**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**Form 20-F**

**o**                                   RegistrationStatement pursuant to Section 12(b) or (g) of the SecuritiesExchange Act of 1934

**or**

**x**                                 Annual reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of1934 for the fiscal year ended December 31, 2005

**or**

**o**                                   Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934

**or**

**o**                                   Shell companyreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934

**Commission file number 333-119497**

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**MECHELOAO**

(Exactname of Registrant as specified in its charter)

**RussianFederation**

(Jurisdictionof incorporation or organization)

**KrasnopresnenskayaNaberezhnaya 12, Moscow 123610, Russian Federation**

(Addressof principal executive offices)

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Securitiesregistered or to be 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 tobe registered pursuant to Section 12(g) of the Act:

**NONE**

(Titleof Class)

Securities for which there isa reporting obligation pursuant to Section 15(d) of the Act:

**NONE**

(Titleof Class)

Indicatethe number of outstanding shares of each of the issuer’s classes of capital orcommon stock as of the close of the period covered by the annual report.

15,710,868ADSs

403,118,680common shares

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.

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

 

Ifthis report is an annual or transition report, indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or 15(d) ofthe Securities Exchange Act of 1934.

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

Note—Checkingthe box above will not relieve any registrant required to file reports pursuantto Section 13 or 15(d) of the Securities Exchange Act of 1934 fromtheir obligations under those Sections.

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check One):

Large acceleratedfiler o                   AcceleratedFiler x              Non-acceleratedfiler o

Indicateby check mark which financial statement item the Registrant has elected tofollow:

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

 

Ifthis is an annual report, indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

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

 

(1)             Listed, not fortrading or quotation purposes, but only in connection with the registration ofADSs pursuant to the requirements of the Securities and Exchange Commission.

 

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**TABLEOF 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                                                   |   | 35 |   |
| *Item 5.*                                             |   | Operating  and Financial Review and Prospects                                 |   | 80 |   |
| *Item 6.*                                             |   | Directors,  Senior Management and Employees                                   |   | 117 |   |
| *Item 7.*                                             |   | Major  Shareholders and Related Party Transactions                            |   | 123 |   |
| *Item  8.*                                            |   | Financial  Information                                                        |   | 124 |   |
| *Item  9.*                                            |   | The Offer  and Listing                                                        |   | 125 |   |
| *Item  10.*                                           |   | Additional  Information                                                       |   | 126 |   |
| *Item 11.*                                            |   | Quantitative  and Qualitative Disclosures and Market Risk                     |   | 146 |   |
| *Item 12.*                                            |   | Description  of Securities Other than Equity Securities                       |   | 151 |   |
| *Item 13.*                                            |   | Defaults,  Dividend Arrearages and Delinquencies                              |   | 152 |   |
| *Item 14.*                                            |   | Material  Modifications to the Rights of Security Holders and Use of Proceeds |   | 152 |   |
| *Item  15.*                                           |   | Controls  and Procedures                                                      |   | 152 |   |
| *Item 16A.*                                           |   | Audit  Committee Financial Expert                                             |   | 154 |   |
| *Item 16B.*                                           |   | Code of  Ethics                                                               |   | 154 |   |
| *Item 16C.*                                           |   | Principal  Accountant Fees and Services                                       |   | 154 |   |
| *Item 16D.*                                           |   | Exemptions  from the Listing Standards for Audit Committees                   |   | 155 |   |
| *Item 16E.*                                           |   | Purchases  of Equity Securities by the Issuer and Affiliated Purchasers       |   | 156 |   |
| *Item  17.*                                           |   | Financial  Statements                                                         |   | 157 |   |
| *Item  18.*                                           |   | Financial  Statements                                                         |   | 157 |   |
| *Item 19.*                                            |   | Exhibits                                                                      |   | 157 |   |
| SIGNATURES                                            |   | 158                                                                           |   |

 

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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 31,2005, 2004, 2003, 2002 and 2001, 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 operationsfor the periods presented are significantly affected by acquisitions. Resultsof operations of these acquired businesses are included in our consolidatedfinancial statements for the periods after their respective dates ofacquisition. The financial data below should be read in conjunction with, andare qualified in their entirety by reference to, our consolidated financialstatements and related notes included under “Item 18. Financial Statements” and“Item 5. Operating and Financial Review and Prospects.”

