, which were valued at fair market price as of the date of exchangeat $119,950. Total cost of investment in Moskoks was $298,908 as of the date ofacquisition.

Moskoks is a well-established coke and chemicalproducer located in the Moscow region. The plant’s annual production capacityis about 1.5 million tonnes of coke. Products are sold domestically, mainly toRussia’s central region manufacturers, as well as shipped abroad, in particularto the Ukraine and European Union countries.

F-16

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Theacquisition of Moskoks was accounted for using the purchase method ofaccounting. The excess of the fair value of the net assets acquired over thepurchase price has been allocated as a pro rata reduction of $15,550 of theamounts that otherwise would have been assigned to property, plant andequipment, in accordance with SFAS No. 141, “Business Combinations”. Theresults of operations of Moskoks are included in the consolidated financialstatements from the date of control, September 25, 2006. The followingtable summarizes the fair values of net assets acquired at the date ofacquisition of control. Moskoks is part of steel operating segment.

| ** **                           | ** ** | **September 25, 2006** | ** **  |
|--------------------------------------|------------|----------------------------------|-------------|
| Cash and cash  equivalents           |       |                             | 22,484      |   |   |
| Non current  assets                  |       |                             | 69,247      |   |   |
| Marketable securities                |       |                             | 216,097     |   |   |
| Other current  assets                |       |                             | 42,191      |   |   |
| Current  liabilities                 |       |                             | (15,289     | ) |   |
| Non current  liabilities             |       |                             | (2,788      | ) |   |
| Deferred income  taxes               |       |                             | (29,705     | ) |   |
| Fair value of net assets acquired    |       |                             | 302,237     |   |   |
| Minority’s share  in net assets |       |                             | (3,329      | ) |   |
| **Total  investment**                | ** ** | ** **                       | **298,908** |   |   |

 

F-17

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(k)**          Discontinuedoperations

On September 14,2004, Mechel Trading, Mechel Zeljezara, and Zeljezara Sisak, concurrentlyconcluded two agreements relating to the operations acquired by MechelZeljezara from Zeljezara Sisak. Pursuant to the first agreement, ZeljezaraSisak, the seller, assigned its rights and obligations under the original assetpurchase agreement to the Croatian Privatization Fund. Pursuant to the secondagreement, all parties terminated the original purchase agreement, subject tothe following conditions: (1) transfer by Mechel Zeljezara to the CroatianPrivatization Fund of the assets acquired by Mechel Zeljezara and the employeesof the plant; (2) donation by Mechel Zeljezara of spare parts in theamount of $1,798 to the Croatian Privatization Fund; (3) the redemption bythe Croatian government of a bank guarantee given to it pursuant to theoriginal purchase agreement in the amount of $4,316; and (4) waiver of anyand all claims against Mechel Trading and Mechel Zeljezara. The Group startedaccounting for Mechel Zeljezara as discontinued operations from September 14,2004. Mechel Zeljezara is currently in liquidation, which is expected to beconcluded in 2007.

Consequently,as of December 31, 2006 and 2005, the Group’s investment in MechelZeljezara was presented in the consolidated balance sheets, as follows:

| ** **                                                  | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Condensed  balance sheet select data**                    |       |                  |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                   |       |                  | 9          |                  |       |   | 88 |   |   |
| Other current assets                                        |       |                  | —     |                  |       |   | — |   |   |
| Total current  assets                                       | ** ** | ** **            | **9**      |                  | ** ** | ** ** | **88** |   | ** ** |
| Property, plant and equipment and other non-current  assets |       |                  | 108        |                  |       |   | 97 |   |   |
| Total non-current  assets                                   | ** ** | ** **            | **108**    |                  | ** ** | ** ** | **97** |   | ** ** |
| Accounts payable and accrued liabilities                    |       |                  | (508       | )                     |       |   | (109 | ) |   |
| **Total current liabilities**                               | ** ** | ** **            | **(508**   | **)**                 | ** ** | ** ** | **(109** | **)** | ** ** |

 

Forthe three years ended December 31, 2006, the Group’s operations pertainingto Mechel Zeljezara were presented on a net basis, as follows:

| ** **                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **2004**                        | ** ** |
|------------------------------------------------------------------|------------|------------|------------|------------|------------|---------------------------------|------------|
| ** **                                                       | ** ** | **2006**   | ** ** | **2005**   | ** ** | **Through  disposal date** | ** ** | **Upon disposal** | ** ** | **Total** | ** ** |
| Revenues and  operating gains                                    |       |       | —     |       |       | 12                              |       |   | 26,531 |   |   |   | — |   |   | 26,531 |   |
| Operating income  (loss)                                         |       |       | 235        |       |       | (116                            | )          |   | (13,083 | ) |   |   | (2,806 | ) |   | (15,889 | ) |
| Income (loss)  before taxes                                      |       |       | 543        |       |       | (1,157                          | )          |   | (12,864 | ) |   |   | (2,347 | ) |   | (15,211 | ) |
| Income tax  effects                                              |       |       | —     |       |       | —                          |       |   | — |   |   |   | — |   |   | — |   |
| **Income (loss) from discontinued  operations, net of tax** | ** ** | ** ** | **543**    |       | ** ** | **(1,157**                      | **)**      | ** ** | **(12,864** | **)** | ** ** | ** ** | **(2,347** | **)** | ** ** | **(15,211** | **)** |

 

Mechel Zeljezara belongedto the Steel segment.

F-18

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(l)**             Goodwill

| **Balance  at December 31, 2003**     | ** ** | **5,402**  | ** ** |
|--------------------------------------------|------------|------------|------------|
| Acquisition of Port Posiet (Note 2(a))     |       | 26,534     |       |
| MMS shares exchange  (Note 19)             |       | 7,505      |       |
| **Balance at December 31, 2004**      | ** ** | **39,441** | ** ** |
| Translation difference                     |       | 139        |       |
| **Balance at December 31, 2005**      | ** ** | **39,580** | ** ** |
| Acquisition of Metal Recycling (Note 2(i)) |       | 3,174      |       |
| Translation  difference                    |       | 3,160      |       |
| **Balance  at December 31, 2006**     | ** ** | **45,914** | ** ** |

 

Goodwill arising from theacquisition of MMS minority interest in 2004 of $7,505 was allocated to theSteel segment. Goodwill arising from the acquisition of Port Posiet in 2004 of$26,534 was allocated to the Mining segment. Goodwill arising from theacquisition of Metal Recycling of $3,174 was allocated to the Steel segment.

**(m)**      Minorityinterest

Thefollowing table summarizes changes in minority interest for the three yearsended December 31, 2006:

| **Balance  at December 31, 2003**                                         | ** ** | **184,344** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------|------------|
| New acquisitions                                                               |       | 47,711      |       |
| Purchase of the  minority interest in existing subsidiaries by the Group       |       | (41,039     | )          |
| Minority’s share  in subsidiaries’ income from continuing operations |       | 11,673      |       |
| Translation  adjustment                                                        |       | 12,135      |       |
| **Balance at December 31, 2004**                                          | ** ** | **214,824** | ** ** |
| New acquisitions                                                               |       | 384         |       |
| Purchase of the  minority interest in existing subsidiaries by the Group       |       | (82,241     | )          |
| Reduction on  disposal of discontinued operations                              |       | (321        | )          |
| Minority’s share  in subsidiaries’ income from continuing operations |       | 6,879       |       |
| Translation  adjustment                                                        |       | (11,691     | )          |
| **Balance at December 31, 2005**                                          | ** ** | **127,834** | ** ** |
| New acquisitions                                                               |       | 3,329       |       |
| Purchase of the  minority interest in existing subsidiaries by the Group       |       | (6,186      | )          |
| Minority’s share  in subsidiaries’ income from continuing operations |       | 31,528      |       |
| Translation  adjustment                                                        |       | 6,531       |       |
| **Balance  at December 31, 2006**                                         | ** ** | **163,036** | ** ** |

 

F-19

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Atvarious dates during 2006, 2005 and 2004, the Group purchased minority interestin the following subsidiaries:

| ** **                                            | ** ** | ** **           | ** ** | **Minority interest acquired** | ** ** | ** **                                                                    | ** ** |
|-------------------------------------------------------|------------|----------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| **Year ended December 31, 2004:** | ** ** | ** **           | ** ** | **Date of acquisition**        | ** ** | **      %      ** | ** ** | **     amount     ** | ** ** | **Cash paid** | ** ** |
| Beloretsk  Metallurgical Plant                        |       | March 19        |       |                                     | 9.72       | %                                                                             |       |   | 2,553 |   |   |   | 261 |   |   |
| Tomusinsk Group  Processing Plant                     |       | July 2          |       |                                     | 5.99       | %                                                                             |       |   | 687 |   |   |   | 56 |   |   |
| Izhstal                                               |       | August-December      |       |                                     | 0.71       | %                                                                             |       |   | 861 |   |   |   | 230 |   |   |
| Chelyabinsk  Metallurgical Plant (CMP)                |       | September-  December |       |                                     | 4.43       | %                                                                             |       |   | 26,884 |   |   |   | 34,191 |   |   |
| Siberian Central  Processing Plant                    |       | September 27    |       |                                     | 1.23       | %                                                                             |       |   | 721 |   |   |   | 54 |   |   |
| Mechel Metal  Supply (Note 19)                        |       | October 1       |       |                                     | 25.00      | %                                                                             |       |   | 1,878 |   |   |   | — |   |   |
| Krasnogorsk Open  Pit Mine                            |       | October-December     |       |                                     | 9.68       | %                                                                             |       |   | 2,844 |   |   |   | 592 |   |   |
| Olzherassk Open  Pit Mine                             |       | October 29      |       |                                     | 1.68       | %                                                                             |       |   | 206 |   |   |   | 24 |   |   |
| Kuzbass Central  Processing Plant                     |       | October-December     |       |                                     | 6.69       | %                                                                             |       |   | 2,261 |   |   |   | 808 |   |   |
| Southern Kuzbass  Coal Company                        |       | October-December     |       |                                     | 0.49       | %                                                                             |       |   | 837 |   |   |   | 379 |   |   |
| Sibirginsk Open  Pit Mine                             |       | December 30     |       |                                     | 4.03       | %                                                                             |       |   | 978 |   |   |   | 211 |   |   |
| Korshunov Mining  Plant (KMP)                         |       | February 25     |       |                                     | 4.75       | %                                                                             |       |   | — |   |   |   | 205 |   |   |
| Lenina Mine (LM)                                      |       | October 6       |       |                                     | 25.00      | %                                                                             |       |   | — |   |   |   | 4 |   |   |
| Other  individually insignificant purchases           |       |                 |       |                                     |       |                                                                          |       |   | 329 |   |   |   | 6 |   |   |
|                                                  |       |                 |       |                                     |       |                                                                          | ** ** | ** ** | **41,039** |   | ** ** | ** ** | **37,021** |   |   |
|                                                       |            |                      |            |                                          |            |                                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

F-20

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                                            | ** ** | ** **                            | ** ** | **Minority interest acquired** | ** ** | ** **                                                                    | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| **Year ended December 31, 2005:** | ** ** | ** **                            | ** ** | **Date of acquisition**        | ** ** | **      %      ** | ** ** | **     amount     ** | ** ** | **Cash paid** | ** ** |
| Chelyabinsk  Metallurgical Plant (CMP)                |       | Different  dates  throughout the year |       |                                     | 6.81       | %                                                                             |       |   | 43,882 |   |   |   | 52,927 |   |   |
| Izhstal                                               |       | January-September                     |       |                                     | 25.14      | %                                                                             |       |   | 30,784 |   |   |   | 15,999 |   |   |
| Korshunov Mining  Plant (KMP)                         |       | Different  dates  throughout the year |       |                                     | 10.52      | %                                                                             |       |   | — |   |   |   | 3,424 |   |   |
| Tomusinsk Auto  Warehouse (TAW)                       |       | April-November                        |       |                                     | 15.72      | %                                                                             |       |   | 2,882 |   |   |   | 543 |   |   |
| Siberian Central  Processing Plant (SCPP)             |       | March 14,  2005                  |       |                                     | 5.46       | %                                                                             |       |   | 85 |   |   |   | 461 |   |   |
| Southern Urals  Nickel Plant (SUNP)                   |       | April-November                        |       |                                     | 0.62       | %                                                                             |       |   | — |   |   |   | 174 |   |   |
| Tomusinsk Energo  Management (TEM)                    |       | April-November                        |       |                                     | 12.93      | %                                                                             |       |   | 1,462 |   |   |   | 163 |   |   |
| Krasnogorsk Open  Pit Mine (KOPM)                     |       | January-November                      |       |                                     | 1.50       | %                                                                             |       |   | 444 |   |   |   | 101 |   |   |
| Kuzbass Central  Processing Plant (KCPP)              |       | January-February                      |       |                                     | 0.16       | %                                                                             |       |   | 1,071 |   |   |   | 53 |   |   |
| Sibirginsk Open  Pit Mine (SOPM)                      |       | January-March                         |       |                                     | 0.68       | %                                                                             |       |   | 1,080 |   |   |   | 33 |   |   |
| Beloretsk  Metallurgical Plant (BMP)                  |       | June-December                         |       |                                     | 0.11       | %                                                                             |       |   | 35 |   |   |   | 25 |   |   |
| Olzherassk Open  Pit Mine (OOPM)                      |       | January-November                      |       |                                     | 1.16       | %                                                                             |       |   | 147 |   |   |   | 13 |   |   |
| Lenin Mine (LM)                                       |       | April-November                        |       |                                     | 0.43       | %                                                                             |       |   | — |   |   |   | 10 |   |   |
| Vzryvprom                                             |       | April-November                        |       |                                     | 1.93       | %                                                                             |       |   | 34 |   |   |   | 9 |   |   |
| Other  individually insignificant purchases           |       | February-November                     |       |                                     |       |                                                                          |       |   | 5 |   |   |   | 1 |   |   |
| Mechel Targoviste  SA                                 |       | April-December                        |       |                                     | 2.62       | %                                                                             |       |   | 52 |   |   |   | — |   |   |
| Mechel Campia  Turzii SA                              |       | June-December                         |       |                                     | 3.90       | %                                                                             |       |   | 278 |   |   |   | — |   |   |
|                                                  |       |                                  |       |                                     |       |                                                                          | ** ** | ** ** | **82,241** |   | ** ** | ** ** | **73,936** |   |   |
|                                                       |            |                                       |            |                                          |            |                                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

| ** **                             | ** ** | ** **                            | ** ** | **Minority interest acquired** | ** ** | ** **                                                                    | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| **Year ended  December 31, 2006:**     | ** ** | ** **                            | ** ** | **Date of acquisition**        | ** ** | **      %      ** | ** ** | **     amount     ** | ** ** | **Cash paid** | ** ** |
| Southern Kuzbass  Coal Company (SKCC)  |       | March-December                        |       |                                     | 0.07       | %                                                                             |       |   | 1,788 |   |   |   | 2,364 |   |   |
| Mechel Targoviste  SA                  |       | September                             |       |                                     | 2.94       | %                                                                             |       |   | 1,523 |   |   |   | — |   |   |
| Port Posiet                            |       | February-November                     |       |                                     | 16.90      | %                                                                             |       |   | 1,295 |   |   |   | 1,302 |   |   |
| Mechel Campia  Turzii SA               |       | August-November                       |       |                                     | 1.63       | %                                                                             |       |   | 927 |   |   |   | — |   |   |
| Krasnogorsk Open  Pit Mine (KOPM)      |       | Different  dates  throughout the year |       |                                     | 0.77       | %                                                                             |       |   | 338 |   |   |   | — |   |   |
| Izhstal                                |       | August-December                       |       |                                     | 0.23       | %                                                                             |       |   | 272 |   |   |   | 216 |   |   |
| Korshunov Mining  Plant (KMP)          |       | Different  dates  throughout the year |       |                                     | 0.10       | %                                                                             |       |   | 22 |   |   |   | 119 |   |   |
| Tomusinsk Auto  Warehouse (TAW)        |       | October                               |       |                                     | 0.05       | %                                                                             |       |   | 8 |   |   |   | — |   |   |
| Chelyabinsk  Metallurgical Plant (CMP) |       | March-July                            |       |                                     | 0.00       | %                                                                             |       |   | 6 |   |   |   | 7 |   |   |
| Beloretsk  Metallurgical Plant (BMP)   |       | March-July                            |       |                                     | 0.02       | %                                                                             |       |   | 7 |   |   |   | 8 |   |   |
|                                   |       |                                  |       |                                     |       |                                                                          | ** ** | ** ** | **6,186** |   | ** ** | ** ** | **4,016** |   |   |
|                                        |            |                                       |            |                                          |            |                                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

As discussed in Note 19, the acquisition of theremaining 25% interest in Mechel Metal Supply was carried out through issuanceof treasury stock on October 1, 2004.

F-21

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

On different dates from September 13 through December 30,2004, the Group acquired 4.43% of voting stock of Chelyabinsk MetallurgicalPlant for consideration of $34,191 paid in cash. The purchase of a minorityinterest in CMP was accounted for using the purchase method of accounting. Theexcess of the fair value of the net assets acquired over the purchase price hasbeen allocated as a pro rata reduction of $8,157 of the amounts that otherwisewould have been assigned to property, plant and equipment in accordance withSFAS No. 141. The purchase of minority share in CMP was recorded in theconsolidated financial statements for the year ended December 31, 2004.

On different dates from October 12 through December 30,2004, the Group acquired 18,238 ordinary and 17,647 preferred shares ofKrasnogorsk Open Pit Mine. The effective percentage acquired in KOPM throughthese transactions equaled to 9.68% of voting stock and consideration was $592in cash. The purchase of a minority interest in KOPM was accounted for usingthe purchase method of accounting and recorded in the consolidated financialstatements for the year ended December 31, 2004. Acquisition of thisminority share resulted in negative goodwill of $11,712 that was allocated on apro rata basis to reduce amounts assigned to non-current assets to zero, exceptfor deferred income tax asset, with the remaining portion of $271 recognized asan extraordinary gain in the results of operations of the Group for the yearended December 31, 2004.

On different dates throughout 2005, the Group acquired6.81% of voting stock of Chelyabinsk Metallurgical Plant for consideration of$52,927 paid in cash. The purchase of a minority interest in CMP was accountedfor using the purchase method of accounting. The excess of the fair value ofthe net assets acquired over the purchase price has been allocated as a prorata reduction of $11,900 of the amounts that otherwise would have beenassigned to property, plant and equipment in accordance with SFAS No. 141.The purchase of minority share in CMP was recorded in the consolidatedfinancial statements for the year ended December 31, 2005.

On different dates throughout 2005, the Group acquired25.14% of voting stock of Izhstal for consideration of $15,999 paid in cash.The purchase of a minority interest in Izhstal was accounted for using thepurchase method of accounting. The excess of the fair value of the net assetsacquired over the purchase price has been allocated as a pro rata reduction of$19,400 of the amounts assigned to non-current assets, except for deferredincome tax asset. The purchase of minority share in Izhstal was recorded in theconsolidated financial statements for the year ended December 31, 2005.

On December 28, 2005, the Group acquired 13.33%of Port Posiet shares held by Russian Property Fund in an auction sale for thetotal consideration of $1,065. The title to the shares was transferred to theGroup on February 8, 2006. The purchase of a minority interest in PortPosiet was accounted for using the purchase method of accounting. The excess ofthe purchase price paid over the book value of the minority interest acquiredof $55 was allocated to the amounts assigned to property, plant and equipment.On June 16, 2006, the Group purchased additional 3.57% of Port Posietshares from third parties for $237 paid in cash. The purchase of minorityshare in Port Posiet was recorded in the consolidated financial statements forthe years ended December 31, 2006.

F-22

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

In accordance with purchase agreement concluded onacquisition of Mechel Targoviste and Mechel Campia Turzii, on different datethroughout 2006 and 2005 the Group converted long-term debt of these twocompanies into shares. As a result of these conversions, the Group’s share wasincreased by 2.94% and 2.62% in Mechel Targoviste and by 1.63% and 3.9% inMechel Campia Turzii, in 2006 and 2005, respectively.

On different dates throughout 2006, SKCC acquired1.21% of its own voting stock for $14,589 paid in cash. The purchase ofminority interests was accounted for using the purchase method of accounting.In October 2006, SKCC acquired small additional interest in KrasnogorskOPM, Tomusinsk Transportation Center and Lenin Mine, for a total of $1,116, andimmediately after these acquisitions SKCC merged with these mines through theissuance of additional shares (see Note 19). As a result of these transactions,SKCC minority interest was reduced by $2,134.

The Group has accountedfor the purchases of minority interest under the purchase method of accounting.