4

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| ** **                                                                                                            | ** ** | **Year ended December 31,**                                                        | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2005**                                                                                          | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                            | ** ** | **(in thousands of U.S. dollars, except per share data)** | ** ** |
| **Consolidated income statement  data:**                                                                              |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Revenue, net                                                                                                          |       | 3,804,995                                                                                         |       | 3,635,955 |   | 2,028,051 |   | 1,314,149 |   | 1,019,726 |   |
| Costs of goods  sold                                                                                                  |       | (2,469,134                                                                                        | )          | (2,225,088 | ) | (1,422,987 | ) | (947,527 | ) | (721,089 | ) |
| Gross margin                                                                                                          |       | 1,335,861                                                                                         |       | 1,410,867 |   | 605,064 |   | 366,622 |   | 298,637 |   |
| Selling,  distribution and operating expenses                                                                         |       | (820,133                                                                                          | )          | (660,060 | ) | (407,383 | ) | (277,478 | ) | (193,853 | ) |
| Operating income                                                                                                      |       | 515,728                                                                                           |       | 750,807 |   | 197,681 |   | 89,144 |   | 104,784 |   |
| Other income and  expense, net                                                                                        |       | 10,131                                                                                            |       | 794,288 |   | (21,555 | ) | (18,083 | ) | (12,178 | ) |
| Income before tax,  minority interest, discounted operations, extraordinary gain and changes in  accounting principle |       | 525,859                                                                                           |       | 1,545,095 |   | 176,126 |   | 71,061 |   | 92,606 |   |
| Income tax expense                                                                                                    |       | (136,643                                                                                          | )          | (175,776 | ) | (47,759 | ) | (2,653 | ) | (30,184 | ) |
| Minority interest  in loss (income) of subsidiaries                                                                   | ** ** | (6,879                                                                                            | **)**      | (11,673 | ) | 18,979 |   | 10,433 |   | (15,521 | ) |
| Income from  continuing operations                                                                                    |       | 382,337                                                                                           |       | 1,357,646 |   | 147,346 |   | 78,841 |   | 46,901 |   |
| Loss from discontinued  operations, net of tax                                                                        |       | (1,157                                                                                            | )          | (15,211 | ) | (5,790 | ) | (1,835 | ) | (735 | ) |
| Extraordinary  gain, net of tax                                                                                       |       | —                                                                                            |       | 271 |   | 5,740 |   | 1,388 |   | 1,252 |   |
| Changes in accounting  principle, net of tax                                                                          |       | —                                                                                            |       | — |   | (3,788 | ) | 10,859 |   | — |   |
| Net income                                                                                                            |       | 381,180                                                                                           |       | 1,342,706 |   | 143,508 |   | 89,253 |   | 47,418 |   |
| Currency translation adjustment                                                                                       |       | (53,822                                                                                           | )          | 49,116 |   | 46,921 |   | — |   | — |   |
| Unrealized losses on marketable  securities                                                                           |       | 2,181                                                                                             |       | (2,350 | ) | — |   | — |   | — |   |
| Comprehensive  income                                                                                                 |       | 329,539                                                                                           |       | 1,389,472 |   | 190,429 |   | 89,253 |   | 47,418 |   |
| Earnings per share  from continuing operations                                                                        |       | 0.95                                                                                              |       | 3.63 |   | 0.39 |   | 0.24 |   | 0.21 |   |
| Loss per share  effect of discontinued operations                                                                     |       | (0.00                                                                                             | )          | (0.04 | ) | (0.01 | ) | (0.01 | ) | (0.01 | ) |
| Earnings per share  effect of extraordinary gain                                                                      |       | 0.00                                                                                              |       | 0.00 |   | 0.02 |   | 0.01 |   | 0.01 |   |
| Earnings per share  effect of changes in accounting principle                                                         |       | 0.00                                                                                              |       | 0.00 |   | (0.01 | ) | 0.03 |   | 0.00 |   |
| Net income per  share                                                                                                 |       | 0.95                                                                                              |       | 3.59 |   | 0.39 |   | 0.27 |   | 0.21 |   |