**(n)**          Proforma condensed consolidated income statement data (unaudited)

Thefollowing unaudited pro forma condensed consolidated income statementinformation for (i) 12 months ended December 31, 2006, giveseffect to the business combinations that occurred in 2006, as if they hadoccurred at the beginning of 2006 and (ii) 12 months ended December 31,2005, gives effect to the business combinations that occurred in 2006 and 2005,as if they had occurred at the beginning of 2005:

| ** **           | ** ** | **Year ended December 31,** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| Revenue, net         |       | 4,427,042                                  |       | 3,835,041 |   |
| Net income           |       | 659,980                                    |       | 437,287 |   |
| Net income per share |       | 1.61                                       |       | 1.08 |   |

 

Thefollowing unaudited pro forma condensed consolidated income statementinformation for (i) 12 months ended December 31, 2005, giveseffect to the business combinations that occurred in 2005, as if they hadoccurred at the beginning of 2005 and (ii) 12 months ended December 31,2004, gives effect to the business combinations that occurred in 2005 and 2004,as if they had occurred at the beginning of 2004:

| ** **           | ** ** | **Year ended December 31,** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Revenue, net         |       | 3,805,810                                  |       | 3,706,781 |   |
| Net income           |       | 380,555                                    |       | 1,345,375 |   |
| Net income per share |       | 0.94                                       |       | 3.60 |   |

 

These unaudited pro formaamounts are provided for informational purposes only and do not purport topresent the results of operations of the Group had the transactions assumedtherein occurred on or as of the date indicated, nor is it necessarilyindicative of the results of operations which may be achieved in the future.

F-23

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**3.**                 SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES

**a)**               Basisof accounting

Russian affiliates and subsidiaries of the Groupmaintain their books and records in Russian rubles and prepare accountingreports in accordance with the accounting principles and practices mandated byRussian Accounting Regulations (“RAR”). Certain other foreign subsidiaries andaffiliates maintain their books and records in different foreign currencies andprepare accounting reports in accordance with generally accepted accountingprinciples (“GAAP”) in various jurisdictions. The financial statements andaccounting reports for the Group and its subsidiaries and affiliates for thepurposes of preparation of these consolidated financial statements inaccordance with generally accepted accounting principles in the United Statesof America (“U.S. GAAP”) have been translated and adjusted on the basis of therespective standalone Russian statutory or other GAAP financial statements.

The accompanying consolidated financial statementsdiffer from the financial statements issued for Russian statutory and otherGAAP purposes in that they reflect certain adjustments, not recorded in thestatutory books, which are appropriate to present the financial position,results of operations and cash flows in accordance with U.S. GAAP. Theprincipal adjustments relate to: (1) purchase accounting; (2) recognitionof interest expense and certain operating expenses; (3) valuation anddepreciation of property, plant and equipment and mineral licenses; (4) foreigncurrency translation; (5) deferred income taxes; (6) accounting fortax penalties; (7) revenue recognition, (8) valuation allowances forunrecoverable assets, and (9) recording at fair value of investments.

**b)**               Basisof consolidation

The consolidated financialstatements of the Group include the accounts of all majority owned subsidiarieswhere no minority shareholder or group of minority shareholders exercisessubstantive participating rights. Investments in companies that the Group doesnot control, but has the ability to exercise significant influence over theiroperating and financial policies, are accounted for under the equity method.Accordingly, the Group’s share of net earnings and losses from these companiesis included in the consolidated income statements as income from equityinvestments. All other investments in equity securities are recorded at cost. Intercompanyprofits, transactions and balances have been eliminated in consolidation.

**c)**                Goodwilland negative goodwill

Purchase price has been allocated to the fair value ofnet assets acquired. Purchase price in excess of the fair value of identifiedassets and liabilities acquired was capitalized as goodwill. The excess of thefair value of net assets acquired over cost is called negative goodwill, andwas allocated to the acquired non-current assets, except for deferred taxes, ifany, until they were reduced to zero.

For the investeesaccounted for under the equity method, the excess of cost of the stock of thosecompanies over the Group’s share of fair value of their net assets as of theacquisition date is treated as goodwill embedded in the investment account.Goodwill arising from equity method investments is not amortized, but testedfor impairment on annual basis.

F-24

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**d)**               Minority interest

Minority interests in thenet assets and net results of consolidated subsidiaries are shown under “Minorityinterest” in the accompanying consolidated balance sheets and incomestatements. Minority interests in the net liabilities of acquired companieswere recorded as additional goodwill, and when subsequently acquired, reversed.For majority-owned subsidiaries that incur losses, the Group’s recognizes 100%of the losses, after first reducing the related minority interests’ balances tozero, unless minority shareholders committed to fund the losses.

Further, when amajority-owned subsidiary becomes profitable, the Group recognizes 100% ofprofits until such time as the excess losses previously recorded have beenrecovered. Thereafter, the Group recognizes profits in accordance with theunderlying ownership percentage.

**e)**                Reporting andfunctional currencies

The Group has determinedits reporting currency to be the U.S. dollar. The functional currencies forRussian and Romanian subsidiaries of the Group are the ruble and the Romanianlei, respectively. As the economy of Romania was considered highly inflationarythrough September 30, 2004, transactions and balances of respectivedomestic operations not already measured in U.S. dollars were re-measured as ifthe functional currency were the U.S. dollar, in accordance with the relevantprovisions of SFAS No. 52, “Foreign Currency Translation”. The objectiveof this re-measurement process is to produce the same results that would havebeen reported if the accounting records had been kept in U.S. dollars. Underthis method, monetary assets and liabilities have been translated using theexchange rate as of the balance sheet dates. Non-monetary assets andliabilities, including non-current non-monetary assets, liabilities andshareholders’ equity, are stated at their actual dollar cost or are restatedfrom their historic cost, by applying the historical exchange rate as at thedate of the original transaction. Income and expenses are restated by applyingthe annual average exchange rates. Items in the statement of cash flows aretranslated at the annual average exchange rates and where applicable at theexchange rates on the dates of the transactions. Foreign currency differencesarising from re-measurement of the local currencies to U.S. dollars areincluded in the consolidated income statement as “Foreign exchange gain (loss)”.

The U.S. dollar is thefunctional currency of the other international operations of the Group.

Effective October 1,2004, Romania no longer meets the criteria for highly inflationary economiesfor purposes of applying SFAS No. 52. Accordingly, for the periodsstarting October 1, 2004, respectively, Mechel’s Romanian subsidiaries nolonger re-measure transactions and balances from their functional currency inlei into reporting currency in U.S. dollars but translate lei into U.S. dollarsusing the current rate method as prescribed by SFAS No. 52. Thetranslation adjustments resulting from the process of translating financial statementsfrom the functional currency into the reporting currency are included indetermining other comprehensive income. Mechel’s Russian subsidiaries translaterubles into U.S. dollars using the current rate method as prescribed by SFAS No. 52for all periods presented.

**f)**                  Managementestimates

The preparation of theconsolidated financial statements requires management to make estimates andassumptions that affect the reported carrying amounts of assets andliabilities, and disclosure of contingent 

F-25

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

assets andliabilities as of the date of the financial statements, and the amounts ofrevenues and expenses recognized during the reporting period. Actual resultscould differ from those estimates.

**g)**                Property,plant and equipment

Property, plant andequipment is recorded at cost less accumulated depletion and depreciation.Property, plant and equipment acquired in business combinations are initiallyrecorded at their respective fair values as determined by independentappraisers in accordance with the requirements of SFAS No. 141. For thepurpose of determining the carrying amounts of the property, plant andequipment pertaining to interests of non-controlling shareholders in businesscombinations when less than a 100% interest is acquired, the Group usesappraised fair values as of the acquisition dates in the absence of reliableand accurate historical cost bases for property, plant and equipment, whichrepresents a departure from US GAAP. The portion of minority interest notrelated to property, plant and equipment is determined based on the historicalcost of assets and liabilities.

**h)**               Miningassets and processing plant and equipment

Mineral exploration costs incurred prior toestablishing proven and probable reserves for a given property are expensed asincurred. Proven and probable reserves are established based on independentfeasibility studies and appraisals performed by mining engineers. Noexploration costs were capitalized prior to the point when proven and probablereserves are established. Reserves are defined as that part of a mineraldeposit, which could be economically and legally extracted or produced at thetime of the reserve determination. Proven reserves are defined as reserves forwhich (a) quantity is computed from dimensions revealed in outcrops,trenches, workings or drill holes; grade and/or quality are computed from theresults of detailed sampling and (b) the sites for inspection, samplingand measurement are spaced so closely and the geologic character is so welldefined that size, shape, depth and mineral content of reserves are well-established.Probable reserves are defined as reserves for which quantity and grade and/orquality are computed from information similar to that used for proven reserves,but the sites for inspection, sampling, and measurement are farther apart orare otherwise less adequately spaced. Accordingly, the degree of assurance,although lower than that for proven reserves, is high enough to assumecontinuity between points of observation. No exploration costs were capitalizedduring the years presented.

Development costs are capitalized beginning afterproven and probable reserves are established. At the Group’s surface mines,these costs include costs to further delineate the mineral deposits andinitially expose the mineral deposits. Additionally, interest expense allocableto the cost of developing mining properties and to constructing new facilitiesis capitalized until assets are ready for their intended use.

Expenditures for betterments are capitalized, whilecosts related to maintenance (turnarounds) are expensed as incurred. Inaddition, cost incurred to maintain current production capacity at a mine andexploration expenditures are charged to expenses as incurred.

When mining assets and processing plant and equipmentare placed in production, the applicable capitalized costs, including minedevelopment costs, are depleted using the unit-of-production method at theratio of tonnes of minerals mined or processed to the estimated proven andprobable mineral reserves 

F-26

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

that are expected to bemined during the estimated lives of the mines or license term, whichever isshorter determined on a mine by mine basis as estimated with the assistance ofindependent mining engineers.

A decision to abandon,reduce or expand activity on a specific mine is based upon many factors,including general and specific assessments of mineral reserves, anticipatedfuture mineral prices, anticipated costs of developing and operating aproducing mine, the expiration date of mineral licenses, and the likelihoodthat the Group will continue exploration on the mine. Based on the results atthe conclusion of each phase of an exploration program, properties that are noteconomically feasible for production are re-evaluated to determine if futureexploration is warranted and that carrying values are appropriate. The ultimaterecovery of these costs depends on the discovery and development of economicore reserves or the sale of the companies owning such mineral rights.

**i)**                  Otherproperty, plant and equipment

Capitalized production costs for internally developedassets include material, direct labor costs, and allocable material andmanufacturing overhead costs. When construction activities are performed overan extended period, interest costs incurred during construction arecapitalized. Construction-in-progress and equipment held for installation arenot depreciated until the constructed or installed asset is substantially readyfor its intended use.

The costs of planned major maintenance activities arerecorded as the costs are actually incurred and are not accrued in advance ofthe planned maintenance. Costs for activities that lead to the prolongation ofuseful life or to expanded future use capabilities of an asset are capitalized.Maintenance and repair costs are expensed as incurred.

Property, plant and equipment are depreciated usingthe straight-line method. Upon sale or retirement, the acquisition orproduction cost and related accumulated depreciation are removed from thebalance sheet and any gain or loss is included in the consolidated incomestatement.

Thefollowing useful lives are used as a basis for calculating depreciation:

| **Category of asset**                                | ** ** | ** ** | ** **         | **Useful economic lives  estimates, years** | ** ** |
|----------------------------------------------------------------|------------|------------|--------------------|------------------------------------------------------------|------------|
| Buildings                                                      |       |       | 20 - 45            |                                                       |       |
| Land improvements                                              |       |       | 20 - 50            |                                                       |       |
| Operating  machinery and equipment, including transfer devices |       |       |   7 - 30 |                                                       |       |
| Transportation  equipment and vehicles                         |       |       |   4 - 15 |                                                       |       |
| Tools, furniture,  fixtures and other                          |       |       |   4 - 8  |                                                       |       |

 

**j)**                  Minerallicenses

Mineral licenses includecapitalized costs incurred to develop mineral resources and the rights (licenses)to develop mineral reserves and resources acquired upon acquisition of certainGroup subsidiaries, net of accumulated amortization. Although immaterial todate since acquisition of the subsidiaries holding licenses, the Groupcapitalizes development costs incurred in relation to the development of newproven and probable reserves. The mineral licenses acquired in businesscombinations 

F-27

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

arerecorded in accordance with the provisions of SFAS No. 141 at their fairvalues at the date of acquisition, based on the appraised fair value. Fairvalue of the acquired mineral licenses is based on independent mining engineerappraisals for proven and probable reserves during the license term. Minerallicenses are amortized using the units-of-production method over the shorter ofthe license term or the estimated proven and probable reserve depletion period.

**k)**               Intangibleassets

Intangible assets withdeterminable useful lives are amortized using the straight-line method overtheir estimated period of benefit, ranging from two to sixteen years.Indefinite-lived intangibles are evaluated annually for impairment or whenindicators exist indicating such assets may be impaired, such evaluationassumes determination of fair value of intangible assets based on a valuationmodel that incorporates expected future cash flows and profitabilityprojections.

**l)**                  Long-livedassets impairment, including definite-lived intangibles and goodwill

The Group follows the requirements of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”),which addresses financial accounting and reporting for the impairment anddisposal of long-lived assets, and SFAS No. 142, “Goodwill and OtherIntangible Assets” (“SFAS No. 142”), with respect to impairment ofgoodwill. The Group reviews the carrying value of its long-lived assets,including property, plant and equipment, investments, goodwill, licenses to usemineral reserves (inclusive of capitalized costs related to assets retirementobligations (ARO)), and intangible assets, for impairment whenever events orchanges in circumstances indicate that the carrying amount of such assets maynot be fully recoverable as prescribed by SFAS No. 144 and SFAS No. 142.Recoverability of long-lived assets, excluding goodwill, is assessed by acomparison of the carrying amount of the asset (or the group of assets,including the asset in question, that represents the lowest level ofseparately-identifiable cash flows) to the total estimated undiscounted cashflows expected to be generated by the asset or group of assets. If theestimated future net undiscounted cash flows are less than the carrying amountof the asset or group of assets, the asset or group of assets is considered impairedand expense is recognized equal to the amount required to reduce the carryingamount of the asset or group of assets to their fair value. Fair value isdetermined by discounting the cash flows expected to be generated by the asset,when the quoted market prices are not available for the long-lived assets. Forassets and groups of assets relating to and including the licenses to usemineral reserves, future cash flows include estimates of recoverable minerals,mineral prices (considering current and historical prices, price trends andother factors), production levels, capital and reclamation costs, all based onthe engineering life of mine plans. Recoverable minerals refer to the estimatedamount that will be obtained from proven and probable reserves. Estimatedfuture cash flows are based on assumptions and are subject to risk anduncertainty. 

SFAS No. 142 prohibits the amortization ofgoodwill and negative goodwill. Instead, goodwill is tested for impairment atleast annually and on an interim basis when an event occurs or circumstanceschange between annual tests that would more-likely-than-not result inimpairment. Under SFAS No. 142, goodwill is assessed for impairment byusing the fair value based method. The Group determines fair value by utilizingdiscounted cash flows. The fair value test required by SFAS No. 142 forgoodwill includes a 

F-28

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

two-step approach. Underthe first step, companies must compare the fair value of a “reporting unit” toits carrying value. A reporting unit is the level at which goodwill impairmentis measured and it is defined as an operating segment or one level below it ifcertain conditions are met. If the fair value of the reporting unit is lessthan its carrying value, goodwill is impaired.

Under step two, the amount of goodwill impairment ismeasured by the amount that the reporting unit’s goodwill carrying valueexceeds the “implied” fair value of goodwill. The implied fair value ofgoodwill can only be determined by deducting the fair value of all tangible andintangible net assets (including unrecognized intangible assets) of thereporting unit from the fair value of the reporting unit (as determined in thefirst step). In this step, the fair value of the reporting unit is allocated toall of the reporting unit’s assets and liabilities (a hypothetical purchaseprice allocation). SFAS No. 142 requires companies to perform theimpairment test at least annually. 

If goodwill and another asset (or asset group) of areporting unit are tested for impairment at the same time, the other asset (orasset group) shall be tested for impairment before goodwill. If the asset groupwas impaired, the impairment loss would be recognized prior to goodwill beingtested for impairment.

In December 2005, theGroup decided to restructure the production process in Mechel Targoviste S.A.and Mechel Campia Turzii S.A. (Steel segment) in order to increase theirefficiency and profitability. As a result of this restructuring certainproduction workshops of Mechel Targoviste S.A. and Mechel Campia Turzii S.A.were closed and abandoned in early 2006 with property, plant and equipmentbeing disposed of other than by sale. As of December 31, 2005, thecarrying value of property, plant and equipment of these workshops was $5,825for Mechel Targoviste S.A. and $6,842 for Mechel Campia Turzii S.A. and waswritten off in full amount. As of December 31, 2006, and December 31,2005, the Group reviewed the remaining property, plant and equipment of theseRomanian subsidiaries for impairment. As a result of such impairment analysis,the Group did not consider the assets impaired.

**m)**           Financelease

The cost of equipmentacquired under the capital (finance) lease contracts is measured at lower ofits fair value or the present value of the minimum lease payments, and reflectedin the balance sheet in full amount less accumulated depreciation. The cost ofthe equipment is subject to an annual impairment review. Capital leaseliabilities are divided into long-term and current portion based on the agreedpayment schedule and discounted using the lessor’s implicit interest rate.Depreciation of assets acquired under the capital (finance) lease is includedinto depreciation charge for the period.

**n)**               Inventories

Inventories are stated at the lower ofacquisition/manufacturing cost or market value. Cost is determined on aweighted average basis and includes all costs in bringing the inventory to itspresent location and condition. The elements of costs include direct material,labor and allocable material and manufacturing overhead.

F-29

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Costs of production in process and finished goodsinclude the purchase costs of raw materials and conversion costs such as directlabor and allocation of fixed and variable production overheads. Raw materialsare valued at a purchase cost inclusive of freight and other shipping costs.

Coal, nickel and iron ore inventory costs includedirect labor, supplies, depreciation of equipment, depletion of mining assetsand amortization of licenses to use mineral reserves, mine operating overheadsand other related costs.

Market value is theestimated price at which inventories can be sold in the normal course ofbusiness after allowing for the cost of completion and sale.

**o)**               Accountsreceivable

Accounts receivable arestated at net realizable value. If receivables are deemed doubtful, bad debtexpense and a corresponding allowance for doubtful accounts is recorded. Ifreceivables are deemed uncollectible, the related receivable balance is chargedoff. Recoveries of receivables previously charged off are recorded whenreceived. Receivables that do not bear interest or bear below market interestrates and have an expected term of more than one year are discounted with thediscount subsequently amortized to interest income over the term of thereceivable. The Group reviews the valuation of accounts receivable on a regularbasis. The amount of provision for doubtful debts is calculated based on theageing of balances in accordance with contract terms. The Group appliesspecific rates to overdue balances of its subsidiaries depending on the historyof cash collections and future expectations of conditions that might impact thecollectibility of accounts of each individual subsidiary. Accounts receivable,which are considered non-recoverable (those aged over 3 years or due frombankrupt entities) are written-off against provision or charged off tooperating expenses (if no provision was created in previous periods).

**p)**               Cashand cash equivalents

Cash and cash equivalentscomprise cash on hand and in transit, checks and deposits with banks, as wellas other bank deposits with an original maturity of three months or less.

**q)**               Retirementbenefit obligations

The Group’s Russian subsidiaries are legally obligatedto make defined contributions to the Russian Pension Fund, managed by theRussian Federation Social Security (a defined contribution plan financed on apay-as-you-go basis). The Group’s contributions to the Russian Pension Fundrelating to defined contribution plans are charged to income in the year towhich they relate.

Contribution to the Russian Pension Fund together withother social contributions are included within a unified social tax (“UST”),which is calculated by the application of a regressive rate from 26% (appliedto the part of the annual gross salary below 280 thousand rubles orapproximately $10 translated at the exchange rate of the rubles to the U.S.dollar at December 31, 2006) to 2% (applied to the part of the annualgross salary above 600 thousand rubles or approximately $21 translated at theexchange rate of the ruble to the U.S. dollar at December 31, 2006) to theannual gross remuneration of each employee. UST is allocated to three socialfunds (including the Russian Pension Fund), where the rate of contributions tothe 

F-30

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Russian Pension Fundvaries from 14% to 5.5%, respectively, depending on the annual gross salary ofeach employee. Contributions to the Russian Pension Fund for the years ended December 31,2006, 2005 and 2004 were $53,276, $47,893, and $39,511, respectively.

In addition, the Group hasa number of defined benefit pension plans that cover the majority of productionemployees. Benefits under these plans are primarily based upon years of serviceand average earnings. The Group accounts for the cost of defined benefit plansusing the projected unit credit method. Under this method, the cost ofproviding pensions is charged to the income statement, so as to attribute thetotal pension cost over the service lives of employees in accordance with thebenefit formula of the plan. The Group’s obligation in respect of definedretirement benefit plans is calculated separately for each defined benefit planby discounting the amounts of future benefits that employees have alreadyearned through their service in the current and prior periods. The discountrate applied represents the yield at the year end on highly rated long-termbonds.

**r)**                Revenuerecognition 

Revenue is recognized on an accrual basis when earnedand realizable, which generally occurs when products are delivered tocustomers. In some instances, while title of ownership has been transferred,the revenue recognition criteria are not met as the selling price is subject toadjustment based upon the market prices. Accordingly, in those instances,revenue and the related cost of goods sold are recorded as deferred revenuesand deferred cost of inventory in transit in the consolidated balance sheetsand are not recognized in the consolidated income statement until the pricebecomes fixed and determinable, which typically occurs when the price is settledwith the end-customer. In certain foreign jurisdictions (e.g. Switzerland), theGroup generally retains title to goods sold to end-customers solely to ensurethe collectibility of its accounts receivable. In such instances, all othersales recognition criteria are met, which allows the Group to recognize salesrevenue in conformity with underlying sales contracts. 