| Cash dividends per  share                                                                                             |       | 0.00                                                                                              |       | 0.01 |   | 0.07 |   | 0.04 |   | 0.04 |   |
| Weighted average  number shares outstanding                                                                           |       | 403,118,680                                                                                       |       | 373,971,312 |   | 366,178,815 |   | 333,243,450 |   | 225,271,391 |   |
| **Steel segment income statement  data:**                                                                             |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Revenue, net(2)                                                                                                       |       | 2,766,846                                                                                         |       | 2,832,189 |   | 1,656,358 |   | 1,050,554 |   | 680,314 |   |
| Cost of goods sold(2)                                                                                                 |       | (2,146,621                                                                                        | )          | (2,065,480 | ) | (1,230,314 | ) | (801,481 | ) | (546,885 | ) |
| Gross margin                                                                                                          |       | 620,225                                                                                           |       | 766,709 |   | 426,044 |   | 249,073 |   | 133,429 |   |
| Selling,  distribution and operating expenses                                                                         |       | (505,749                                                                                          | )          | (399,955 | ) | (291,814 | ) | (194,341 | ) | (133,273 | ) |
| Operating income                                                                                                      |       | 114,475                                                                                           |       | 366,754 |   | 134,230 |   | 54,732 |   | 155 |   |
| **Mining segment income statement  data:**                                                                            |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Revenue, net(2)                                                                                                       |       | 1,431,375                                                                                         |       | 1,201,409 |   | 599,756 |   | 372,216 |   | 339,971 |   |
| Cost of goods sold(2)                                                                                                 |       | (715,738                                                                                          | )          | (557,252 | ) | (420,736 | ) | (254,667 | ) | (174,763 | ) |
| Gross margin                                                                                                          |       | 715,637                                                                                           |       | 644,158 |   | 179,020 |   | 117,549 |   | 165,208 |   |
| Selling,  distribution and operating expenses                                                                         |       | (314,383                                                                                          | )          | (260,103 | ) | (115,570 | ) | (83,137 | ) | (60,580 | ) |
| Operating income                                                                                                      |       | 401,252                                                                                           |       | 384,055 |   | 63,450 |   | 34,412 |   | 104,628 |   |
| **Consolidated balance sheet data  (at period end):**                                                                 |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Total assets                                                                                                          |       | 3,600,083                                                                                         |       | 3,678,269 |   | 1,834,509 |   | 1,387,378 |   | 1,116,473 |   |
| Shareholders’  equity                                                                                            |       | 2,210,474                                                                                         |       | 2,057,629 |   | 448,826 |   | 278,051 |   | 195,122 |   |
| Long-term  debt, net of current portion                                                                               |       | 45,615                                                                                            |       | 216,113 |   | 122,311 |   | 36,496 |   | 16,525 |   |
| **Consolidated cash flows data:**                                                                                     |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Net cash provided  by operating activities                                                                            |       | 618,875                                                                                           |       | 296,137 |   | 119,858 |   | 81,069 |   | 34,751 |   |
| Net cash provided  by (used in) investing activities                                                                  |       | (994,707                                                                                          | )          | 455,716 |   | (210,317 | ) | (86,633 | ) | (93,068 | ) |
| Net cash provided  by (used in) financing activities                                                                  |       | (306,870                                                                                          | )          | 252,269 |   | 103,079 |   | 3,422 |   | 65,701 |   |
| **Non-U.S. GAAP measures****(3)****:**                                                                                |       |                                                                                              |       |   |   |   |   |   |   |   |   |
| Consolidated  EBITDA**(4)**                                                                                           |       | 726,252                                                                                           |       | 1,707,711 |   | 341,472 |   | 207,452 |   | 105,506 |   |
| Steel segment  EBITDA**(4)**                                                                                          |       | 260,542                                                                                           |       | 1,249,643 |   | 245,820 |   | 133,448 |   | 2,976 |   |
| Mining segment  EBITDA                                                                                                |       | 465,710                                                                                           |       | 458,068 |   | 95,652 |   | 74,004 |   | 102,529 |   |

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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.

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

5

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(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 haslimitations as an analytical tool, and you should not consider it in isolation,or as a substitute 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 incur moredebt, 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,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Consolidated  EBITDA reconciliation:**   |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income                                 |       | 381,180                                    |       | 1,342,706 |   | 143,508 |   | 89,253 |   | 47,418 |   |
| Add:                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation, depletion and amortization   |       | 167,600                                    |       | 137,820 |   | 101,689 |   | 78,773 |   | 13,378 |   |
| Interest expense                           |       | 40,829                                     |       | 51,409 |   | 48,516 |   | 36,773 |   | 14,526 |   |
| Income taxes                               |       | 136,643                                    |       | 175,776 |   | 47,759 |   | 2,653 |   | 30,184 |   |
| Consolidated EBITDA                        |       | 726,252                                    |       | 1,707,711 |   | 341,472 |   | 207,452 |   | 105,506 |   |
| **Steel  segment EBITDA reconciliation:**  |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income                                 |       | 67,443                                     |       | 1,014,356 |   | 114,011 |   | 57,977 |   | (16,924 | ) |
| Add:                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation, depletion and amortization   |       | 95,789                                     |       | 81,052 |   | 67,272 |   | 49,728 |   | 154 |   |
| Interest expense                           |       | 35,890                                     |       | 36,058 |   | 38,351 |   | 30,416 |   | 11,708 |   |
| Income taxes                               |       | 61,420                                     |       | 118,177 |   | 26,186 |   | (4,673 | ) | 8,038 |   |
| Consolidated EBITDA                        |       | 260,542                                    |       | 1,249,643 |   | 245,820 |   | 133,448 |   | 2,976 |   |
| **Mining  segment EBITDA reconciliation:** |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income                                 |       | 313,736                                    |       | 328,350 |   | 29,497 |   | 31,274 |   | 64,341 |   |
| Add:                                       |       |                                       |       |   |   |   |   |   |   |   |   |
| Depreciation, depletion and amortization   |       | 71,811                                     |       | 56,768 |   | 34,417 |   | 29,045 |   | 13,224 |   |
| Interest expense                           |       | 4,940                                      |       | 15,351 |   | 10,165 |   | 6,357 |   | 2,818 |   |
| Income taxes                               |       | 75,223                                     |       | 57,599 |   | 21,573 |   | 7,328 |   | 22,146 |   |
| Consolidated  EBITDA                       |       | 465,710                                    |       | 458,068 |   | 95,652 |   | 74,004 |   | 102,529 |   |

 

(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** | ** ** |
| 2005                                       |       | 29.00                                     |       | 27.46 |   |   | 28.31 |   |   |   | 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 |   |   |
| 2001                                       |       | 30.30                                     |       | 28.16 |   |   | 29.22 |   |   |   | 30.14 |   |   |
|                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

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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** | ** ** |
| April 2006    | ** ** | 27.77                                 | ** ** | 27.27 | ** ** |
| March 2006    |       | 28.12                                 |       | 27.66 |   |
| February 2006 |       | 28.26                                 |       | 28.10 |   |
| January 2006  |       | 28.48                                 |       | 28.02 |   |
| December 2005 |       | 29.00                                 |       | 28.64 |   |
| November 2005 |       | 28.88                                 |       | 28.50 |   |

 

The exchange rate between the ruble and the U.S.dollar on May 19, 2006 was 27.07 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 described the risks and uncertainties that ourmanagement believes are material, but these risks and uncertainties may not bethe only ones we face. Additional risks and uncertainties, including those wecurrently are not aware of or deem immaterial, may also result in decreasedoperating revenues, increased operating expenses or other events that couldresult in a decline in the value of our shares and ADSs.*

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**Risks Relating toOur Business and Industry**

***We operate in acyclical industry, and any local or global downturn in the mining or steelindustry may have an adverse effect on our results of operations and financialcondition.***

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 approximately46% and 39% of our total revenues from sales to customers in Russia in 2005 and2004, 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 6.6% per year from 1999 to 2005. Russian production ofsteel also suffered a substantial decline from over 77 million tonnes in1991 to 44 million tonnes in 1998, but then recovered to 66.2 milliontonnes in 2005. Further, our products in Russia are mainly used in theconstruction, engineering and automotive industries, which are particularlyvulnerable to general economic downturns. In addition to Russia, Asia and theMiddle East are also large destinations for our products, and these areas, likeRussia, face greater risks of volatility. Accordingly, any significant decreasein demand for steel products or decline in the price of these products inRussia or other emerging market economies could result in significantly reducedrevenues, thereby materially adversely affecting our results of operations andfinancial condition.