Sales are recognized netof applicable provisions for discounts and allowances and associated salestaxes (VAT) and export duties. 

**s)**                Advertisingcosts

Advertising costs areexpensed as incurred. During the years ended December 31, 2006, 2005 and2004 advertising costs were insignificant. 

**t)**                  Shippingand handling costs

The Group classifies allamounts billed to customers in a sale transaction and related to shipping andhandling as part of sales revenue and all related shipping and handling costsas selling, distribution and operating expenses. These costs totaled $349,952,$389,598 and $326,393 for the years ended December 31, 2006, 2005 and2004, respectively.

F-31

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**u)**               Incometaxes

Provision is made in the financial statements fortaxation of profits in accordance with applicable legislation currently inforce. The Group accounts for income taxes under the liability method inaccordance with SFAS No. 109, “Accounting for Income Taxes”, and relatedinterpretations. Under the liability method, deferred income taxes reflect thefuture tax consequences of temporary differences between the tax and financialstatement bases of assets and liabilities and are measured using enacted taxrates to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in the tax rates is recognized in income inthe period that includes the enactment date. A valuation allowance is providedwhen it is more likely than not that some or all of the deferred tax assetswill not be realized in the future. These evaluations are based on theexpectations of future taxable income and reversals of the various taxabletemporary differences. 

The Group did notrecognize deferred tax liabilities or assets for those differences relating toassets and liabilities of its Romanian subsidiaries that, under SFAS No. 52,are re-measured from the local currency into the functional currency usinghistorical exchange rates and that result from changes in exchange rates or indexingfor tax purposes until September 30, 2004, as Romanian economy wasconsidered hyper-inflationary. The deferred tax effect associated with thetemporary differences that arose from the change in the functional currency ofthe Group’s Romanian subsidiaries (from U.S. dollar to lei) and when Romaniaceased to be considered hyper-inflationary on October 1, 2004, wasreflected as an adjustment to the cumulative translation adjustment componentof accumulated other comprehensive income on October 1, 2004. 

**v)**                Comprehensiveincome 

SFAS No. 130, “ReportingComprehensive Income”, requires the reporting of comprehensive income inaddition to net income. Accumulated other comprehensive income includes foreigncurrency translation adjustments, unrealized holding gains and losses onavailable-for-sale securities and on derivative financial instruments, as wellas pension liabilities not recognized as net periodic pension cost. For theyears ended December 31, 2006, 2005 and 2004, as a result of the change infunctional currency as described in Note 3(e), in addition to the netincome, total comprehensive income included the effect of translation of thefinancial statements denominated in currencies other than the reportingcurrency, in accordance with SFAS No. 52, and adjustments ofavailable-for-sale securities.

Accumulatedother comprehensive income is comprised of the following components: 

| ** **                                                | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Cumulative  translation adjustment                        |       |                            | 191,135     |                            |       |   | 42,215 |   |   |
| Unrealized gains  (loss) on available-for-sale securities |       |                            | 11,034      |                            |       |   | (169 | ) |   |
| Pension  adjustments (Note 17)                            |       |                            | (13,951     | )                               |       |   | — |   |   |
| **Total  other comprehensive income**                     | ** ** | ** **                      | **188,218** |                            | ** ** | ** ** | **42,046** |   |   |

 

F-32

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**w)**              Stock-basedcompensation 

Effective January 1, 2006, the Group adopted thefair-value method of accounting for employee stock-compensation costs asoutlined in SFAS No. 123(r), “Share-Based Payment”. Prior to that date,the Group used the intrinsic-value method in accordance with requirements ofAPB Opinion No. 25. 

The Group does not presentpro forma disclosures of results of operations as if the fair value method hadbeen applied as of January 1, 2004, since the result would besubstantially the same when compared to the intrinsic method applied inaccordance with APB Opinion No. 25. 

**x)**                Segmentreporting 

According to SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information”, segment reporting followsthe internal organizational and reporting structure of the Group. Correspondingto the main products and services the Group’s organization comprises twobusiness segments: 

Steel segment, comprising production and sales ofsemi-finished steel products, carbon and specialty long products, carbon andstainless flat products, value-added downstream metal products, includingforgings, stampings, hardware and coke products. 

Mining segment, comprisingproduction and sales of coal (coking and steam), iron ore and nickel, whichsupplies raw materials to the Steel segment and also sells substantial amountsof raw materials to third parties. 

**y)**                Financialinstruments 

The carrying amount of theGroup’s financial instruments, which include cash equivalents, marketablesecurities, non-marketable debt securities, cost method investments, accountsreceivable and accounts payable approximates their fair value at December 31,2006 and 2005. For long-term borrowings, the difference between the fair valueand carrying value was not material. The Group, using available marketinformation and appropriate valuation methodologies, such as discounted cashflows, has determined the estimated fair values of financial instruments. Sincedifferent entities are located and operate in different regions of Russia andelsewhere with different business and financial market characteristics, thereare generally very limited or no comparable market values available to assessthe fair value of the Group’s debt and other financial instruments. The costmethod investments are shares of Russian companies that are not publicly tradedand their market value is not available. It is not practicable for the Group toestimate the fair value of these investments for which a quoted market price isnot available because it has not yet obtained or developed the valuation modelnecessary to make the estimate, and the cost of obtaining an independentvaluation would be excessive considering the materiality of the instruments tothe Group. Therefore, such investments are recorded at cost (also see Notes 8and 9). 

**z)**                Derivativeinstruments and hedging activities 

The Group recognizes allits derivative instruments as either assets or liabilities at fair value inaccordance with SFAS No. 133, “Accounting for Derivative instruments andHedging Activities”, and 

F-33

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

relatedinterpretations. The accounting for changes in the fair value of a derivativeinstrument depends on whether it has been designated and qualifies as anaccounting hedge and further, on the type of hedging relationship. For theyears ended December 31, 2006, 2005 and 2004, the Group did not have anyderivatives designated as hedging instruments. Therefore, the gain or loss on aderivative instruments held by the Group was recognized currently in income.The net gain (loss) of $207, $(418) and $(1,480) related to the change in thefair value of the derivative instruments was included in the net foreignexchange gain (loss) in the accompanying consolidated income statements for theyears ended December 31, 2006, 2005 and 2004, respectively. There were noforeign currency forward and options contracts outstanding as of December 31,2006 and 2005. 

**aa)**        Investments

The Group recognizes allits debt and equity investments in accordance with SFAS No. 115, “Accountingfor Certain Investments in Debt and Equity Securities”. At the acquisition, theGroup classifies debt and equity securities into one of three categories:held-to-maturity, available-for-sale or trading. At each reporting date theGroup reassesses appropriateness of the classification. 

***Held-to-maturity securities***

Investments in debtsecurities that the Group has both the ability and the intent to hold tomaturity are classified as held-to-maturity and measured at amortized cost inthe consolidated financial statements. 

***Trading securities***

Investments (debt orequity), which the Group intends to sell in the near term, and which areusually acquired as part of the Group’s established strategy to buy and sell,generating profits based on short-term price movements, are classified by theGroup as trading securities. Changes in fair value of trading securities arerecognized in earnings. 

***Available-for-sale securities***

Investments (debt orequity), which are not classified as held-to-maturity or trading are classifiedas available-for-sale. Change in their fair value is reflected in othercomprehensive income. 

***Recoverability of equity method and other investments***

Management periodically assesses the recoverability ofits equity method and other investments. For investments in publicly tradedentities, readily available quoted market prices are an indication of the fairvalue of the investments. For investments in non-publicly traded entities, ifan identified event or change in circumstances requires an evaluation,management assesses their fair value based on valuation techniques includingdiscounted cash flow estimates or sales proceeds, external appraisals andmarket prices of similar investments as appropriate. 

F-34

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Management considers theassumptions that a hypothetical market place participant would use in hisanalysis of discounted cash flows models and estimates of sales proceeds. If aninvestment is considered to be impaired and the decline in value is other thantemporary, the Group records an impairment loss. 

**bb)**        Concentrationof credit and other risks 

Financial instruments, which potentially expose theGroup to concentrations of credit risk, consist primarily of cash and cashequivalents, short-term and long-term investments, trade accounts receivableand other receivables. Generally, the Group does not require any collateral tobe pledged in connection with its investments in the above financialinstruments. 

Thefollowing table presents the exchange rates for the functional and operatingcurrencies at various subsidiaries, other than the reporting currency: 

| ** **       | ** ** | **At June 27,** | ** ** | **Year end rates*  at December 31,** | ** ** | **Average exchange rates* for the  years ended December 31,** | ** ** |
|------------------|------------|---------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| **Currency**     | ** ** | ** **                | ** ** | **2007**                                                 | ** ** | **2006**                                                                                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Russian ruble    |       |                      | 25.78      |                                                     |       | 26.33                                                                                       |       | 28.78 |   | 27.75 |   | 27.19 |   | 28.29 |   | 28.82 |   |
| Swiss franc      |       |                      | 1.23       |                                                     |       | 1.22                                                                                        |       | 1.31 |   | 1.13 |   | 1.25 |   | 1.24 |   | 1.24 |   |
| Euro             |       |                      | 0.74       |                                                     |       | 0.76                                                                                        |       | 0.84 |   | 0.73 |   | 0.80 |   | 0.80 |   | 0.81 |   |
| Romanian lei**   |       |                      | 2.37       |                                                     |       | 2.57                                                                                        |       | 3.11 |   | 29,067 |   | 2.81 |   | 2.91 |   | 32,637 |   |
| Croatian kuna    |       |                      | 5.44       |                                                     |       | 5.58                                                                                        |       | 6.23 |   | 5.64 |   | 5.58 |   | 5.97 |   | 6.04 |   |
| Lithuania lit    |       |                      | 2.57       |                                                     |       | 2.63                                                                                        |       | 2.91 |   | 2.53 |   | 2.75 |   | 2.77 |   | 2.78 |   |
| Kazakhstan tenge |       |                      | 123.99     |                                                     |       | 127.00                                                                                      |       | 133.66 |   | 130.00 |   | 126.09 |   | 132.67 |   | 136.04 |   |
|                  |            |                           |            |                                                          |            |                                                                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

*                    Exchange ratesshown in local currency units for one U.S. dollar

**             On July 1, 2005,Romanian lei was denominated in proportion 1/10,000

The majority of the balances and operations notalready denominated in the reporting currency were denominated in the Russianruble, Romanian lei, Swiss franc and euro.

The Russian ruble is not aconvertible currency outside the territory of Russia. Official exchange ratesare determined daily by the Central Bank of Russia (“CBR”) and are generallyconsidered to be a reasonable approximation of market rates.

**cc)**          Reclassifications

Certain reclassificationshave been made to the prior years’ consolidated financial statements to conformto the current year presentation. Such reclassifications have no impact on netincome or shareholders’ equity.

F-35

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**dd)**        Recentlyissued accounting pronouncements

***How Taxes Collectedfrom Customers and Remitted to Governmental Authorities Should Be Presented inthe Income Statement (That Is, Gross versus Net Presentation)***

In March 2006, EITFreached consensus on Issue No. 06-3, “How Taxes Collected from Customersand Remitted to Governmental Authorities Should Be Presented in the IncomeStatement (That Is, Gross versus Net Presentation)” (“EITF 06-3”), whichconcludes that for taxes within the scope of the issue, a company may adopt apolicy of presenting taxes either gross within revenue or net. That is, it mayinclude charges to customers for taxes within revenues and the charge for thetaxes from the taxing authority within cost of sales, or, alternatively, it maynet the charge to the customer and the charge from the taxing authority. Iftaxes subject to this Issue are significant, a company is required to discloseits accounting policy for presenting taxes and the amounts of such taxes thatare recognized on a gross basis. The guidance in EITF 06-3 is effective for thefirst interim reporting period beginning after December 15, 2006, withearly application of this guidance permitted. The Group will begin applying theprovisions of this statement in 2007. The adoption of EITF 06-3 is not expectedto have a material impact on the Group’s financial position and results ofoperations.

***Accounting for Servicing of Financial Assets***

In March 2006, theFASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—anamendment of FASB Statement No. 140 (“SFAS No. 156”), which changesthe requirements of accounting for servicing of financial assets. SFAS No. 156requires an entity to recognize a servicing asset or servicing liability eachtime it undertakes an obligation to service a financial asset by entering intoa servicing contract. In addition, all separately recognized servicing assetsand servicing liabilities are to be initially measured at fair value. SFAS No. 156is effective as of beginning of the first fiscal year that begins after September 15,2006. The Group will begin applying the provisions of this statement in 2007.The adoption of SFAS No. 156 is not expected to have a material impact onthe Group’s financial position and results of operations.

***Accounting for Uncertainty in Income Taxes***

In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes—An Interpretation of FASB Statement No. 109” (“FIN 48”),effective for fiscal years beginning after December 15, 2006. FIN 48prescribes the minimum recognition threshold a tax position must meet beforebeing recognized in the financial statements and provides guidance onderecognition, measurement, classification, interest and penalties, accountingin interim periods, disclosure and transition. The Group estimates that theadoption of FIN 48 will result in a $68,000 to $100,000 increase of its taxliabilities, which would be accounted for as a cumulative adjustment to the January 1,2007 retained earnings.

***Fair Value Measurements***

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).SFAS No. 157 defines fair value, establishes a framework for measuringfair value and requires enhanced disclosures about fair value measurements.SFAS No. 157 requires companies to disclose the fair value of 

F-36

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

theirfinancial instruments according to a fair value hierarchy as defined in thestandard. Additionally, companies are required to provide enhanced disclosureregarding financial instruments in one of the categories (level 3), including areconciliation of the beginning and ending balances separately for each majorcategory of assets and liabilities. SFAS No. 157 is effective forfinancial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years, that the Group does notexpect the adoption of SFAS No. 157 to have a material impact on the Group’sfinancial position and results of operation.

***Employers’ Accounting for Defined Benefit Pension andOther Post-Retirement Plans***

On September 29,2006, the FASB issued SFAS No. 158, “Employers’ Accounting for DefinedBenefit Pension and Other Post-Retirement Plans, an amendment of FASBStatements No. 87, 88, 106 and 132(R)” ( “ SFAS No. 158”). Thestandard is effective for fiscal years ending after December 15, 2006, andrequires the Group to:

·       recognizethe funded status of the Company’s defined benefit plans in its consolidatedfinancial statements;

·       recognizeas a component of other comprehensive income any actuarial gains and losses andprior service costs and credits that arise during the period but are notimmediately recognized as components of net periodic benefit cost;

·       measuredefined benefit plan assets and obligations as of the Group’s fiscal year end.

The standard is effectivefor fiscal years ending after December 15, 2006. The Group adoption ofSFAS No. 158 in 2006 resulted in the increase in recognized pensionbenefit obligations by $9,282 with a corresponding decrease in othercomprehensive income (see Note 17).

***Fair Value option for Financial Assets and FinancialLiabilities***

On February 15, 2007, the FASB issued SFAS No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities—Includingan Amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159permits an entity to choose to measure many financial instruments and certainother items at fair value.

Most provisions of SFAS No. 159 are elective;however, the amendment to SFAS No. 115, “Accounting for CertainInvestments in Debt and Equity Securities”, applies to all entities withavailable-for-sale and trading securities.

The fair value option established by SFAS No. 159permits all entities to choose to measure eligible items at fair value atspecified election dates. A business entity will report unrealized gains andlosses on items for which the fair value option has been elected in earnings(or another performance indicator if the business entity does not reportearnings) at each subsequent reporting date.

F-37

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

The fair valueoption:

·       maybe applied instrument by instrument, with a few exceptions, such as investmentsotherwise accounted for by the equity method; 

·       isirrevocable (unless a new election date occurs); and

·       isapplied only to entire instruments and not to portions of instruments.

SFAS No. 159 is effective as of the beginning ofan entity’s first fiscal year that begins after November 15, 2007.

The Group does not expectthe adoption of SFAS No. 159 to have a material impact on the Group’sfinancial position or results of operations.

***Effect of Prior Year Misstatements when QualifyingMisstatements in Current Year Financial Statements***

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effectof Prior Year Misstatements when Qualifying Misstatements in Current YearFinancial Statements” (“SAB No. 108”). SAB No. 108 provides guidanceon the consideration of the effects of prior year misstatements in qualifyingcurrent year misstatements for the purpose of a materiality assessment. SABNo.108 establishes a dual approach that requires qualification of financialstatement errors based on both the roll-over method and iron curtain methodregarding the effects of each of the Group’s balance sheets and statement ofoperations and the related financial statement disclosures. SAB No.108 permitsexisting public companies to record the cumulative effect of initially applyingthis approach in the first reporting period ending after November 15,2006, by recording the necessary correcting adjustments to the carrying valuesof assets and liabilities as at the beginning of that year with the offsettingadjustments recorded to the opening balance of retained earnings. The adoptionof SAB No. 108 did not have an impact of the Company’s financialstatements.

**4.**                 CASH AND CASHEQUIVALENTS

Cashand cash equivalents are comprised of:

| ** **                           | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Russian ruble  bank deposits         |       |                            | 111,191     |                            |       |   | 30,611 |   |   |
| USD bank deposits                    |       |                            | 37,881      |                            |       |   | 106,639 |   |   |
| EURO bank deposits                   |       |                            | 20,583      |                            |       |   | 164,784 |   |   |
| Other                                |       |                            | 2,959       |                            |       |   | 9,741 |   |   |
| **Total  cash and cash equivalents** | ** ** | ** **                      | **172,614** |                            | ** ** | ** ** | **311,775** |   |   |

 

As of December 31, 2006, $1,528 and $319,included in USD and EURO bank deposits, respectively, were restricted for usein accordance with loan agreement with Raiffeisenbank and guarantee provided byBNP Paribas to a customer at the request of one of the Group’s foreignsubsidiaries.

F-38

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**5.**                 ACCOUNTSRECEIVABLE, NET

Accountsreceivable, net are comprised of:

| ** **                           | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Domestic  customers                  |       |                            | 138,320     |                            |       |   | 48,385 |   |   |
| Foreign customers                    |       |                            | 72,444      |                            |       |   | 109,773 |   |   |
| Total accounts receivable            |       |                            | 210,764     |                            |       |   | 158,158 |   |   |
| Less allowance for doubtful accounts |       |                            | (19,592     | )                               |       |   | (17,509 | ) |   |
| **Total  accounts receivable, net**  | ** ** | ** **                      | **191,172** |                            | ** ** | ** ** | **140,649** |   |   |

 

Thefollowing summarizes the changes in the allowance for doubtful accounts for theyears ended December 31:

| ** **                                                                           | ** ** | **2006**    | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **Balance  at beginning of year**                                                    |       | (17,509     | )          | (20,850     | )          | (22,276     | )          |
| Provision for doubtful accounts receivable                                           |       | (2,722      | )          | (3,569      | )          | 7,859       |       |
| Accounts receivable written off /(Recovery of accounts  previously written off), net |       | 669         |       | 6,983       |       | (5,900      | )          |
| Provision for doubtful accounts of acquired entities                                 |       | (30         | )          | (73         | )          | (533        | )          |
| **Balance  at the end of year**                                                      | ** ** | **(19,592** | **)**      | **(17,509** | **)**      | **(20,850** | **)**      |

 

**6.**                 INVENTORIES

Inventoriesare comprised of:

| ** **                        | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|-----------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Finished goods                    |       |                            | 214,461     |                            |       |   | 174,173 |   |   |
| Raw materials and purchased parts |       |                            | 311,171     |                            |       |   | 235,782 |   |   |
| Work-in-process                   |       |                            | 127,447     |                            |       |   | 86,703 |   |   |
| **Total  inventories**            | ** ** | ** **                      | **653,079** |                            | ** ** | ** ** | **496,658** |   |   |

 

F-39

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**7.**                 PREPAYMENTS ANDOTHER CURRENT ASSETS

Prepaymentsand other current assets are comprised of:

| ** **                             | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| VAT and other  taxes recoverable       |       |                            | 218,363     |                            |       |   | 277,832 |   |   |
| Prepayments and advances for materials |       |                            | 57,514      |                            |       |   | 34,734 |   |   |
| Other current assets                   |       |                            | 48,723      |                            |       |   | 34,434 |   |   |
| **Total  other current assets**        | ** ** | ** **                      | **324,600** |                            | ** ** | ** ** | **347,000** |   |   |

 

Generally in Russia, VATrelated to sales is payable to the tax authorities on an accrual basis basedupon invoices issued to the customer. VAT incurred for purchases may bereclaimed, subject to certain restrictions, against VAT related to sales. VATrelated to purchase transactions, which is not yet reclaimable against VATrelated to sales as of the balance sheet dates, is recognized in the balancesheets on a gross basis, i.e. as other current assets and taxes and socialcharges payable.

**8.**                 TRADINGSECURITIES

Investmentsin trading securities were as follows as of December 31, 2006:

| ** **                    | ** ** | ** **  | ** ** | ** **          | ** **  | **Unrealized** | ** ** | **Unrealized** | ** ** |
|-------------------------------|------------|-------------|------------|---------------------|-------------|----------------|------------|----------------|------------|
| ** **                    | ** ** | **Cost**    | ** ** | **Fair value** | ** **  | **gains**      | ** ** | **losses**     | ** ** |
| Equity securities             |       | 220,276     |       |                | 270,964     |           |       |           | 50,688     |   |   |   | — |   |   |
| **Total  trading securities** | ** ** | **220,276** | ** ** | ** **          | **270,964** |           | ** ** | ** **     | **50,688** |   | ** ** | ** ** | **—** |   |   |

 

Unrealized gains of$50,688 for trading securities in 2006 represent gains on revaluation oftrading securities held by Moskoks between September 25 and December 31,2006. These investments are comprised mainly of shares of Russian leading banksand oil and gas companies, which are traded at various Russian exchanges thatwere acquired with other assets of Moskoks.

F-40

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**9.**                 LONG-TERMINVESTMENTS

Long-terminvestments are comprised of:

| ** **                               | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Equity method  investments               |       |                            | 428,845     |                            |       |   | 408,377 |   |   |
| Other related parties                    |       |                            | 361         |                            |       |   | 331 |   |   |
| **Total investments in related parties** | ** ** | ** **                      | **429,206** |                            | ** ** | ** ** | **408,708** |   |   |
| Available-for-sale securities            |       |                            | 19,461      |                            |       |   | 4,792 |   |   |
| Cost method investments                  |       |                            | 6,025       |                            |       |   | 5,980 |   |   |
| Other                                    |       |                            | 18,906      |                            |       |   | 5,376 |   |   |
| **Total other long-term investments**    | ** ** | ** **                      | **44,392**  |                            | ** ** | ** ** | **16,148** |   |   |
| **Total  long-term investments**         | ** ** | ** **                      | **473,598** |                            | ** ** | ** ** | **424,856** |   |   |

 

**(a)**          Equitymethod investments

Equitymethod investments are comprised of:

| ** **                                        | ** ** | **Percent voting shares held at** | ** ** | **Investment carrying value at**                      | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **December 31,**                                 | ** ** | **December 31,**                                                | ** ** |
| **Investee**                                      | ** ** | ** **                                            | ** ** | **     2006     ** | ** ** | **     2005          ** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Yakutugol (Mining  segment)                       |       |                                                  | 25         | %                                                                    |       |   | 25 | % |   |   | 416,839 |   |   | 399,522 |   |
| Mechel Energy AG (Conares Eagle) (Mining segment) |       |                                                  | 50         | %                                                                    |       |   | 50 | % |   |   | 5,149 |   |   | 3,417 |   |
| TPTU (Mining segment)                             |       |                                                  | 40         | %                                                                    |       |   | 40 | % |   |   | 3,438 |   |   | 2,654 |   |
| TRMZ (Mining segment)                             |       |                                                  | 25         | %                                                                    |       |   | 25 | % |   |   | 1,864 |   |   | 1,444 |   |
| RIKT (Mining segment)                             |       |                                                  | 36         | %                                                                    |       |   | 36 | % |   |   | 1,555 |   |   | 1,340 |   |
| **Total  equity method investments**              | ** ** |                                                  |       |                                                                 |       |   |   |   | ** ** | ** ** | **428,845** |   | ** ** | **408,377** | ** ** |
|                                                   |            |                                                       |            |                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

25%+1 shares of Yakutugol were acquired by the Groupon January 24, 2005. The core business of Yakutugol is extraction andprocessing of coal (Note 2(f)). Yakutugol experienced losses of $54,511 in2006. As Yakutugol shares are not publicly traded, their market value is notreadily available. Management evaluated the carrying amount of Yakutugol forpotential impairment as of December 31, 2006 using valuation techniquesand assumptions that a market participant would employ to value Yakutugol, andbased on these techniques, concluded that no impairment was necessary. Nevertheless,the majority shareholder of Yakutugol, plans to sell its holding, 75% minus 1share, at a public auction in August 2007. The results of this auction mayadversely affect the carrying amount of Yakutugol.

Mechel Energy AG is a joint venture with U.K. tradingpartners of the Group that facilitates the Group’s sales in Europe.

F-41

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

TRMZ (Tomusinskiy Auto Repair Shop) shares are ownedby Southern Kuzbass Coal Company (SKCC) and its subsidiaries. TRMZ providesrepair services to the Group’s subsidiaries.

TPTU (TomusinskiyTransportation Management Center) shares are owned by SKCC. The core businessis provision of transportation services both to the Group’s subsidiaries andthird parties.

RIKT(Russian-Italian Telephone Company) shares are owned by SKCC and its subsidiaries.The core business is provision of communication services both to the Group’ssubsidiaries and third parties.

As of December 31, 2006, there were no equitymethod investments other than those disclosed in the table above.

Summarizedunaudited financial information on equity method investees as of December 31,2006 and 2005 and for the years then ended is as follows:

| **Income data**       | ** ** | ** **      | ** ** | **2006**        | ** ** | **2005** | ** ** |
|----------------------------|------------|-----------------|------------|-----------------|------------|----------|------------|
| ** **                 | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenues and  other income |       |            | 744,914    |            |       |     | 706,931    |   |   |
| Operating income  (loss)   |       |            | (8,539     | )               |       |     | 83,885     |   |   |
| Net income (loss)          |       |            | (47,483    | )               |       |     | 42,368     |   |   |

 

| ** **                       | ** ** | **At December 31,** | ** ** | **At December 31,** | ** ** |
|----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| **Balance sheet data** | ** ** | ** **                    | ** ** | **2006**                      | ** ** | **2005** | ** ** |
| ** **                       | ** ** | **(unaudited)**               | ** ** | **(unaudited)**               | ** ** |
| Current assets                   |       |                          | 245,026    |                          |       |   | 213,648 |   |   |
| Non-current  assets              |       |                          | 1,980,735  |                          |       |   | 1,855,770 |   |   |
| Current  liabilities             |       |                          | 112,561    |                          |       |   | 93,055 |   |   |
| Non-current liabilities          |       |                          | 632,094    |                          |       |   | 553,057 |   |   |
|                                  |            |                               |            |                               |            |  |  |  |  |  |  |

 

F-42

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Thefollowing table shows movements in the equity method investments:

| ** **                                           | ** ** | ** **     | ** **  | **Share in net**   | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|----------------|-------------|------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **Capital**    | ** **  | **income/(loss) since** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **investment** | ** **  | **acquisition**              | ** ** | **Total**  | ** ** |
| **December 31,  2003**                          | ** ** |           | **1,898**   | ** **                   |       |       | **1,383**  | ** ** |   | **3,281** | ** ** |
| Share in net income                                  |       |           | —      |                         |       |       | 4,621      |   |   | 4,621 |   |
| Disposals through  sales and write-off               |       |           | (549        | )                            |       |       | —     |   |   | (549 | ) |
| **December 31, 2004**                           | ** ** |           | **1,349**   | ** **                   |       |       | **6,004**  | ** ** |   | **7,353** | ** ** |
| Investments                                          |       |           | 412,182     |                         |       |       | —     |   |   | 412,182 |   |
| Translation difference                               |       |           | (18,322     | )                            |       |       | —     |   |   | (18,322 | ) |
| Dividends                                            |       |           | (5,262      | )                            |       |       | —     |   |   | (5,262 | ) |
| Share in net  income                                 |       |           | —      |                         |       |       | 12,426     |   |   | 12,426 |   |
| **December 31, 2005**                           | ** ** |           | **389,947** | ** **                   |       |       | **18,430** | ** ** |   | **408,377** | ** ** |
| Effect of adoption of SFAS No. 158 by Yakutugol |       |           | (2,627      | )                            |       |       | —     |   |   | (2,627 | ) |
| Translation  difference                              |       |           | 37,053      |                         |       |       | —     |   |   | 37,053 |   |
| Dividends                                            |       |           | (4,100      | )                            |       |       | —     |   |   | (4,100 | ) |
| Share in net loss                                    |       |           | —      |                         |       |       | (9,858     | ) |   | (9,858 | ) |
| **December 31,  2006**                          | ** ** |           | **420,273** | ** **                   |       |       | **8,572**  | ** ** |   | **428,845** | ** ** |

 

During the year ended December 31,2006, the Group received cash dividends of $4,100 from equity investees. Cashdividends received from equity investees amounted to $2,000 for the year ended December 31,2005.

**(b)**          Costmethod investments

Cost method investments represent investments inequity securities of various Russian companies, where the Group has less than a20% equity interest and no significant influence. As shares of those Russiancompanies are not publicly traded, their market value is not available and theinvestment is recorded at cost.

The investments were notevaluated for impairment because the Group did not identify any events orchanges in circumstances that may have a significant effect on the fair valueof these investments.

**(c)**           Available-for-salesecurities

Investmentsin available-for-sale securities were as follows as of December 31, 2006:

| ** **                               | ** ** | ** ** | ** ** | ** **          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** |
|------------------------------------------|------------|------------|------------|---------------------|------------|----------------|------------|----------------|------------|
| ** **                               | ** ** | **Cost**   | ** ** | **Fair value** | ** ** | **gains**      | ** ** | **losses**     | ** ** |
| Equity securities                        |       | 8,427      |       |                | 19,461     |           |       |           | 11,034     |   |   |   | — |   |   |
| **Total  available-for-sale securities** | ** ** | **8,427**  | ** ** | ** **          | **19,461** |           | ** ** | ** **     | **11,034** |   | ** ** | ** ** | **—** |   |   |

 

F-43

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

As of December 31, 2006, included in available-for-salesecurities were $5,839 of investments into equity securities ofwell-established Russian energy and oil and gas companies, acquired with otherassets of MosKoks.

Investmentsin available-for-sale securities were as follows as of December 31, 2005:

| ** **                               | ** ** | ** ** | ** ** | ** **          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** |
|------------------------------------------|------------|------------|------------|---------------------|------------|----------------|------------|----------------|------------|
| ** **                               | ** ** | **Cost**   | ** ** | **Fair value** | ** ** | **gains**      | ** ** | **losses**     | ** ** |
| Equity securities                        |       | 4,961      |       |                | 4,792      |           |       |           | —     |   |   |   | (169 | ) |   |
| **Total  available-for-sale securities** | ** ** | **4,961**  | ** ** | ** **          | **4,792**  |           |       |           | —     |   | ** ** | ** ** | **(169** | **)** | ** ** |

 

**10.**          RELATEDPARTIES

Duringthe three years ended December 31, 2006, the Group had the followingtransactions and current balances in settlement with related parties:

| ** **       | ** ** | **2006**      | ** **  | ** ** | ** ** |
|------------------|------------|---------------|-------------|------------|------------|
| ** **       | ** ** | ** **    | ** **  | ** ** | ** ** | **Financing** | ** ** | **Balances at December 31, 2006** | ** ** |
| ** **       | ** ** | ** **    | ** **  | ** ** | ** ** | **provided** | ** ** | **Receivable** | ** ** | **Payable** | ** ** | **Total** | ** ** |
| ** **       | ** ** | **Purchases** | ** **  | **Sales**  | ** ** | **(received), net** | ** ** | **from** | ** ** | **to** | ** ** | **outstanding, net** | ** ** |
| Mechel Energy AG |       |          | —      |       |       | 53,765 |   |   | — |   |   |   | — |   |   |   | (461 | ) |   |   | (461 | ) |   |
| TPTU             |       |          | 2,247       |       |       | 98 |   |   | — |   |   |   | 25 |   |   |   | (177 | ) |   |   | (152 | ) |   |
| TRMZ             |       |          | 10,074      |       |       | 4,555 |   |   | — |   |   |   | 59 |   |   |   | (753 | ) |   |   | (694 | ) |   |
| Yakutugol        |       |          | 129,968     |       |       | 8,042 |   |   | — |   |   |   | 309 |   |   |   | (928 | ) |   |   | (619 | ) |   |
| Calridge         |       |          | 36,449      |       |       | 10 |   |   | — |   |   |   | 11 |   |   |   | — |   |   |   | 11 |   |   |
| Other            |       |          | 670         |       |       | 528 |   |   | — |   |   |   | 141 |   |   |   | (34 | ) |   |   | 107 |   |   |
| **Total**        | ** ** | ** **    | **179,408** |       | ** ** | **66,998** | ** ** | ** ** | **—** |   | ** ** | ** ** | **545** |   | ** ** | ** ** | **(2,353** | **)** | ** ** | ** ** | **(1,808** | **)** | ** ** |

 

| ** **       | ** ** | **2005**      | ** ** | ** ** | ** ** | ** **               | ** ** | ** **                                            | ** ** |
|------------------|------------|---------------|------------|------------|------------|--------------------------|------------|-------------------------------------------------------|------------|
| ** **       | ** ** | ** **    | ** ** | ** ** | ** ** | **Financing**            | ** ** | **Balances at December 31, 2005** | ** ** |
| ** **       | ** ** | ** **    | ** ** | ** ** | ** ** | **provided**             | ** ** | **Receivable**                                        | ** ** | **Payable** | ** ** | **Total** | ** ** |
| ** **       | ** ** | **Purchases** | ** ** | **Sales**  | ** ** | **(received), net** | ** ** | **from**                                              | ** ** | **to** | ** ** | **outstanding, net** | ** ** |
| Mechel Energy AG |       |          | —     |       |       | 59,257                   |       |                                                  | —     |   |   |   | 990 |   |   |   | — |   |   |   | 990 |   |   |
| TPTU             |       |          | 2,313      |       |       | 106                      |       |                                                  | —     |   |   |   | 21 |   |   |   | (135 | ) |   |   | (114 | ) |   |
| TRMZ             |       |          | 7,862      |       |       | 4,044                    |       |                                                  | —     |   |   |   | — |   |   |   | (463 | ) |   |   | (463 | ) |   |
| Yakutugol        |       |          | 61,271     |       |       | 1,293                    |       |                                                  | —     |   |   |   | 3,437 |   |   |   | (2,117 | ) |   |   | 1,320 |   |   |
| Other            |       |          | 2,383      |       |       | 731                      |       |                                                  | 411        |   |   |   | 7 |   |   |   | (220 | ) |   |   | (213 | ) |   |
| **Total**        | ** ** | ** **    | **73,829** |       | ** ** | **65,431**               | ** ** | ** **                                            | **411**    |   | ** ** | ** ** | **4,455** |   | ** ** | ** ** | **(2,935** | **)** | ** ** | ** ** | **1,520** |   |   |

 

F-44

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                    | ** ** | **2004**      | ** ** | ** ** | ** ** |
|-------------------------------|------------|---------------|------------|------------|------------|
| ** **                    | ** ** | ** **    | ** ** | ** ** | ** ** | **Financing** | ** ** | **Balances at December 31, 2004** | ** ** |
| ** **                    | ** ** | ** **    | ** ** | ** ** | ** ** | **provided** | ** ** | **Receivable** | ** ** | **Payable** | ** ** | **Total** | ** ** |
| ** **                    | ** ** | **Purchases** | ** ** | **Sales**  | ** ** | **(received), net** | ** ** | **from** | ** ** | **to** | ** ** | **outstanding, net** | ** ** |
| Conares Holding               |       |          | —     |       |       | — |   |   | — |   |   |   | 1,199 |   |   |   | — |   |   |   | 1,199 |   |   |
| Uglemet  Kooperatsia          |       |          | —     |       |       | 944 |   |   | — |   |   |   | 9,271 |   |   |   | (605 | ) |   |   | 8,666 |   |   |
| MMK                           |       |          | 2,509      |       |       | 2 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Mechel Energy AG              |       |          | —     |       |       | 63,528 |   |   | — |   |   |   | 759 |   |   |   | — |   |   |   | 759 |   |   |
| TPTU                          |       |          | 2,564      |       |       | 101 |   |   | — |   |   |   | 40 |   |   |   | (217 | ) |   |   | (177 | ) |   |
| TRMZ                          |       |          | 4,927      |       |       | 3,134 |   |   | — |   |   |   | 6 |   |   |   | (356 | ) |   |   | (350 | ) |   |
| ZAO Konsultatsia  I Marketing |       |          | 592        |       |       | — |   |   | 1,280 |   |   |   | 721 |   |   |   | (7 | ) |   |   | 714 |   |   |
| Other                         |       |          | 1,742      |       |       | 1,097 |   |   | — |   |   |   | 4,462 |   |   |   | (2,563 | ) |   |   | 1,899 |   |   |
| **Total**                     | ** ** | ** **    | **12,334** |       | ** ** | **68,806** | ** ** | ** ** | **1,280** |   | ** ** | ** ** | **16,458** |   | ** ** | ** ** | **(3,748** | **)** | ** ** | ** ** | **12,710** |   |   |

 

**(a)**          Uglemetkooperatsia

Uglemetkooperatsia, a company affiliated with theControlling Shareholders, provided and received financing from the Group during2002 in the form of loans and advance payment financing for certain of theGroup’s operating subsidiaries.

During 2004 and 2005,there were no significant transactions between the Group andUglemetkooperatsia, except for repayment of loans due by the latter. On July 8,2005, Uglemetkooperatsia was liquidated.

**(b)**          MagnitogorskIron and Steel Works (MMK)

In 2004, the Group had an investment in MMK shares andparticipated in the board of directors. The Group subsidiaries owned 17.25% ofordinary shares and 12.57% of preferred shares through December 22, 2004.The shares of MMK shares were disposed of in 2004 (see Note 23).

During the year ended December 31,2004, the Group curtailed sales of coal and coke to and purchases of metal fromMMK. The purchases of metal from MMK amounted to $2,509. Sales and purchases toand from MMK were made on market terms.

**(c)**           MechelEnergy AG

Mechel Energy AG, in whichthe Group owns 50% of its ordinary shares, purchased coal from the Group duringthe years ended December 31, 2006 and 2005 in the amount of $53,765 and$59,257, respectively. Sales to Mechel Energy AG were made on market terms withaverage margin attributable to coal sales.

F-45

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(d)**          TomusinskiyTransportation Management Center (TPTU)

The Group subsidiaries own40% of the ordinary shares in TPTU, which provides transportation services.During the years ended December 31, 2006, 2005 and 2004, the Grouppurchased transportation services in the amount of $2,247, $2,313 and $2,564,respectively.

**(e)**           TomusinskiyAuto Repair Shop (TRMZ)

The Group subsidiaries own25.00% of the ordinary shares in TRMZ, which provides auto repair services.During the years ended December 31, 2006, 2005 and 2004, the Grouppurchased repair services in the amount of $10,074, $7,862 and $4,927,respectively.

**(f)**             Yakutugol

The Group owns 25% of theordinary shares in Yakutugol which provides the Group with coal. During theyears ended December 31, 2006 and 2005, the Group’s purchases fromYakutugol amounted to $129,968 and $61,271, respectively. The Group’s sales ofservices and auxiliary materials to Yakutugol amounted to $8,042 and $1,293. Asof December 31, 2006 and 2005, the Group had accounts payable to Yakutugolfor goods supplied of $928 and $2,117, trade receivables of $309 for the goodssold as of December 31, 2006 and dividends receivable of $3,437 as of December 31,2005.

**(g)**           CalridgeLtd

Calridge Ltd is a companywholly owned by the Controlling shareholder. In July 2006, the Groupacquired 5,648,850 ordinary shares of Mechel OAO from Calridge Ltd forapproximately $36,449. The acquired shares were used as a purchaseconsideration in the acquisition of controlling stake in MosKoks.

**11.**          INTANGIBLEASSETS, NET

Identifiableintangible assets, net are comprised of:

| ** **                                      | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Intangible  assets with determinable lives:** |       |                            |       |                            |       |   |   |   |   |
| Energy license                                  |       |                            | 1,770      |                            |       |   | 1,872 |   |   |
| Software                                        |       |                            | 2,531      |                            |       |   | 1,589 |   |   |
| Intangible  pension asset                       | ** ** | ** **                      | **—** |                            |       |   | 3,962 |   |   |
| Other                                           |       |                            | 445        |                            |       |   | 167 |   |   |
| **Total  intangible assets**                    | ** ** | ** **                      | **4,746**  |                            | ** ** | ** ** | **7,590** |   |   |

 

F-46

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**12.**          PROPERTY,PLANT AND EQUIPMENT, NET

Property,plant and equipment, net are comprised of:

| ** **                                    | ** ** | **December 31, 2006** | ** **    | **December 31, 2005** | ** ** |
|-----------------------------------------------|------------|---------------------------------|---------------|---------------------------------|------------|
| Land improvements                             |       |                            | 23,032        |                            |       |   | 19,354 |   |   |
| Buildings                                     |       |                            | 582,083       |                            |       |   | 434,257 |   |   |
| Transfer devices                              |       |                            | 62,110        |                            |       |   | 53,311 |   |   |
| Operating  machinery and equipment            |       |                            | 1,136,655     |                            |       |   | 812,018 |   |   |
| Transportation  equipment and vehicles        |       |                            | 181,361       |                            |       |   | 139,343 |   |   |
| Tools, furniture,  fixtures and other         |       |                            | 116,402       |                            |       |   | 68,026 |   |   |
|                                          |       |                            | 2,101,643     |                            |       |   | 1,526,309 |   |   |
| Less accumulated  depreciation                |       |                            | (595,359      | )                               |       |   | (404,544 | ) |   |
| Operating  property, plant and equipment, net |       |                            | 1,506,284     |                            |       |   | 1,121,765 |   |   |
| Mining,  processing plant and equipment       |       |                            | 117,244       |                            |       |   | 140,142 |   |   |
| Less accumulated  depletion                   |       |                            | (27,981       | )                               |       |   | (17,227 | ) |   |
| Mining, processing plant and equipment, net   |       |                            | 89,263        |                            |       |   | 122,915 |   |   |
| Construction-in-progress                      |       |                            | 417,281       |                            |       |   | 264,304 |   |   |
| **Property,  plant and equipment, net**       | ** ** | ** **                      | **2,012,828** |                            | ** ** | ** ** | **1,508,984** |   |   |

 

Included within construction-in-progress are advancesto suppliers of equipment of $40,744 and $26,839 as of December 31, 2006and 2005, respectively. During the years ended December 31, 2006, 2005 and2004, the Group incurred interest expenses of $54,049, $58,192 and $61,218,respectively, of which interest capitalized in the cost of property, plant andequipment was $15,866, $17,363 and $9,809, respectively. The depreciationcharge amounted to $177,303, $147,117 and $120,444 for the years ended December 31,2006, 2005 and 2004, respectively.