***The steel industryis highly competitive, and we may not be able to compete successfully.***

We face competition from domestic and foreign steel manufacturers,many of which have greater resources. A number of our Russian competitors areundertaking modernization and expansion plans, which may make them moreefficient 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.

***Successfulimplementation of our strategy to expand our specialty long product salesdepends on our ability to increase our export sales 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.

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***We will require asignificant amount of cash to fund our capital improvements program. Ourability to generate cash or obtain financing depends on many factors beyond ourcontrol.***

The total cost of ourcapital improvements over the next five years is expected to be approximately$1.1 billion. Most of our current borrowing is from Russian banks andfinancial institutions and ruble-denominated bonds. In the future, we may relyto a greater extent than currently on foreign capital markets and other foreignfinancing sources for our capital needs. It is possible that these foreignsources of financing, as well as domestic sources, may not be available in thefuture in the amounts we require or at an acceptable cost. See “—RisksRelating to the Economic Environment in Russia—Emerging markets such asRussia are subject to greater risks than more developed markets, and financialturmoil in any emerging market could disrupt our business, as well as cause theprice of our securities to suffer” and “—Risks Relating to the EconomicEnvironment in Russia—The Russian banking system remains underdeveloped, andanother banking crisis could place severe liquidity constraints on ourbusiness.”

***Our businessstrategy foresees additional acquisitions and continued integration, and we mayfail to identify suitable targets, acquire them on acceptable terms orsuccessfully 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.

Moreover, the integrationof new businesses may be difficult for a variety of reasons, includingdiffering culture, management styles and systems and infrastructure and poorrecords or internal controls. For example, regional governments have specialperpetual rights, or a “golden share,” in our subsidiaries BeloretskMetallurgical Plant and Izhstal, giving them the right to veto certainshareholder decisions and appoint a voting representative on the board ofdirectors of these subsidiaries. The shareholder decisions regarding thesesubsidiaries that may be vetoed by the regional governments are as follows:

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

·       reorganizationof the company;

·       liquidationof the company;

·       changesin the charter capital of the company; and

·       approvalof major and interested party transactions.

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In addition, integratingnew acquisitions may require significant initial cash investments. Furthermore,even if we are successful in integrating our existing and new businesses,expected synergies and cost savings may not materialize, resulting in lowerthan expected profit margins. We cannot assure you that we will be successfulin realizing any of the anticipated benefits of the companies that we are nowin the process of integrating or that we may acquire in the future. If we donot realize these benefits, our financial condition, results of operations andprospects could be materially adversely affected.

***Our independent registered public accounting firmreported material weaknesses in our internal control over financial reportingand we may not be able to remedy these material weaknesses or prevent futureweaknesses. If we fail to do so, there is a more than remote likelihood that amaterial misstatement of the annual or interim statements will not be preventedor detected.***

Inconnection with the audit of our consolidated financial statements for the yearended December 31, 2005, management and our independent registered publicaccounting firm identified material weaknesses in our internal control overfinancial reporting as defined in the standards established by the PublicCompany Accounting Oversight Board’s Auditing Standard No. 2 that affectedour financial statements for the year ended December 31, 2005. Thematerial weaknesses in our internal control over financial reporting aresummarized below:

·       wedo not have an adequate system of internal control over the preparation of ourU.S. GAAP consolidated financial statements to ensure that material errors donot occur in their preparation;

·       wedo not have an adequate system of internal controls at our Swiss subsidiaries,which conduct our export sales;

·       wedo not have a unified, comprehensive accounting and financial reporting systemfor U.S. GAAP reporting purposes; and

·       wedo not have adequate accounting resources and expertise in respect of thepreparation of our U.S. GAAP consolidated financial statements.