In the third quarter of2006, the Group implemented a new methodology for the classification ofoperating and mining plant and equipment. Following this new classification,gross book value and accumulated depletion of Mining processing plant andequipment decreased by $47,788 and $12,598, respectively, with a correspondingincrease in Operating machinery and equipment and accumulated depreciation.

F-47

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**13.**          MINERALLICENSES, NET

Minerallicenses, net, are comprised of the following:

| ** **                         | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Coal deposits                      |       |                            | 232,468     |                            |       |   | 192,700 |   |   |
| Iron ore deposits                  |       |                            | 84,360      |                            |       |   | 78,120 |   |   |
| Nickel deposits                    |       |                            | 32,327      |                            |       |   | 29,574 |   |   |
| Limestone deposits                 |       |                            | 3,289       |                            |       |   | 3,018 |   |   |
| Mineral licenses before  depletion |       |                            | 352,444     |                            |       |   | 303,412 |   |   |
| Accumulated depletion              |       |                            | (82,593     | )                               |       |   | (61,406 | ) |   |
| **Mineral licenses, net**          | ** ** | ** **                      | **269,851** |                            | ** ** | ** ** | **242,006** |   |   |

 

Most of existing minerallicenses were recorded upon acquisition of mining subsidiaries in precedingyears. Fair values of mineral licenses pertaining to the appraised proven andprobable mineral reserves at the date of acquisition were determined based onindependent appraisals performed by independent mining engineers, for eachacquisition date. The carrying values of the mineral licenses were reducedproportionate to the depletion of the respective mineral reserves at eachdeposit related to mining and production of reserves adjusted for the reservesre-measurement and purchase accounting effects. No residual value is assumed inthe mineral license valuation.

In valuation of minerallicenses the Group used only quantities of proven and probable deposits thatare expected to be produced within the term of the Group’s current licenses.The Group’s mining segment production activities are located primarily withinRussia; therefore, all of the information provided in this note pertains tothis region.

The Group’s mineralreserves and deposits are situated on the land belonging to government andregional authorities. In Russia, mining minerals require a subsoil license fromthe state authorities with respect to identified mineral deposits. The Groupobtains licenses from such authorities and pays certain taxes to explore andproduce from these deposits. These licenses expire between 2007 and 2027, withthe most significant licenses expiring between 2012 and 2024, and managementbelieves that they may be extended at the initiative of the Group withoutsubstantial cost. Management intends to extend such licenses for depositsexpected to remain productive subsequent to their license expiry dates.

In November 2004,SKCC won the auction to develop a coking coal mine in the Sibirginskaya Minearea in the Kuzbass region of Russia for $2,487 paid in cash. The coal reservesof the Sibirginskaya Mine license area are estimated at approximately 40million tonnes, based on independent reserve evaluation. Due to the fact thatofficial registration of the right to develop a coking coal mine in theSibirginskaya Mine area is granted in December 2004, mineral licenses of$2,487 were recorded in consolidated financial statements as of December 31,2004.

In December 2004,SKCC won two auctions for the right to use subsoil plots for coking coalexploration and mining at the Raspadsky Open Pit Mine and Berezovsky-2areas, with total reserves of 55.5 million tonnes according to independentreserve evaluation. The consideration paid for the right to 

F-48

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

usesubsoil plots for coking coal exploration and mining at the Raspadsky Open PitMine and Berezovsky-2 areas amounted to $1,030 and $780, respectively.

In April 2005, SKCCwon the auction for exploration and development of Erunakovskaya-1 andErunakovskaya-3 coal mines near Kemerovo for the total consideration of$19,118 paid in cash.

In June 2005, SKCCacquired the right for exploration and development of coking coal fromOlzherasskaya, Razvedochny and Sorokinsky coal mines in the Kemerovo region forthe total consideration of $69,300 paid in cash.

On March 10, 2006,SKCC acquired 100% of Shakhtouchastok Uregolsky OOO for the total considerationof $7,143. The entity owns a license for mineral reserves extraction inSouthern Kuzbass, Western Siberia on the Uregolskaya Mine situated close toSibirginsk OPM. The acquisition was accounted as an asset purchase because themine does not comprise a business. $6,382 was allocated to the cost of thelicense of adjacent Sibirginsk OPM, which will benefit from this acquisition,and the remaining $761 was allocated to property, plant and equipment.

**14.**          DEBT

| ** **                                                                                          | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Short-term borrowings and current portion of long-term debt:** | ** ** | ** **                      | ** ** | **Amount**                      | ** ** | **Rate p.a.,  %** | ** ** | **Amount** | ** ** | **Rate p.a.,  %** | ** ** |
| *Russian ruble-denominated:*                                                                        |       |                            |       |                            |       |   |   |   |   |   |   |
| Banks and financial  institutions                                                                   |       | 61,006                          |       | 6-7.8                           |       | 26,404 |   |   | 7-25 |   |   |
| Bonds issue                                                                                         |       | 2,071                           |       | 5.5                             |       | 178,420 |   |   | 7-11.75 |   |   |
| Corporate lenders                                                                                   |       | 90                              |       | 0-16                            |       | 251 |   |   | 0-11 |   |   |
| Total                                                                                               |       | 63,167                          |       |                            |       | 205,075 |   |   |   |   |   |
| *U.S. dollar-denominated:*                                                                          |       |                            |       |                            |       |   |   |   |   |   |   |
| Banks and financial  institutions                                                                   |       | 62,864                          |       | 6-9.45                          |       | 163,247 |   |   | 4.3-8.9 |   |   |
| Corporate lenders                                                                                   |       | **—**                      | ** ** | ** **                      |       | 1,032 |   |   | 7.25-10 |   |   |
| Total                                                                                               |       | 62,864                          |       |                            |       | 164,279 |   |   |   |   |   |
| *Euro-denominated:*                                                                                 |       |                            |       |                            |       |   |   |   |   |   |   |
| Banks and financial  institutions                                                                   |       | 14,758                          |       | 4-7.75                          |       | 13,978 |   |   | 4-10.3 |   |   |
| Corporate lenders                                                                                   | ** ** | **—**                      |       |                            |       | 1,413 |   |   | 24 |   |   |
| Total                                                                                               |       | 14,758                          |       |                            |       | 15,391 |   |   |   |   |   |
| *Romanian lei-denominated:*                                                                         |       |                            |       |                            |       |   |   |   |   |   |   |
| Banks and financial  institutions                                                                   |       | 17,653                          |       | 9.7-10.8                        |       | 4,558 |   |   | 5.5-8 |   |   |
| Total                                                                                               |       | 17,653                          |       |                            |       | 4,558 |   |   |   |   |   |
| *Swiss francs—denominated*                                                                     |       |                            |       |                            |       |   |   |   |   |   |   |
| Banks and financial  institutions                                                                   | ** ** | **—**                      |       |                            |       | 108 |   |   | 6 |   |   |
| Total                                                                                               | ** ** | **—**                      |       |                            |       | 108 |   |   |   |   |   |
| Total short-term  borrowings                                                                        |       | 158,442                         |       |                            |       | 389,411 |   |   |   |   |   |
| Current portion of  long-term debt                                                                  |       | 8,075                           |       |                            |       | — |   |   |   |   |   |
| **Total short-term borrowings and  current portion of long-term debt**                              | ** ** | **166,517**                     | ** ** | ** **                      | ** ** | **389,411** | ** ** |   |   |   |   |
|                                                                                                     |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |

 

F-49

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Theweighted average interest rate of the ruble-denominated short-term borrowingsas of December 31, 2006 and 2005 was 6.61% and 10.29% p.a., respectively. Theweighted average interest rate of the U.S. dollar-denominated short-termborrowings as of December 31, 2006 and 2005 was 7.26% and 6.34% p.a.,respectively. The weighted average interest rate of the euro-denominatedshort-term borrowings as of December 31, 2006 and 2005 was 6.25% and 7.90%p.a., respectively. The weighted average interest rate of the Romanianlei-denominated short-term borrowings as of December 31, 2006 and 2005 was10.11% and 7.32% p.a., respectively.

| ** **                       | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Long-term debt:**         | ** ** | ** **                      | ** ** | **Amount**                      | ** ** | **Rate p.a.,  %** | ** ** | **Amount** | ** ** | **Rate p.a.,  %** | ** ** |
| *Russian ruble-denominated:*     |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions |       | 10,726                          |       | 6.8-8.0                         |       |   | — |   |   |   |   |   |   |
| Bonds issue                      |       | 196,302                         |       | 5.5-8.4                         |       |   | — |   |   |   |   |   |   |
| Corporate lenders                |       | 2,672                           |       | 7.49                            |       |   | 2,353 |   |   |   | 7 |   |   |
| Total                            |       | 209,700                         |       |                            |       |   | 2,353 |   |   |   |   |   |   |
| *U.S.  dollar-denominated:*      |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions |       | 20,344                          |       | 7.5-10.9                        |       |   | 6,507 |   |   |   | 9.8 |   |   |
| Corporate lenders                |       | 59                              |       | 12                              |       |   | 181 |   |   |   | 0 |   |   |
| Total                            |       | 20,403                          |       |                            |       |   | 6,688 |   |   |   |   |   |   |
| *Euro-denominated:*              |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions |       | 100,576                         |       | 6-7                             |       |   | — |   |   |   |   |   |   |
| Total                            |       | 100,576                         |       |                            |       |   | — |   |   |   |   |   |   |
| *Romanian  lei-denominated:*     |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Corporate lenders                |       | —                          |       |                            |       |   | 36,574 |   |   |   | 24-28 |   |   |
| Total long-term obligations      |       | 330,679                         |       |                            |       |   | 45,615 |   |   |   |   |   |   |
| Less: current  portion           |       | 8,075                           |       |                            |       |   | — |   |   |   |   |   |   |
| **Long-term  portion**           | ** ** | **322,604**                     |       |                            | ** ** | ** ** | **45,615** |   |   |   |   |   |   |
|                                  |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

The weighted average interest rate of theruble-denominated long-term borrowings as of December 31, 2006 and 2005was 8.23% and 7.00% p.a., respectively. The weighted average interest rate ofthe U.S. dollar-denominated long-term borrowings as of December 31, 2006and 2005 was 10.41% and 9.47% p.a., respectively. The weighted average interestrate of the euro-denominated long-term borrowings as of December 31, 2006was 6.34% p.a.

F-50

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Aggregatescheduled maturities of the debt outstanding as at December 31, 2006, areas follows:

| **Payable in:**    | ** ** | ** **  | ** ** | ** ** | ** ** |
|-------------------------|------------|-------------|------------|------------|------------|
| 2007 (current  portion) |       | 166,517     |       |
| 2008                    |       | 47,306      |       |
| 2009                    |       | 86,043      |       |
| 2010                    |       | 106         |       |
| 2011 and  thereafter    |       | 189,149     |       |
| **Total**               | ** ** | **489,121** | ** ** |

 

The most significant debt provided by bank financingcomprised credit line facilities from Gazprombank, Vneshtorgbank, BNP Paribas,Commerzbank, UralSib and Raiffeisen Bank. The unused portion under all creditfacilities as of December 31, 2006 and 2005 was $198,421 and $182,538,respectively. As of December 31, 2006, the Group’s credit facilitiesprovided aggregated borrowing capacity of $687,542, of which $364,939 expiresin 2007, $47,306 in 2008, and $275,295 in 2009 and thereafter.

During 2006 and 2005, Gazprombank providedruble-denominated loans to various Group subsidiaries bearing interest at 6.5-7.5%p.a., secured by inventory. The outstanding balances as of December 31,2006 and 2005 were $42,017 and $17,719, respectively.

During 2005, Gazprombank provided euro-denominatedlong-term credit facilities to CMP bearing interest at 6.5% p.a. and secured byinventory. The outstanding balance as of December 31, 2006 was $6,118, ofwhich $3,059 is due in 2008 and the remaining balance in 2009. During 2006,Gazprombank also provided euro-denominated long-term credit facilities toSouthern Kuzbass Coal Company bearing interest at 6.5% p.a., secured byproperty, plant and equipment and inventory. The outstanding balance as of December 31,2006 was $57,622, of which $28,811 is due in 2008 and the remaining balance in2009.

During 2006 and 2005, Vneshtorgbank provided long-termU.S. dollar-denominated loans to Southern Kuzbass Coal Company bearing interestat 10.94% and 9.73% p.a., respectively, and secured by property, plant andequipment. As of December 31, 2006 and 2005, the balances outstanding were$17,160 and $6,507, respectively. The outstanding balance as of December 31,2006 in amount of $9,085 is due in 2008, the remaining part of $8,075represents the current portion of the debt.

During 2006 and 2005, the Group utilized U.S.dollar-denominated bank overdraft facilities bearing interest at 6-7.2%and 4.28-6.3% p.a., respectively, at BNP Paribas, secured by the MechelTrading and Mechel Metal Supply accounts receivable and inventory. As of December 31,2006 and 2005, the balances outstanding were $41,956 and $125,765,respectively. During 2006 and 2005, BNP Paribas also provided short-termeuro-denominated bank overdraft facilities bearing interest at 4.89-7.45% p.a.and secured by the Mechel Trading and Mechel Metal Supply accounts receivableand inventory. The outstanding balances as of December 31, 2006 and 2005were $1,179 and $205, respectively.

F-51

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

During 2006 and 2005, UralSib provided a series ofruble-denominated short-term loans and credit facilities to various Groupsubsidiaries at 6-7% and 7-11% p.a., respectively. As of December 31,2006 and 2005, the balances outstanding were $11,393 and $8,686, respectively.

During 2006, Commerzbank provided long-termruble-denominated credit facilities to Southern Kuzbass Coal Company bearinginterest at 6.8% p.a.. The balance outstanding as of December 31, 2006,was $5,606.

During 2006, Commerzbank provided long-term U.S.dollar-denominated credit facilities to SKCC bearing interest at 7.5% p.a.. Thebalance outstanding as of December 31, 2006, was $3,184.

During 2006, Commerzbank also provided long-termeuro-denominated credit facilities to CMP bearing interest at 5.96%. Thebalance outstanding as of December 31, 2006, was $32,943.

During 2006, a portion of short-term U.S. dollar-denominatedcredit facilities provided in 2005 to various Group companies by Raiffeisenbankwas fully repaid. During 2006, the Group also utilized bank overdraftfacilities bearing interest at 6% p.a. at Raiffeisenbank, secured by MechelTrading accounts receivable and inventory. As of December 31, 2006 and2005, the outstanding balances were $4,699 and $13,292, respectively.

During 2006 and 2005, Raiffeisenbank providedshort-term euro-denominated credit facilities bearing interest at 6.25-7.75%p.a. and 5.4-5.55% p.a., respectively and secured by inventory. As of December 31,2006 and 2005, the outstanding balances were $3,729 and $8,181, respectively.

During 2006, Raiffeisenbank provided long-termeuro-denominated credit facilities bearing interest at 6.88-6.93% p.a. As of December 31,2006, the outstanding balance was $3,894, which is due in 2008.

During 2006 and 2005,Raiffeisenbank provided Romanian lei-denominated loans bearing interest at 9.7-10.8%p.a. and 8% p.a., respectively. As of December 31, 2006 and 2005, theoutstanding balances were $17,652 and $3,379, respectively.

***Bonds***

On February 4, 2004, Chelyabinsk MetallurgicalPlant issued 1,000,000 ruble-denominated bonds in an aggregate principal amountof 1 billion rubles ($31,395). The bonds were issued at 100% par value.Interest was payable every six months in arrears. The interest rate for thefirst coupon period was determined upon the issuance based on the bids ofbuyers and amounted to 16.85% p.a. The interest rate for the second, third andfifth coupon periods was set by the Group and was made public 10 days beforethe respective coupon period started. Bondholders were entitled to earlyredemption of the bonds at face value before the second, third and fifth couponperiods. The interest rate for the fourth and sixth coupon periods was set asequal to the rate for the immediately preceding coupon period. The Grouprepurchased 865,127 bonds in February 2005. The bonds were fully redeemedon February 4, 2006. The interest rate for the sixth coupon periodamounted to 7% p.a. As of December 31, 2006 and 2005, the balancesoutstanding were $nil and $4,703, respectively.

F-52

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

On June 19, 2003, Mechel Trading House issued3,000,000 ruble-denominated bonds in an aggregate principal amount of 3 billionrubles ($98,749). The bonds were issued at 100% of par value. Interest rate forthe first coupon periods was determined upon the issuance based on the bids ofbuyers and amounted to 11.75% p.a. The interest rate for the second, third andfifth coupon periods is set by the Group and is made public 10 days before therespective coupon period starts. The interest rate for the fourth and sixthcoupon periods are set as equal to the rate for the immediately precedingcoupon period. The bondholders have an option to demand repayment of the bondsstarting June 19, 2006, with an obligatory redemption date on June 19,2009. The total commission and issue costs amounted to $4,295. On June 19,2006, the Group repurchased 2,807,250 bonds at par value. As of December 31,2006 and 2005, the balances outstanding were $7,320 and $104,230, respectively.

On November 25, 2004, Mechel OAO issued 2,000,000ruble-denominated bonds in an aggregate principal amount of 2 billion rubles($70,387). The bonds were issued at 100% of par value. Interest is payableevery six months in arrears. The interest rate for the first coupon periods isdetermined upon the issuance based on the bids of buyers and comprised 10.69%p.a. The interest rate for the second and third coupon period was set by theGroup and is made public 10 days before the end of the third coupon period. Theinterest rate for the fifth and sixth coupon periods is set as equal to that ofthe fourth period. Bondholders are entitled to early redemption of the bonds atface value within 10 days before the end of the third coupon period. Theobligatory redemption date of the bonds is November 22, 2007. The totalcommission and issue costs amounted to $610. On May 31, 2006, the Grouprepurchased 1,798,852 bonds at par value. As of December 31, 2006 and2005, the balances outstanding were $2,071 and $69,487, respectively.

On June 21, 2006, Mechel OAO issued 5,000,000ruble-denominated bonds in an aggregate principal amount of 5 billion rubles($183,045). The bonds were issued at 100% par value. Interest is payable every3 months in arrears. The interest rate for the first coupon period wasdetermined upon the issuance based on the bids of buyers and amounted to 8.4%p.a. The interest rate for the second to the eighth coupon periods is set asequal to that of the first period. The interest rate for the ninth to thefourteenth coupon periods is set by the Group and made public 10 days beforethe respective coupon period starts. The bondholders have an option to demandrepayment of the bonds at par value starting June 21, 2010. The obligatoryredemption date is June 12, 2013. The costs related to the issuance of bonds inthe amount of $739 were capitalized and are amortized to interest expense overthe term of bonds. The balance outstanding as of December 31, 2006 was$188,982. The increase in the balance of bonds as of December 31, 2006, isdue to appreciation of ruble against U.S. dollar from the date of issuancethrough December 31, 2006.

As of December 31, 2006and 2005, carrying value of property, plant and equipment pledged under loanagreements amounted to $125,818 and $20,946, respectively. Carrying value ofinventories pledged under loan agreements amounted to $141,824 and $87,820 asof December 31, 2006 and 2005, respectively. Accounts receivable pledged as ofDecember 31, 2006 and 2005 amounted to $30,254 and $61,869, respectively.

F-53

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended  December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**15.**          TAXESAND SOCIAL CHARGES PAYABLE 

Thebalances of taxes, social charges and contributions to the Russian Pension Fundand other obligatory payments owed, including fines and penalties relatedthereto, are comprised of:

| ** **                                                             | ** ** | **December 31, 2006** | ** **  | **December 31, 2005** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Current period  taxes and social contributions                         |       |                            | 143,037     |                            |       |   | 136,967 |   |   |
| Restructured  prior period taxes and social charges, principal amount  |       |                            | 1,230       |                            |       |   | 14,391 |   |   |
| Restructured  related fines and penalties                              |       |                            | 6,552       |                            |       |   | 27,223 |   |   |
| **Total taxes and social charges payable**                             | ** ** | ** **                      | **150,819** |                            | ** ** | ** ** | **178,581** |   |   |
| Presented on the  balance sheets as:                                   |       |                            |        |                            |       |   |   |   |   |
| Taxes and social charges payable                                       |       |                            | 143,037     |                            |       |   | 144,715 |   |   |
| Restructured  taxes and social charges payable, net of current portion |       |                            | 7,782       |                            |       |   | 33,866 |   |   |
| **Total**                                                              | ** ** | ** **                      | **150,819** |                            | ** ** | ** ** | **178,581** |   |   |

 

Taxes,social charges and contributions to the Russian Pension Fund and the Agency forState Ownership Administration of Romania, including restructured amounts withthe related fines and penalties, at December 31, 2006, mature as follows: 

| ** **           | ** ** | ** **             | ** ** | **Restructured prior**    | ** ** | ** **                | ** ** |
|----------------------|------------|------------------------|------------|--------------------------------|------------|---------------------------|------------|
| ** **           | ** ** | **Restructured**       | ** ** | **period taxes and** | ** ** | ** **                | ** ** |
| ** **           | ** ** | **related fines** | ** ** | **social charges,**       | ** ** | ** **                | ** ** |
| **Payable in:** | ** ** | ** **             | ** ** | **and penalties**         | ** ** | **principal amount** | ** ** | **Total** | ** ** |
| 2007                 |       |                   | 6,552      |                           |       |                      | —     |   |   | 6,552 |   |
| 2008                 |       |                   | —     |                           |       |                      | 1,230      |   |   | 1,230 |   |
| **Total**            | ** ** | ** **             | **6,552**  |                           | ** ** | ** **                | **1,230**  |   | ** ** | **7,782** | ** ** |
|                      |            |                        |            |                                |            |                           |            |  |  |  |  |  |  |

 

**Restructured priorperiod taxes and social charges**

***Russia***

The Group subsidiaries entered into agreements withRussian tax and social security authorities from 2000 to 2002 to restructurethe amounts and timing of payments of liabilities related to taxes other thanincome tax (i.e., value added tax and road users tax) and contributions due tothe Russian National Pension Fund, along with related fines and penalties.Prior to the restructuring, a significant portion of these liabilities includingfines and penalties, were overdue and payable with short maturities and wereaccrued by the Group. Upon conclusion of the restructuring agreements, overduetaxes and charges accrued became payable in equal quarterly installments withinsix years; and related fines and penalties became payable only if certainconditions were not met. Subject to timely payment of at least 50% of all therestructured principal amounts of taxes and charges within two years onschedule, and the full and 

F-54

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended  December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

timely payment of currenttaxes being accrued, a 50%-portion of the restructured fines and penalties willbe forgiven. 

Furthermore, subject to timely payment of theremaining restructured principal amounts of taxes and charges within four yearson schedule, and the full and timely payment of current taxes, the remaining50% of the restructured fines and penalties will be forgiven. Restructuredprincipal of taxes and charges are subject to interest of 5.5% p.a., payable inequal quarterly installments. Restructured fines and penalties do not bear interest.

Contributions to theRussian Pension Fund and 15% of the related fines and penalties are payable inequal quarterly installments over five years. Subject to full repayment of therestructured principal contributions to the Russian Pension Fund and payment ofat least 15% of the fines and penalties accrued within five years, as well asthe full and timely payment of current contributions, the remaining 85% of therestructured fines and penalties related to the contributions to the RussianPension Fund will be forgiven. The restructured principal contributions to theRussian Pension Fund and the related fines and penalties do not bear interest. 

***Romania***

Upon acquisition of Mechel Targoviste and MechelCampia Turzii as part of the purchase agreement, Authority for State AssetsResolution (AVAS) agreed to restructure the liabilities of Mechel Targovisteand Mechel Campia Turzii related to taxes payable to the National SocialSecurity Fund and Ministry of Labor and Social Security, along with related finesand penalties. Prior to the restructuring, a significant portion of theseliabilities, including fines and penalties, were overdue and payable with shortmaturities. Restructured taxes, fines and penalties do not bear interest.Restructured long-term liabilities of Mechel Targoviste to state energycorporations and those of Mechel Campia Turzii, which are due to state budget,are included into long-term restructured taxes and payable.

On December 5, 2006, the AVAS formally confirmedfulfillment of all investment obligations assumed during the acquisition ofMechel Targoviste, which enabled closing the Privatization Contract for MechelTargoviste ahead of the original date. As a result, restructured liabilities ofMechel Targoviste as of that date of $44,571 were forgiven (see Note 23). 

Based on the restructuring agreements, the amountpayable in 2008 of $1,230, including fines and penalties relating to MechelCampia Turzii, can be forgiven if Mechel Campia Turzii is in compliance withthe current payments schedule for the first four years.

In addition, as of December 31, 2006, Mechel CampiaTurzii had a possible (rather than probable) loss contingency, not reflected onthe balance sheet, related to rescheduled tax related penalties and latepayment interests amounting to $36,194, that were conditionally forgiven inaccordance with the Romanian Common Orders (the “Orders”). They may becomepayable in case of non-fulfillment by the Group of certain conditions in theOrders. Management believes that the Group will be able to meet all futureconditions required to obtain full forgiveness. 

F-55

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended  December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Labor force of MechelTargoviste and Mechel Campia Turzii comprise 5.55% and 4.98%, respectively, oftotal labor force of the Group. 90% and 87% of these employees, respectively,are under protection of collective bargaining agreement, which, according toprivatization agreements, will expire not earlier than June 2008 (Mechel CampiaTurzii). As of December 31, 2006, the net assets of Mechel Targoviste andMechel Campia Turzii amounted to $43,127 and $24,572, respectively. 

**16.**          ASSETRETIREMENT OBLIGATIONS 

The Group has numerous asset removal obligations thatit is required to perform under law or contract once an asset is permanentlytaken out of service. The majority of these obligations are not expected to bepaid for many years, and will be funded from general Group resources at thetime of removal. The Group’s asset retirement obligations primarily relate toits steel and mining production facilities with related landfills and dumpareas and its mines.

Thefollowing table presents the movements in asset retirement obligations for theyears ended December 31, 2006 and 2005: 

| **Asset retirement obligation**   | ** ** | ** ** | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------|------------|------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Balance  at beginning of year**           | ** ** |       | **59,052** | ** **                      |       |                            | **74,977** | ** ** |   |
| Liabilities  incurred in the current period |       |       | 2,160      |                            |       |                            | —     |   |   |
| Liabilities  settled in the current period  |       |       | (510       | )                               |       |                            | (2,249     | ) |   |
| Liabilities  disposed in the current period |       |       | —     |                            |       |                            | (9,091     | ) |   |
| Accretion expense                           |       |       | 7,433      |                            |       |                            | 3,248      |   |   |
| Revision in  estimated cash flow            |       |       | 17,876     |                            |       |                            | (4,501     | ) |   |
| Translation and  other                      |       |       | 6,347      |                            |       |                            | (3,332     | ) |   |
| **Balance  at end of year**                 | ** ** |       | **92,358** | ** **                      |       |                            | **59,052** | ** ** |   |

 

Revision in estimated cashflow represented the effect of the changes resulting from the managementrevisions to the timing and/or the amounts of the original estimates, and isrecorded through an increase or decrease in the value of the underlyingnon-current assets. The revision in estimated cash flows in 2006 relatedprimarily to the refinement of future asset removal and restoration costs atCMP and KMP. 

**17.**          PENSIONAND POSTRETIREMENT BENEFITS

In addition to the State Pension and Social insurancerequired by the Russian legislation, the Group has a number of defined benefitoccupational pension plans that cover the majority of production employees andsome other postretirement benefit plans.

SKCC and BMP have an agreement with a non-Governmentpension fund (the “Fund”) in accordance with which contributions are made as alump-sum payment to the Fund upon the retirement of employees. Group’s pensionobligation to a retiree is fully funded and settled upon such lump-sum paymentto the Fund. The Fund is obligated to provide former employees with monthlynon-state pensions throughout their life period. As of December 31, 2006, theGroup’s obligations under this Fund were unfunded. 

F-56

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended  December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

A number of the Group’s companies provide their formeremployees with regular old age retirement pensions. The old age retirementpension is conditional to the member qualifying for the State old age pension.Some employees are also eligible for an early retirement in accordance with thestate pension regulations and specific coal industry rules (so-called“territorial treaties”), which also provide for certain post retirementbenefits above old age pensions. Additionally the Group voluntarily providesfinancial support, of a defined benefit nature, to its old age and disabledpensioners, who did not acquire any pension under the occupational pensionprogram.

The Group also provides several types of long-termemployee benefits such as death-in-service benefit and invalidity pension of adefined benefit nature. The Group may also provide the former employees withreimbursement of coal and wood used for heating purposes. In addition, one-timelump sum benefits are paid to employees of a number of the Group’s companiesupon retirement depending on the employment service with the Group and thesalary level of an individual employee. All pension plans are unfunded untilthe qualifying event occurs. 

As of December 31, 2006, there were approximately69,524 active participants to the defined benefit pension plans and 19,264pensioners receiving monthly pensions or other regular financial support fromthe employer. As of December 31, 2005, the related figures were 71,300 and20,000, respectively. 

Actuarial valuation of pension and other postemployment and postretirement benefits was performed in March 2007, with themeasurement date of December 31, 2006. Members’ census data as of that date wascollected for all relevant business units of the Group. 

Pension costs determined are supported by anindependent qualified actuary, and are charged to the income statement ratablyover employees' working service with the Group.

Themovements in the projected benefit obligation (PBO) were as follows during theyears ended December 31: 

| ** **                                   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------------|------------|------------|------------|------------|------------|
| **Benefit  obligation at beginning of year** | ** ** | **51,699** | ** ** | **46,981** | ** ** |
| Service cost                                 |       | 3,223      |       | 2,161      |       |
| Amortization of  prior year service cost     |       | 498        |       | 350        |       |
| Interest cost                                |       | 5,835      |       | 5,191      |       |
| Obligation  incurred                         |       | 1,409      |       | 2,762      |       |
| Settlement of  obligation                    |       | (4,361     | )          | (3,787     | )          |
| Actuarial (gain)  losses                     |       | 490        |       | —     |       |
| Curtailment  (gain) losses                   |       | (597       | )          | —     |       |
| Unrecognized net  actuarial (gain) losses    |       | 2,018      |       | —     |       |
| Unrecognized  prior year service cost        |       | 4,975      |       | —     |       |
| Translation  difference                      |       | 5,025      |       | (1,959     | )          |
| **Benefit obligation at end of  year**       | ** ** | **70,214** | ** ** | **51,699** | ** ** |

 

F-57

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended  December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Theeffect of implementation of SFAS No. 158 as of December 31, 2006 was asfollows: 

| ** **                               | ** ** | **Prior to**    | ** ** | **Effect of**   | ** ** | ** **                | ** ** |
|------------------------------------------|------------|----------------------|------------|----------------------|------------|---------------------------|------------|
| ** **                               | ** ** | **adoption of** | ** ** | **adoption of** | ** ** | **After adoption**   | ** ** |
| ** **                               | ** ** | **SFAS 158**    | ** ** | **SFAS 158**    | ** ** | **of SFAS 158** | ** ** |
| Liability for  pension benefits          |       |                 | (65,778    | )                    |       |                      | (4,436     | ) |   |   | (70,214 | ) |   |
| Intangible assets                        |       |                 | 6,945      |                 |       |                      | (2,219     | ) |   |   | 4,726 |   |   |
| Accumulated other  comprehensive income  |       |                 | (197,500   | )                    |       |                      | 9,282      |   |   |   | (188,218 | ) |   |
| Long-term investment in  related parties |       |                 | 431,833    |                 |       |                      | (2,627     | ) |   |   | 429,206 |   |   |

 

Amounts recognized in accumulated other comprehensiveincome as of December 31, 2006 consist of actuarial losses and prior servicecosts amounted to $8,976 and $4,976, respectively. 

Thefunded status of the plan was as follows as of December 31: 

| ** **                            | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|---------------------------------------|------------|-------------|------------|-------------|------------|
| Projected benefit  obligation (PBO)   |       | (70,214     | )          | (60,415     | )          |
| Accumulated  benefit obligation (ABO) |       | (60,007     | )          | (47,671     | )          |
| Funded status                         |       | (70,214     | )          | (60,415     | )          |
| Unrecognized net  actuarial loss      |       | —      |       | 7,609       |       |
| Unrecognized  prior service cost      |       | —      |       | 5,069       |       |
| **Net amount recognised**             | ** ** | **(70,214** | **)**      | **(47,737** | **)**      |

 

Amountsrecognized in the balance sheet were as follows as of December 31: 

| ** **                                  | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|---------------------------------------------|------------|-------------|------------|-------------|------------|
| Pension  obligation, current portion        |       | (11,044     | )          | (8,189      | )          |
| Pension obligation,  net of current portion |       | (59,170     | )          | (43,510     | )          |
| Intangible assets                           |       | —      |       | 3,962       |       |
| Accumulated other  comprehensive income     |       | 11,324      |       | —      |       |
|                                        | ** ** | **(58,890** | **)**      | **(47,737** | **)**      |

 

Thecomponents of net periodic benefit cost were as follows for the year endedDecember 31: 

| ** **                          | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-------------------------------------|------------|-----------|------------|-----------|------------|
| Service cost                        |       | 3,222     |       | 2,161     |       |
| Interest cost                       |       | 5,830     |       | 5,191     |       |
| Expected return  on assets          |       | —    |       | —    |       |
| Amortization of  prior service cost |       | 504       |       | 350       |       |
| Recognised  actuarial loss          |       | (106      | )          | (159      | )          |
| **Net periodic benefit cost**       | ** ** | **9,450** | ** ** | **7,543** | ** ** |

 

F-58

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended  December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Thekey actuarial assumptions used were as follows as of December 31: 

| ** **                                                               | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Discount rate                                                            |       |       |       |       |       |
| Russian entities                                                         |       | 6.60       | %          | 9.48       | %          |
| Romanian entities                                                        |       | 6.50       | %          | 6.71       | %          |
| Expected return  on plan assets                                          |       | N/A        |       | N/A        |       |
| Rate of  compensation increase                                           |       |       |       |       |       |
| Russian entities                                                         |       | 7.10       | %          | 8.42       | %          |
| Romanian entities                                                        |       | 6.10       | %          | 5.67       | %          |
| Rate of pension  entitlement increase (before benefit commencement) |       | 7.10       | %          | 8.42       | %          |
| Rate of monthly  financial support increase                              |       | 5.00       | %          | 6.3        | %          |
| Rate used for  calculation of purchased annuity value*                   |       | below 5.00 | %          | below 5.00 | %          |

----

*                    Regularretirement pensions in payment are insured by Penfosib

Thefollowing benefit payments, which reflect expected future service, asappropriate, are expected to be paid: 

| ** **                                      | ** ** | **2007**   | ** ** | **2008**  | ** ** | **2009**  | ** ** | **2010**  | ** ** | **2011**  | ** ** | **2012-2016** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|---------------|------------|-----------|------------|
| Pensions  (including monthly financial support) |       | 5,335      |       | 3,267     |       | 3,388     |       | 3,512     |       | 3,688     |       |          | 20,577     |      |       | 39,767 |   |
| Other benefits                                  |       | 5,363      |       | 2,010     |       | 2,307     |       | 2,290     |       | 2,419     |       |          | 11,949     |      |       | 26,338 |   |
| **Total expected benefits to be  paid**         | ** ** | **10,698** | ** ** | **5,277** | ** ** | **5,695** | ** ** | **5,802** | ** ** | **6,107** | ** ** | ** **    | **32,526** |      | ** ** | **66,105** | ** ** |

 

**18.**          FINANCELEASE 

In 2006 and 2005, Mechel-Trans OOO, a 100% subsidiaryof MTH, entered into several agreements with third parties for the lease oftransport equipment. The lease was classified as a finance (capital) lease inaccordance with SFAS No.13, “Accounting for Leases”. The lease contains abargain purchase option and the title to the leased equipment transfers to thelessee at the end of the lease term. 

In 2006, Mechel Nemunas entered into a finance leaseagreement with a third party for the lease of production equipment. The leasecontains a bargain purchase option and the title to the leased equipment transfersto the lessee at the end of the lease term.

F-59

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

As ofDecember 31, 2006 and 2005, the net book value of the leased assets was asfollows: 

| ** **                                                                                        | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Transport  equipment and vehicles                                                                 |       |                            | 58,930     |                            |       |   | 10,291 |   |   |
| Machinery and  equipment                                                                          |       |                            | 1,778      |                            |       |   | — |   |   |
| Less: accumulated  depreciation                                                                   |       |                            | (2,786     | )                               |       |   | (133 | ) |   |
| **Net  value of property, plant and equipment, obtained under** **capital lease agreements** | ** ** | ** **                      | **57,922** |                            | ** ** | ** ** | **10,158** |   |   |

 

Thecarrying amount and maturities of capital lease liabilities as of December 31,2006 were as follows:

| ** **                           | ** ** | **Total payable** | ** ** | **Interest** | ** ** | **Net payable** | ** ** |
|--------------------------------------|------------|------------------------|------------|--------------|------------|----------------------|------------|
| Payable in 2007                      |       |                   | 15,761     |         |       | (9,695               | )          |   | 6,066 |   |   |
| Payable in 2008                      |       |                   | 15,565     |         |       | (8,603               | )          |   | 6,962 |   |   |
| Payable in 2009                      |       |                   | 15,565     |         |       | (7,244               | )          |   | 8,321 |   |   |
| Payable in 2010                      |       |                   | 15,565     |         |       | (5,646               | )          |   | 9,919 |   |   |
| Payable in 2011                      |       |                   | 15,477     |         |       | (3,735               | )          |   | 11,742 |   |   |
| Payable after  2011                  |       |                   | 15,812     |         |       | (1,688               | )          |   | 14,124 |   |   |
| **Total  capital lease liabilities** | ** ** | ** **             | **93,745** |         | ** ** | **(36,611**          | **)**      | ** ** | **57,134** |   |   |

 

The discount rate used forthe calculation of the present value of minimum lease payments equals the implicitrate for the lessor and varies from 19.7% to 19.9% on different groups ofequipment. Interest expense charged to the accompanying Group’s incomestatement in 2006 and 2005 amounts to $6,270 and $300, respectively.

**19.**          SHAREHOLDERS’EQUITY

**Capital stock**

The capital stock of Mechel OAO consists of497,969,086 authorized common shares with par value of 10 Russian rubles(approximately $0.3), of which 416,270,745 and 403,118,680 common shares wereoutstanding as of December 31, 2006 and 2005, respectively. As disclosedin Note 1, in the context of the reorganization under common control and basedon the presentation of the Group as if it existed for all periods presentedsince its inception, the number of shares authorized and issued and earningsper share were based on the shares issued to Controlling Shareholders inconnection with the formation of the Group in 2003, and that number of shares(less treasury shares) has been treated as outstanding for all periodspresented except where capital contributions were made during 2002 and 2001 forwhich shares have been allocated to those contributions as if issued at thattime based upon the number of shares that were issued for the contribution toacquired companies in the common control reorganization as determined inaccordance with Russian law.

F-60

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

On October 29, 2004,Mechel sold 33,301,659 additionally issued ordinary shares that were offered inthe form of American Depositary Shares (ADS) on New York Stock Exchange andregistered with the U.S. Securities and Exchange Commission. The Group’sshareholders offered 14,569,476 previously owned ordinary shares that consistedof 8,325,414 shares sold together with the Group’s shares and 6,244,062 sharessold as a result of underwriters exercising their over-allotment option.Placement price was equal to $21 per ADS. Net proceeds attributable to theGroup amounted to $213,353 after deducting underwriters’ discount of $12,238and direct placement related expenses of $7,520. Net proceeds attributable tothe Group’s selling shareholders amounted to $96,632.

**Additional paid-incapital**

The excess of the proceeds from contributions made bythe Controlling Shareholders into Mechel’s capital in the form of the shares ofvarious subsidiaries, which equity stakes accumulating to a control interestresulted in purchase business combinations, over the aggregate par value ofMechel common shares issued, was allocated to additional paid-in capital.

The excess of the proceedsfrom sale of ADSs over their par value in 2004 amounted to $201,781.

**Treasury shares**

In connection with the reorganization described inNote 1, 16,790,271 common shares were issued to Mechel Trading, a Groupsubsidiary, in exchange for shares contributed by the Controlling Shareholdersand held by Mechel Trading. Consistent with the presentation of common sharesas described above, 13,152,065 of these shares valued at their aggregate parvalue have been treated as held in treasury as of December 31, 2004 and2005.

During the year ended December 31,2006, the Group used 18,645,058 of its treasury shares to acquire 25.33%interest in Moskoks (see Note 2(j)). 12,996,208 shares used for the acquisitionwere treasury shares previously held by MIH (3.12% of voting stock) and5,648,850 shares were acquired for this purpose from Calridge Ltd (See Note 10).

**Stock-basedcompensation**

During the year ended December 31,2006, the Group sold 155,857 of its ordinary shares held in treasury (0.04% ofvoting shares) to certain Group executives. The difference of $209 between thesales price of $1,248 (or $8 per share) and market price of $1,457 was recordedas an operating expense.

**Dividends**

In accordance with applicable legislation, Mechel andits subsidiaries can distribute all profits as dividends or transfer them toreserves. Dividends may only be declared from accumulated undistributed andunreserved earnings as shown in the statutory financial statements of bothRussian and foreign Group’s subsidiaries. Dividends are subject to a 9%withholding tax in Russia for residents and 15% for non-residents, whichcan be reduced or eliminated if paid to foreign owners under certain applicabledouble tax treaties. Additional dividend tax could be imposed on the transferof undistributed earnings of 

F-61

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

subsidiaries to Mechel(generally, tax rate is assumed as 9%). Approximately $4,032,317 and $2,507,142were available for dividends as of December 31, 2006 and 2005,respectively. Approximately $316,382 of undistributed retained earnings of theGroup’s subsidiaries were restricted for distribution in accordance with acovenant provided in a loan agreement with BNP Paribas as of December 31,2006.

On June 30, 2006,Mechel declared a dividend of 5,134 billion rubles ($189,582) for 2005, whichwas paid in July-September 2006. On June 29, 2005, Mechel declared adividend of 5,543 million rubles (approximately $194,154), which was paid inJuly-August 2005.

**Earnings per share**

Netincome per common share for all periods presented was determined in accordancewith SFAS No. 128, “Earnings per Share”, by dividing income available toshareholders by the weighted average number of shares outstanding during thethree years ended December 31:

| ** **                                                             | ** ** | **2006**    | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Net income  available to shareholders                                  |       | 603,249     |       | 381,180     |       | 1,342,706   |       |
| Total weighted average number of shares outstanding  during the period |       | 408,979,356 |       | 403,118,680 |       | 373,971,312 |       |
| **Earnings  per common share**                                         | ** ** | **1.48**    | ** ** | **0.95**    | ** ** | **3.59**    | ** ** |

 

F-62

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Totalweighted-average number of common shares outstanding during the period is asfollows:

| **Dates outstanding**                                       | ** ** | ** **      | ** ** | **Shares  outstanding** | ** ** | **Fraction of  period (days)** | ** ** | **Weighted-average  number of shares** | ** **      |
|------------------------------------------------------------------|------------|-----------------|------------|-------------------------|------------|------------------------------------------|------------|--------------------------------------------------|-----------------|
| **2004:**                                                        |       |            |       |                    |       |                                     |       |                                             |            |   |   |
| Common shares:  January 1-October 28                   |       | 382,969,086     |       |                    | 302        |                                     |       |                                             | 316,001,814     |   |   |
| Common shares:  October 29-December 31                 |       | 416,270,745     |       |                    | 64         |                                     |       |                                             | 72,790,513      |   |   |
| Treasury shares:  January 1-April 15                        |       | (16,790,271     | )          |                    | 106        |                                     |       |                                             | (4,862,756      | ) |   |
| Treasury shares  sold on April 15                           |       | 2,297,815       |       |                    |       |                                     |       |                                             |            |   |   |
| Treasury shares: April 16-September  30                     |       | (14,492,456     | )          |                    | 168        |                                     |       |                                             | (6,652,275      | ) |   |
| Treasury shares  sold on October 1                          |       | 1,340,391       |       |                    |       |                                     |       |                                             |            |   |   |
| Treasury shares:  October 1-December 31                     |       | (13,152,065     | )          |                    | 92         |                                     |       |                                             | (3,305,984      | ) |   |
| **Total weighted average shares outstanding during  the period** | ** ** | **403,118,680** |       |                    |       |                                     | ** ** | ** **                                       | **373,971,312** |   |   |
| **2005:**                                                        |       |            |       |                    |       |                                     |       |                                             |            |   |   |
| Common shares:  January 1-December 31                  |       | 416,270,745     |       |                    | 365        |                                     |       |                                             | 416,270,745     |   |   |
| Treasury shares:  January 1-December 31                     |       | (13,152,065     | )          |                    | 365        |                                     |       |                                             | (13,152,065     | ) |   |
| **Total weighted average shares outstanding during  the period** | ** ** | **403,118,680** |       |                    |       |                                     | ** ** | ** **                                       | **403,118,680** |   |   |
| **2006:**                                                        |       |            |       |                    |       |                                     |       |                                             |            |   |   |
| Common shares:  January 1-December 31                  |       | 416,270,745     |       |                    | 365        |                                     |       |                                             | 416,270,745     |   |   |
| Treasury shares:  January 1-March 6                    |       | (13,152,065     | )          |                    | 65         |                                     |       |                                             | (2,342,149      | ) |   |
| Treasury shares  sold on March 6                            |       | 155,857         |       |                    |       |                                     |       |                                             |            |   |   |
| Treasury shares:  March 7-July 23                      |       | (12,996,208     | )          |                    | 139        |                                     |       |                                             | (4,949,240      | ) |   |
| Treasury shares  sold on July 23                            |       | 12,996,208      |       |                    |       |                                     |       |                                             |            |   |   |
| Treasury shares:  July 24-December 31                  |       | —          |       |                    | 161        |                                     |       |                                             | —          |   |   |
| **Total  weighted average shares outstanding during the period** | ** ** | **416,270,745** |       |                    |       |                                     | ** ** | ** **                                       | **408,979,356** |   |   |

 

There were no dilutivesecurities issued as of December 31, 2006, 2005 and 2004.

**Stock issued tominority shareholders**

On October 1, 2004, Mechel Trading, a 100%-ownedsubsidiary by the Group, agreed to transfer 1,072,313 and 268,078 of Mechel’sshares held by it in treasury to two employees of MMS, the Group’sLiechtenstein trading subsidiary, in return for 20% and 5%, respectively, ofthe shares of this subsidiary owned by these employees. The transaction wasaccounted for as the purchase of a minority interest in exchange for theissuance of treasury stock. The cost of the purchase was based upon the fairvalue of treasury shares issued. The non-monetary exchange of Mechel shares forMMS shares was accounted for using the purchase method of accounting and,accordingly, the fair value of the Mechel stock issued of 

F-63

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

$8,956 was credited toadditional paid-in capital, and the excess of fair value of Mechel stock overMMS shares of $7,505 was debited to goodwill.

In an effort to merge SKCC with several of itssubsidiaries, additional shares of SKCC were issued in October 2004 andexchanged for current minority interest in Tomusinsk Group Processing Plant(TGPP). On October 15, 2004, TGPP merged with SKCC and ceased itsexistence as a legal entity. The non-monetary exchange of SKCC shares for TGPPshares that were cancelled was accounted for using the purchase method ofaccounting and, accordingly, the fair value of the SKCC stock issued of $340,was credited to additional paid-in capital.

The Group’s effort to consolidate SKCC subsidiaries in2005 continued with the merger of Siberian CPP, Kuzbass CPP and Sibirginsk OPMwith SKCC in October and December 2005. The merger involved differentacquisitions of minority stakes of SCPP, KCPP and SOPM and their subsequentconversion into SKCC shares. On October 31, 2005, Siberian CPP and KuzbassCPP ceased their existence as legal entities, and on December 30, 2005 thesame happened to Sibirginsk OPM. The non-monetary exchange of SKCC shares forSCPP, KCPP and SOPM shares that were cancelled was accounted for using thepurchase method of accounting and, accordingly, the fair value of the SKCCstock issued of $17,460, was credited to additional paid-in capital.

On October 2-3,2006, KOPM, Tomusinsk Transportation Centre and Lenin Mine merged with SKCC.The minority interests outstanding as of the merger dates were converted intoSKCC shares. The non-monetary exchange was accounted for using the purchasemethod of accounting and accordingly, the fair value of SKCC stock of $9,641issued, to acquire the minority interests was credited to additional paid-incapital.

**20.**          INCOMETAXES

Income(loss) before income tax, minority interests, discontinued operation andextraordinary gain attributable to different jurisdictions was as follows:

| ** **              | ** ** | **Years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Russia                  |       | 591,006                                     |       | 505,995 |   | 526,536 |   |
| Switzerland             |       | 163,971                                     |       | 104,398 |   | 238,895 |   |
| British Virgin  Islands |       | 74,322                                      |       | (28,249 | ) | 787,829 |   |
| Romania                 |       | 35,217                                      |       | (55,560 | ) | (9,885 | ) |
| Lithuania               |       | 287                                         |       | (1,255 | ) | 2,390 |   |
| Kazakhstan              |       | —                                      |       | 486 |   | (670 | ) |
| Ukraine                 |       | 30                                          |       | 44 |   | — |   |
| **Total**               | ** ** | **864,833**                                 | ** ** | **525,859** | ** ** | **1,545,095** | ** ** |

 

F-64

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                               | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| *Current income tax expense*             |       |                                        |       |   |   |   |   |
| Russia                                   |       | 196,659                                     |       | 140,753 |   | 162,057 |   |
| Switzerland                              |       | 11,630                                      |       | 8,176 |   | 22,713 |   |
| Romania                                  |       | —                                      |       | 239 |   | 2,223 |   |
| Lithuania                                |       | —                                      |       | — |   | — |   |
| Ukraine                                  |       | 11                                          |       | 10 |   | — |   |
|                                     |       | 208,300                                     |       | 149,178 |   | 186,993 |   |
| *Deferred income tax expense  (benefit)* |       |                                        |       |   |   |   |   |
| Russia                                   |       | 24,776                                      |       | (10,136 | ) | (14,389 | ) |
| Switzerland                              |       | (1,476                                      | )          | (1,555 | ) | 3,183 |   |
| Romania                                  |       | (1,003                                      | )          | (580 | ) | 70 |   |
| Lithuania                                |       | 2                                           |       | 110 |   | (43 | ) |
| Kazakhstan                               |       | —                                      |       | (374 | ) | (38 | ) |
|                                     |       | 22,299                                      |       | (12,535 | ) | (11,217 | ) |
| **Total  income tax expense**            | ** ** | **230,599**                                 | ** ** | **136,643** | ** ** | **175,776** | ** ** |

 

Taxes represent the Group’s provision for profit tax.In 2004-2006, income tax was calculated at 24% of taxable profit inRussia, at 10.5% in Switzerland, at 16% in Romania, at 15% in Lithuania and at30% in Kazakhstan. The Group’s subsidiaries incorporated in Liechtenstein andBritish Virgin Islands are exempt from profit tax.

F-65

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Thereconciliation between the income tax expense computed by applying the Russianenacted statutory tax rates (24% for all three years ended December 31,2006) to the income before taxes, minority interest and extraordinary items, tothe income tax expense reported in the financial statements is as follows:

| ** **                                                                                      | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                            |       |                                        |       |   |   |   |   |
| Theoretical  income tax expense computed on income before taxes at Russian statutory  rate |       | 207,560                                     |       | 126,206 |   | 370,823 |   |
| *Effects  of other jurisdictions and permanent differences:*                                    |       |                                        |       |   |   |   |   |
| Property, plant  and equipment basis difference                                                 |       | (2,349                                      | )          | 707 |   | 1,481 |   |
| Non-deductible  expenses and non-taxable income, net                                            |       | 47,546                                      |       | 8,591 |   | 25,502 |   |
| Social  expenditures                                                                            |       | 9,605                                       |       | 6,711 |   | 7,838 |   |
| Loss  carry-forward used                                                                        |       | —                                      |       | — |   | (5,840 | ) |
| Change in  valuation allowance                                                                  |       | (17                                         | )          | 7,200 |   | (4,563 | ) |
| Deferred tax on  planned distributions of Swiss subsidiaries                                    |       | 10,500                                      |       | — |   | — |   |
| Other permanent  differences                                                                    |       | 8,862                                       |       | (520 | ) | 919 |   |
| Different tax  rates in foreign jurisdictions                                                   |       | (48,485                                     | )          | (4,352 | ) | (233,929 | ) |
| Fines and  penalties related to taxes                                                           |       | (2,563                                      | )          | (7,900 | ) | (284 | ) |
| Change in tax  rate and tax legislation                                                         |       | (60                                         | )          | — |   | 13,829 |   |
| **Income tax expense, as reported**                                                             | ** ** | **230,599**                                 | ** ** | **136,643** | ** ** | **175,776** | ** ** |

 

Included in the effect of different tax rates inforeign jurisdiction in 2004 is non-taxable gain of $787,829 related to thesale of the MMK shares realized through the Group’s subsidiary incorporated inBritish Virgin Islands.

The deferred tax balances were calculated by applyingthe currently enacted statutory tax rate in each jurisdiction applicable to theperiod in which the temporary differences between the carrying amounts and taxbase (both in respective local currencies) of assets and liabilities areexpected to reverse.

F-66

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Theamounts reported in the accompanying consolidated financial statementsconsisted of the following:

| ** **                                   | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Deferred tax  assets, current:               |       |                  |       |                  |       |   |   |   |   |
| Inventory and product related reserves       |       |                  | 3,846      |                  |       |   | 3,148 |   |   |
| Bad debt allowance                           |       |                  | 2,671      |                  |       |   | 3,155 |   |   |
| Timing difference in cost recognition        |       |                  | 1,050      |                  |       |   | 3,010 |   |   |
| Accrued liabilities                          |       |                  | 6,089      |                  |       |   | 1,442 |   |   |
| Vacation provision                           |       |                  | 5,482      |                  |       |   | 4,123 |   |   |
| Other                                        |       |                  | 772        |                  |       |   | 514 |   |   |
| Total deferred tax asset, current            |       |                  | 19,910     |                  |       |   | 15,392 |   |   |
| Deferred tax assets, non-current:            |       |                  |       |                  |       |   |   |   |   |
| Net operating loss carry-forward             |       |                  | 7,499      |                  |       |   | 9,781 |   |   |
| Asset retirement obligation                  |       |                  | 12,747     |                  |       |   | 4,612 |   |   |
| Property, plant and equipment                |       |                  | 41,104     |                  |       |   | 7,970 |   |   |
| Pension obligations                          |       |                  | 11,958     |                  |       |   | 11,757 |   |   |
| Other                                        |       |                  | 2,301      |                  |       |   | 105 |   |   |
| Total deferred tax assets, non-current       |       |                  | 75,609     |                  |       |   | 34,225 |   |   |
| Valuation  allowance for deferred tax assets |       |                  | (12,836    | )                     |       |   | (11,130 | ) |   |
| **Total  deferred tax asset, net**           | ** ** | ** **            | **82,683** |                  | ** ** | ** ** | **38,487** |   |   |

 

F-67

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                                  | ** ** | **December 31,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------|-------------|-----------------------|------------|
| ** **                                  | ** ** | **2006**              | ** **  | **2005**              | ** ** |
| Deferred tax  liabilities, current:         |       |                  |        |                  |       |   |   |   |   |
| Timing difference in revenue recognition    |       |                  | 17,345      |                  |       |   | 13,451 |   |   |
| Marketable securities                       |       |                  | 30,554      |                  |       |   | — |   |   |
| Timing difference in cost recognition       |       |                  | 1,210       |                  |       |   | 2,833 |   |   |
| Inventories                                 |       |                  | 12,683      |                  |       |   | 12,686 |   |   |
| Bad debt provision                          |       |                  | 1,157       |                  |       |   | 1,316 |   |   |
| Other                                       |       |                  | 2,686       |                  |       |   | 1,788 |   |   |
| Total deferred  tax liabilities, current    |       |                  | 65,635      |                  |       |   | 32,074 |   |   |
| Deferred tax liabilities, non-current:      |       |                  |        |                  |       |   |   |   |   |
| Property, plant and equipment               |       |                  | 140,116     |                  |       |   | 75,556 |   |   |
| Mineral licenses                            |       |                  | 39,194      |                  |       |   | 32,044 |   |   |
| Investments                                 |       |                  | 2,807       |                  |       |   | 3,329 |   |   |
| Unremitted earnings of foreign subsidiaries |       |                  | 10,500      |                  |       |   | — |   |   |
| Timing difference in cost recognition       |       |                  | —      |                  |       |   | 153 |   |   |
| Other                                       |       |                  | 4,500       |                  |       |   | 917 |   |   |
| Total deferred tax liabilities, non-current |       |                  | 197,117     |                  |       |   | 111,999 |   |   |
| **Total  deferred tax liability**           | ** ** | ** **            | **262,752** |                  | ** ** | ** ** | **144,073** |   |   |

 

A deferred tax liability of approximately $10,500 wasrecognized as of December 31, 2006, due to the Group management’s decisionto distribute $70,000 of MIH unremitted earnings as dividends.

A deferred tax liability of approximately $155,077 and$278,492 as of December 31, 2006 and 2005, respectively, has not beenrecognized for temporary differences related to the Group’s investment in otherforeign subsidiaries primarily as a result of unremitted earnings ofconsolidated subsidiaries, as it is the Group’s intention, generally, toreinvest such earnings permanently, except the case described in the previousparagraph.

Similarly, a deferred tax liability of $269,862 and $89,553as of December 31, 2006 and 2005, respectively, has not been recognizedfor temporary difference related to unremitted earnings of consolidateddomestic subsidiaries as management believes the Group has both the ability andintention to a tax-free reorganization or merger of major subsidiaries intoMechel. A deferred tax liability of $3,706 and $2,251 as of December 31,2006 and 2005, respectively, was recognized for temporary difference related tounremitted earnings of Yakutugol.

F-68

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Forfinancial reporting purposes, a valuation allowance is recognized to reflectmanagement’s estimate for realization of the deferred tax assets. Valuationallowances are provided when it is more likely than not that some or all of thedeferred tax assets will not be realized in the future. These evaluations arebased on expectations of future taxable income and reversals of the varioustaxable temporary differences. For Russian income tax purposes, certainsubsidiaries of the Group have accumulated tax losses incurred in 2002-2006,which may be carried forward for use against their future income within 10years. Their use was restricted to a maximum of 30% of taxable income of therespective subsidiary of the Group in 2005, to a maximum of 50% of taxable incomein 2006 and will have no restrictions effective January 1, 2007. Tax losscarryforwards may be eroded by future devaluation of the ruble. As of December 31,2006, for statutory income tax purposes, the subsidiaries of the Group had taxlosses available to carryforward of approximately $69,204 expiring as follows:

| December 31,  2007      |       | 374        |       |
|------------------------------|------------|------------|------------|
| December 31,  2008      |       | 11,038     |       |
| December 31,  2009      |       | 6,175      |       |
| December 31,  2010      |       | 31,424     |       |
| December 31,  2011      |       | 3,417      |       |
| Thereafter                   |       | 16,776     |       |
| **Total  loss carryforward** | ** ** | **69,204** | ** ** |

 

**21.**          TAXESOTHER THAN INCOME TAX

Taxesother than income tax included in the consolidated income statements arecomprised of the following:

| ** **                             | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Property and land  tax                 |       | 56,463                                      |       | 51,280 |   | 42,476 |   |
| VAT                                    |       | 2,885                                       |       | 1,887 |   | 1,017 |   |
| Fines and  penalties related to taxes  |       | (2,895                                      | )          | 14,047 |   | 13,340 |   |
| Other taxes and  penalties             |       | 25,687                                      |       | 23,469 |   | 12,452 |   |
| **Total  taxes other than income tax** | ** ** | **82,140**                                  | ** ** | **90,683** | ** ** | **69,285** | ** ** |

 

Property and land taxconsists mostly of payments for land tax, which amounted to $29,356, $30,700,and $28,880 for the years ended December 31, 2006, 2005 and 2004,respectively. This tax is levied on the land beneath the Group’s productionsubsidiaries that is occupied based on the right of perpetual use. According toland legislation, the right of perpetual use has to be re-registered before January 1,2008 through purchase of land or operating leases up to 49 years, which will bedecided by the Group during 2007.

F-69

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**22.**          GENERAL,ADMINISTRATIVE AND OTHER OPERATING EXPENSES

General,administrative and other operating expenses are comprised of the following:

| ** **                                                      | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Personnel and  social contributions                             |       | 134,840                                     |       | 109,735 |   | 88,189 |   |
| Social expenses                                                 |       | 33,156                                      |       | 38,269 |   | 27,751 |   |
| Fixed assets  disposals                                         |       | 1,320                                       |       | 1,801 |   | 5,736 |   |
| Audit and  consulting services                                  |       | 20,426                                      |       | 20,234 |   | 12,432 |   |
| Depreciation                                                    |       | 12,856                                      |       | 9,434 |   | 7,621 |   |
| Rent                                                            |       | 4,238                                       |       | 5,341 |   | 13,729 |   |
| Banking charges  and services                                   |       | 6,468                                       |       | 3,907 |   | 3,678 |   |
| Other                                                           |       | 76,631                                      |       | 71,007 |   | 69,903 |   |
| **Total  general, administrative and other operating expenses** | ** ** | **289,935**                                 | ** ** | **259,728** | ** ** | **229,039** | ** ** |

 

Rentrepresents office-related expenses and expenses for the operating lease ofland, which ranges between 1 and 49 years. These land lease expenses amountedto $3,608, $2,843 and $2,184 for the years ended December 31, 2006, 2005and 2004, respectively. The amount of rental payments is determined by localauthorities and cannot be reasonably estimated beyond a five-year horizon. Thetable below presents future land rental payments for the next five years undernon-cancelable operating lease agreements based on the current rental rates:

| ** **                               | ** ** | **Operating** | ** **  |
|------------------------------------------|------------|---------------|-------------|
| **Year of payment**            | ** ** | ** **    | ** **  | **lease payments** | ** ** |
| 2007                                     |       |          | 4,512       |   |   |
| 2008                                     |       |          | 3,788       |   |   |
| 2009                                     |       |          | 4,121       |   |   |
| 2010                                     |       |          | 4,505       |   |   |
| 2011                                     |       |          | 4,949       |   |   |
| Thereafter                               |       |          | 127,290     |   |   |
| **Total  land operating lease payments** | ** ** | ** **    | **149,165** |   |   |
|                                          |            |               |             |  |  |  |  |

 

F-70

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**23.**          OTHERINCOME, NET

Other income, net, iscomprised of the following:

| ** **                                          | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Gain on sale of MMK  shares                         |       | —                                      |       | — |   | 799,982 |   |
| (Loss) gain on sale of  other long-term investments |       | (5,047                                      | )          | 2,743 |   | 3,423 |   |
| Gain on forgiveness of  fines and penalties         |       | 69,767                                      |       | 38,383 |   | 18,296 |   |
| Gain on accounts payable  with expired legal term   |       | 843                                         |       | 23,347 |   | 1,250 |   |
| Dividends received                                  |       | —                                      |       | — |   | 2,407 |   |
| Gain (loss) on  sale of promissory notes            |       | 150                                         |       | (3 | ) | (2,044 | ) |
| Other                                               |       | 3,688                                       |       | 1,450 |   | 13,503 |   |
| **Total  other income, net**                        | ** ** | **69,401**                                  | ** ** | **65,920** | ** ** | **836,817** | ** ** |

 

On December 21, 2004, the Group sold most of itsshares in MMK to a third party for the total of $870,000, including $90,000 paidunder a mutual release agreement, in which all potential claims between Mechel,on one hand, and MMK and its other shareholders, on the other, are waived. Thetotal sales price was received in cash. The gain realized on the sale of MMKshares in 2004 was equal to $799,982.

Gain on forgiveness of fines and penalties of $69,767in 2006 includes forgiveness of specified portion of restructured fines andpenalties of the Groups’ Russian subsidiaries in accordance with the terms ofrestructuring agreements, upon the full and timely payment of current taxes, aswell as of restructured principle amounts of taxes and charges, and $44,571 offines and penalties forgiven due to closing the Privatization Contract forMechel Targoviste nine months ahead of schedule (see also Note 15).

Gain on accounts payablewith expired legal term constitutes gain on the write-off of payable amountsthat were written-off due to legal liquidation of the creditors or expirationof the statute of limitation.

**24.**          SEGMENTALINFORMATION

The Group has two reportable business segments: Steeland Mining. These segments are combinations of subsidiaries and have separatemanagement teams and offer different products and services. The above twosegments meet criteria for reportable segments. Subsidiaries are consolidatedby the segment to which they belong based on their products and by which theyare managed.

The Group’s management evaluates performance of thesegments based on segment revenues, gross margin, operating income and incomebefore income taxes, minority interest and extraordinary items.

F-71

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Segmentalinformation for 2006, 2005 and 2004 is as follows:

| ** **                                              | ** ** | **Mining** | ** ** | **Steel** | ** ** | **2006**  | ** ** | **Mining** | ** ** | **Steel** | ** ** | **2005**  | ** ** | **Mining** | ** ** | **Steel** | ** ** | **2004**  | ** ** |
|---------------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|------------|------------|-----------|------------|-----------|------------|------------|------------|-----------|------------|-----------|------------|
| Revenues from external                                  |       |       |       |      |       |      |       |       |       |      |       |      |       |       |       |      |       |      |       |
| customers                                               |       | 1,336,142  |       | 3,061,669 |       | 4,397,811 |       | 1,094,782  |       | 2,710,213 |       | 3,804,995 |       | 878,417    |       | 2,757,538 |       | 3,635,955 |       |
| Intersegment revenues                                   |       | 376,569    |       | 23,664    |       | 400,233   |       | 336,593    |       | 56,633    |       | 393,226   |       | 322,992    |       | 74,651    |       | 397,643   |       |
| Gross margin                                            |       | 679,390    |       | 849,857   |       | 1,529,247 |       | 715,636    |       | 620,225   |       | 1,335,861 |       | 644,158    |       | 766,709   |       | 1,410,867 |       |
| Gross margin*, %                                   |       | 39.7       | %          | 27.5      | %          | 34.8      | %          | 50.0       | %          | 22.4      | %          | 35.1      | %          | 53.6       | %          | 27.1      | %          | 38.8      | %          |
| Depreciation, depletion and amortization                |       | 94,115     |       | 102,112   |       | 196,227   |       | 71,811     |       | 95,789    |       | 167,600   |       | 56,768     |       | 81,052    |       | 137,820   |       |
| Loss on write-off of property, plant and equipment |       | —     |       | (2,418    | )          | (2,418    | )          | —     |       | (12,667   | )          | (12,667   | )          | —     |       | —    |       | —    |       |
| Operating income                                        |       | 321,962    |       | 403,736   |       | 725,698   |       | 401,252    |       | 114,476   |       | 515,728   |       | 384,053    |       | 366,754   |       | 750,807   |       |
| (Loss) / Income from equity investees                   |       | (9,858     | )          | —    |       | (9,858)   |       | 12,426     |       | —    |       | 12,426    |       | 4,621      |       | —    |       | 4,621     |       |
| Interest income                                         |       | 2,974      |       | 5,340     |       | 8,314     |       | 6,884      |       | 3,165     |       | 10,049    |       | 881        |       | 1,494     |       | 2,375     |       |
| Interest expense                                        |       | 12,461     |       | 25,722    |       | 38,183    |       | 4,940      |       | 35,889    |       | 40,829    |       | 15,351     |       | 36,058    |       | 51,409    |       |
| Segment assets                                          |       | 1,798,064  |       | 2,650,994 |       | 4,449,058 |       | 1,667,017  |       | 1,933,066 |       | 3,600,083 |       | 1,682,871  |       | 1,995,398 |       | 3,678,269 |       |
| Invesments in equity investees**                        |       | 428,845    |       | —    |       | 428,845   |       | 408,377    |       | —    |       | 408,377   |       | 7,353      |       | —    |       | 7,353     |       |
| Capital expenditures                                    |       | 233,371    |       | 164,472   |       | 397,843   |       | 260,056    |       | 260,498   |       | 520,555   |       | 81,177     |       | 222,234   |       | 303,411   |       |
| Income tax expense                                      |       | (104,762   | )          | (125 ,837 | )          | (230,599  | )          | (75,223    | )          | (61,420   | )          | (136,643  | )          | (57,599    | )          | (118,177  | )          | (175,776  | )          |
| Extraordinary gain                                      |       | —     |       | —    |       | —    |       | —     |       | —    |       | —    |       | 271        |       | —    |       | 271       |       |

----

*                      Gross margin percentage is calculated as afunction of total revenues for the segment, including both from externalcustomers andintersegment.

**                 Included in total segment assets

Thefollowing table presents the Group’s revenues segregated between domestic andexport sales. Domestic represents sales by a production subsidiary in thecountry in which it is located. This category is further divided betweensubsidiaries located in Russia and other countries. Export representscross-border sales by a subsidiary regardless of its location.

| ** **             | ** ** | **2006**      | ** ** | **2005**      | ** ** | **2004**      | ** ** |
|------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| **Domestic:**          |       |          |       |          |       |          |       |
| Russia                 |       | 2,422,621     |       | 1,753,103     |       | 1,432,866     |       |
| Other                  |       | 335,759       |       | 328,229       |       | 244,210       |       |
| Total                  |       | 2,758,380     |       | 2,081,332     |       | 1,677,076     |       |
| **Export**             |       | 1,639,431     |       | 1,723,663     |       | 1,958,879     |       |
| **Total revenue, net** | ** ** | **4,397,811** | ** ** | **3,804,995** | ** ** | **3,635,955** | ** ** |

 

F-72

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2006 and 2005, and for each of the three years in the period ended**

**December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Allocationof total revenue by country is based on the location of the customer. The Group’stotal revenue from external customers by geographic area for the last threefiscal years was as follows:

| ** **    | ** ** | **2006**      | ** ** | **2005**      | ** ** | **2004**      | ** ** |
|---------------|------------|---------------|------------|---------------|------------|---------------|------------|
| Russia        |       | 2,285,702     |       | 1,753,103     |       | 1,432,866     |       |
| Europe        |       | 1,220,867     |       | 1,175,743     |       | 1,260,264     |       |
| Asia          |       | 198,226       |       | 342,450       |       | 551,153       |       |
| CIS           |       | 305,170       |       | 281,570       |       | 224,907       |       |
| Middle East   |       | 116,877       |       | 148,395       |       | 114,372       |       |
| USA           |       | 242,936       |       | 57,074        |       | 33,090        |       |
| Other regions |       | 28,033        |       | 46,660        |       | 19,303        |       |
| **Total**     | ** ** | **4,397,811** | ** ** | **3,804,995** | ** ** | **3,635,955** | ** ** |

 

Themajority of the Group’s long-lived assets are located in Russia. The carryingamount of net assets pertaining to the Group’s major operation located outsideRussia as of December 31, 2006 and 2005 was as follows:

| ** **                | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Switzerland/Liechtenstein |       | 2,281    |       | 2,457    |       |
| Lithuania                 |       | 4,924    |       | 2,059    |       |
| Romania                   |       | 108,469  |       | 81,593   |       |

 

Because of significantnumber of customers, there are no individual external customers that generatesales greater than 10% of the Group’s consolidated total revenue, except forthe Group’s sales to Glencore International AG (predominantly Steel segmentproducts), which comprised 13.1%, 9.7% and 8.2% of the Group’s total revenuefor 2006, 2005 and 2004, respectively.

**25.**          COMMITMENTSAND CONTINGENCIES

***Commitments***

In the course of carrying out its operations and otheractivities, the Group and its subsidiaries enter into various agreements, whichwould require the Group to invest in or provide financing to specific projectsor undertakings. In management’s opinion, these commitments are entered intounder standard terms, which are representative of each specific project’spotential and should not result in an unreasonable loss.

As of December 31,2006, total Group’s contract commitments amounted to $775,835, which consistedof the following: commitment to acquire property, plant and equipment $26,486,and commitment for delivery of goods and services $749,349.

F-73

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

***Contingencies***

**(a)**          Guarantees

As of December 31,2006, the Group guaranteed the fulfillment of obligations to third partiesunder various debt agreements for the total amount of $473,740. The guaranteesgiven for loans received by various subsidiaries and employees of the Groupamounted to $472,146 and $1,594, respectively. In case the borrower fails tofulfill its obligations under the loan agreement, the Group repays theoutstanding amount under the debt agreement with all interests, fines andpenalties due. Maximum potential amount of future payments under the guaranteesgiven as of December 31, 2006 amounted to $473,740.

**(b)**          Environmental

In the course of the Group’s operations, the Group maybe subject to environmental claims and legal proceedings. The quantification ofenvironmental exposures requires an assessment of many factors, includingchanging laws and regulations, improvements in environmental technologies, thequality of information available related to specific sites, the assessmentstage of each site investigation, preliminary findings and the length of timeinvolved in remediation or settlement. Management does not believe that anypending environmental claims or proceedings will have a material adverse effecton its financial position and results of operations.

Upon acquisition of Mechel Targoviste and MechelCampia Turzii, as part of the purchase agreements, the Group committed to theRomanian government to invest $7,300 and $4,581, through 2008, respectivelyinto environment development and restoration. The environment obligation takenby the Group in relation to Mechel Campia Turzii was discounted using 17% rateand included in the cost of investment in the amount of $2,673, together withcash consideration paid. Mechel Targoviste and Mechel Campia Turzii met allenvironmental obligations by December 31, 2006.

In April 2006, the Group became aware ofunasserted claims related to the potential non-compliance with establishedpollution norms. Management estimated and accrued for, and this risk in thefinancial statements for the year ended December 31, 2006 in the amount of$69.

The estimated amount ofcapital investments under the abovementioned environmental claims could be upto approximately $10,915, including $7,615 for Mechel Campia Turzii disclosedin section (g) below. These amounts are not accrued in the consolidatedfinancial statements until actual capital investments are made.

**(c)**           EUascension commitments

Integration of Romaniainto the European Union (“EU”) required, in particular, adoption of a newstrategy aimed at restructuring of major national metallurgical entities,including Mechel Targoviste and Mechel Campia Turzii. As an integral part ofrestructuring process, individual viability plans agreed with EU consultantsare to be incorporated into the business plans of all entities. Implementationof these plans and achievement of the targets should to be provided byinvestors in accordance with their contractual obligations under privatizationcontracts. Viability plans of Mechel Targoviste and Mechel Campia Turzi 

F-74

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

includeadditional investments into technology development and ecology improvement.After restructuring completion, key business performance indicators of bothcompanies are to be in line with effectiveness requirements of the EU.Management has not determined impact thereof on the Group’s Romaniansubsidiaries as of June 26, 2007.

**(d)**          Taxation

The Group is subject to taxation to the largest extentin Russia, and secondarily in other jurisdictions. The Russian tax system continuesto evolve. Applicable taxes include value-added tax, corporate income tax(profit tax), turnover-based taxes, payroll (social) taxes and others. Lawsrelated to these taxes have been adopted only recently, in contrast to moredeveloped market economies; and implementing regulations are often unclear ornonexistent. Many Russian tax laws and related regulations introduced in 2002and previous years were not always clearly drafted and their interpretation issubject to the opinions of local tax authorities, the Central Bank and theMinistry of Finance. Instances of inconsistent opinions between local, regionaland federal tax authorities and between the Central Bank and the Ministry ofFinance are not unusual, and few precedents with regard to issues have beenestablished. Tax declarations, together with other legal compliance areas (forexample, customs and currency control matters) are subject to review andinvestigation by a number of authorities that are enabled by law to imposesevere fines, penalties and interest charges. These facts create tax risks inRussia substantially more significant than typically found in countries withmore developed tax systems.

In Russia, generally, tax declarations remain open andsubject to inspection for a period of three years. The fact that a year hasbeen reviewed does not close that year, or any tax declaration applicable to thatyear, from further review during the three-year period.

In other tax jurisdictions where the Group conductsoperations or holds shares, taxes are generally charged on the income arisingin that jurisdiction. In some jurisdictions agreements to avoid double taxationare signed between different jurisdictions; however, the risk of additionaltaxation exists, especially in respect of certain domiciles where some of theGroup entities are located and which are considered to be tax havens.

Management believes that it has paid or accrued alltaxes that are applicable. Where uncertainty exists, the Group has accrued taxliabilities based on management’s best estimate of the probable outflow ofresources embodying economic benefits, which will be required to settle theseliabilities. The Group accrued $34,143 of tax claims, including fines andpenalties related to mineral extraction tax of KMP in the amount of $27,269,for which the Group had lost court hearings in the first two levels of Russianjudicial system. The management believes these tax contingencies are probable.Consequently, relevant accruals have been made in the financial statements asof December 31, 2006 for this contingency.

As of December 31, 2006, the Group does notbelieve that any other material tax matters exist relating to the Group,including current pending or future governmental claims and demands, whichwould require adjustment to the accompanying financial statements in order forthose statements not to be materially misstated or misleading.

F-75

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Possible liabilities,which were identified by management at the balance sheet date as those that canbe subject to different interpretations of the tax laws and regulations and arenot accrued in the consolidated financial statements could be up toapproximately $89,000 as of December 31, 2006, including those related totransfer pricing (Note 25 (f)).

**(e)**           Litigation,claims and assessments

The Group is subject to various lawsuits, claims andproceedings related to matters incidental to its business. In the opinion ofmanagement, the Group’s liability, if any, in all pending litigation, otherlegal proceeding or other matters, other than those described in Notes 15 and25, would not have a material effect upon the financial condition, results ofoperations or liquidity of the Group.

The Group operates in a number of differentjurisdictions with varying legal systems and regimes, including developingmarkets with evolving fiscal and regulatory environments.

The Russian legal system, which affects most of theGroup’s subsidiaries, is characterized by: (1) inconsistencies between andamong laws, presidential decrees, and Russian governmental, ministerial andlocal orders, decisions, and resolutions and other acts; (2) conflictinglocal, regional and federal rules and regulations; (3) the lack ofjudicial and administrative guidance on interpreting legislation; (4) therelative inexperience of judges and courts in interpreting legislation; and (5) ahigh degree of discretion on the part of governmental authorities. Managementis unable to estimate what developments may occur or the resulting effect ofany such developments on the Group’s financial condition or future results ofoperations.

The Group’s operations and financial position willcontinue to be affected by Russian political developments including theapplication of existing and future legislation and tax regulations. Thelikelihood of such occurrences and their effect on the Group could have asignificant impact on the Group’s ability to continue operations.

In the third quarter of 2006, certain SKCC minorityshareholders filed several legal claims against the Group. In particular, Austro(Cyprus) Limited, possessing 4.1% and 0.5% of total share capital ofKrasnogorsk Open Pit Mine and Lenin Mine, respectively, and LankrennanInvestments Limited, possessing 7.3% of total share capital of Olzherassk OpenPit Mine, issued claims in respect of alleged minority shareholders’ rightsviolation during the merger of these subsidiaries with SKCC in the fourthquarter of 2005.

Claimants demand torescind shares exchanges between SKCC and its subsidiaries and to compensatethe above mentioned subsidiaries for allegedly deprived profits of $259,000. Ifsatisfied in court, this claim may result in minority share increase ofapproximately $45,541 in the Group’s consolidated financial statements. Thereis also another portion of claims in respect of undervaluation of SKCCsubsidiaries’ shares. The maximum amount that could be allocated to claimants’shares based on these claims approximates $31,000. In addition, if sustained bythe court, these claims could also trigger additional significant tax implicationsfor the Group. The claim of Lankrennan Investments Limited of $98,000 wasdismissed by the court in the first legal instance. The Group is expecting anappeal.

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(f)**             Transferpricing

Russian transfer pricing rules enteredinto force in 1999, giving Russian tax authorities the right to make transferpricing adjustments and impose additional tax liabilities in respect of allcontrolled transactions, provided that the transaction price differs from themarket price by more than 20%. Controlled transactions include transactionbetween related entities and certain other types of transactions between independentparties, such as foreign trade transactions with significant (by more than 20%)price fluctuations. The Russian transfer pricing rules are vaguely drafted,leaving wide scope for interpretation by Russian tax authorities and courts.Due to the uncertainties in interpretation of transfer pricing legislation, thetax authorities may challenge the Group’s price and propose adjustments. Ifsuch price adjustments are upheld by the Russian courts and implemented, theGroup’s future financial results could be adversely affected. In addition, theGroup could face significant losses associated with the assessed of prior taxunderpaid and related interest and penalties, which could have an adverseeffect on the Group’s financial condition and results of operations. The Groupbelieves that such transfer pricing related tax contingencies are possiblerather than probable.

**(g)**           Othercommitments

In the course of acquisitionof various subsidiaries in 2002 and 2003, the Group undertook a number ofcommitments in respect of future capital expenditures connected with thedevelopment of production facilities. The Group committed to make theinvestment for the development of the production facilities and improvements ofthe environmental compliance in Mechel Campia Turzii and Mechel Targoviste, forthe total of approximately $22,659 and $21,072 respectively, during a period offive years from the date of acquisition. Also the Group committed to maintainworkforce level at Mechel Campia Turzii for five years. Total obligations ofMechel Campia Turzii and Mechel Targoviste under privatization contracts as of December 31,2006 amounted to $7,615 and $nil, respectively. Environmental obligations ofMechel Targoviste were fulfilled completely in the third quarter of 2006.Environmental obligations of Mechel Campia Turzii increased in comparison withprior periods due to revision of some contracts’ substance and relevantreclassification of obligations to appropriate categories of some contracts.Amounts related to environmental obligations are disclosed separately insection (b) above.

**26.**          SUBSEQUENTEVENTS

**(a)**          Earlytermination of Privatization Agreement for Mechel Campia Turzii

In April 2007, theAVAS officially confirmed that the Group had fully fulfilled all its investmentobligations assumed in accordance with the Privatization Agreement for MechelCampia Turzii. As a result, the Group will recognize gain on discharge of allobligations disclosed in Note 25(g) in the second quarter of 2007.

**(b)**          SouthernKuzbass Power Plant OAO (SKPP)

On March 29, 2007,the Group acquired 93.4% of the charter capital of SKPP for approximately$265,000 at a public auction. The plant was separated from Kuzbassenergo as aresult of its reorganization 

F-77

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

in July 2006.SKPP is located in the Kemerovo Region. As of January 1, 2007, itsinstalled electric power capacity is 554 MWt, and the heat power capacity is560 Gcal/h. The acquisition will be accounted for using the purchase method ofaccounting from the date of acquisition of control, March 29, 2007.

**(c)**           KuzbassEnergy Sales Company OOO (Kuzbassenergosbyt)

In May 2007, theGroup acquired 49% of the charter capital of Kuzbassenergosbyt forapproximately $43,000 at a public auction. Together with 1.2% owned by theGroup before the acquisition, the share of the Group in Kuzbassenergosbyt hasreached 50.2%. The acquisition will be accounted for using the purchase methodof accounting in 2007 from the date of acquisition of control.

**(d)**          Cancellationof golden share in Izhstal

On February 6, 2007, the “golden share” of theGovernment of the Russian Federation in Izhstal OAO was cancelled by the order No. 141-p****of the Government of the RussianFederation.

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