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 may not be able to preventother material weaknesses in the future. Any failure to maintain or implement requirednew or improved internal control over financial reporting, or any difficultieswe encounter in their implementation, could result in significant deficienciesor additional material weaknesses, cause us to fail to meet our periodicreporting obligations or result in material misstatements in our financialstatements. Any such failure could also adversely affect the results ofperiodic management evaluations and annual auditor attestation reportsregarding the effectiveness of our internal control over financial reportingthat will be required when the SEC’s rules under Section 404 of theSarbanes-Oxley Act of 2002 become applicable to us beginning with ourannual report for the year ending December 31, 2006, to be filed in 2007.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 theprice of our securities. See “Item 15. Controls and Procedures” for additionalinformation.

***We depend on keyaccounting staff for the preparation of U.S. GAAP financial information. Giventhe competition for such personnel and the remote locations of oursubsidiaries, our key accounting staff may leave our company, which coulddisrupt our ability to timely and accurately report U.S. GAAP financialinformation.***

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 

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maintainsits books in rubles and prepares separate unconsolidated financial statementsin accordance with Russian accounting standards. For every reporting period, wetranslate, adjust and combine these standalone Russian statutory financialstatements to prepare consolidated U.S. GAAP financial statements. This is adifficult task requiring U.S. GAAP-experienced accounting personnel at each ofour subsidiaries and at our Moscow corporate offices. Russia has available onlya small number of accounting personnel with U.S. GAAP expertise. Moreover,there is an increasing demand for such personnel as more Russian companies arebeginning to prepare financial statements on the basis of U.S. GAAP or otherinternational standards. Such competition, combined with the remote locationsof our subsidiaries which such personnel may not find suitable in comparison toother opportunities, makes it difficult for us to hire and retain suchpersonnel, and our key accounting staff may leave our company. Under thesecircumstances, we may have difficulty in remedying the material weaknessesidentified by our independent registered public accounting firm and in thetimely and accurate reporting of our financial information in accordance withU.S. GAAP.

***The potentialimplementation by the Russian government of a law requiring companies topurchase or lease the land on which they operate may have a material adverseeffect 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 unified way to determine the purchase price ofland as different regulatory authorities have proposed different figures, butall approaches propose determining the purchase price by multiplying the resaleprice of the land quoted in the land registry by a specified ratio. Ourestimates of the cost for us to purchase land where we have operations usingthe proposed valuations ranges from $40.6 million to $129.7 million. However,these estimates do not include the land on which the Beloretsk Metallurgical Plant,Vyartsilya Metal Products Plant and Southern Kuzbass Coal Company operatebecause the governmental authorities have not yet determined the resale priceof the land to be quoted in the land registry for those properties.

***Increasing tariffsand restructuring in the energy sector could materially adversely affect ourbusiness.***

In 2005, our Russian operations purchasedapproximately 3.9 billion kWh of electricity, representing 70% 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 government. The government is currently inthe early stages of implementing a restructuring plan for the power sectoraimed at introducing competition, liberalizing the wholesale electricity marketand moving from regulated pricing to a market-based system by 2008. Thisreform process could also cause disruptions to the supply of electricity to us.In addition, while subject to doubt as to whether it will be implemented ascurrently written, according to the Russian Energy Strategy approved by theRussian government in 2003, electricity tariffs for industrial users areexpected to reach 3.2-3.6 cents per kWh by 2006 and 4.0-4.5 cents perkWh by 2020. In 2005, our average cost of electricity was 3.1 cents per kWh.Assuming a price of 3.6 cents per kWh in 2005, our Russian operationswould have incurred approximately $37.6 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.

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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 $39 perthousand cubic meters ($1.11 per thousand cubic feet) in 2005, and increased by39% in comparison with 2004. Further, domestic natural gas prices aresignificantly below Western European levels, which helps to provide us with acost advantage over our competitors. According to the Russian Energy Strategyapproved by the Russian government in 2003, natural gas prices are expected toreach $40-42 per thousand cubic meters ($1.13-1.19 per thousandcubic feet) by 2006 and to $59-64 per thousand cubic meters ($1.67-1.81per thousand cubic feet) by 2010. Assuming a price of $42 per thousand cubicmeters in 2005, our Russian operations would have incurred approximately$6 million in additional costs. If we are required to pay a higher price fornatural gas, our costs will rise and our business and prospects could bematerially adversely affected.

***The reorganizationof the Russian railways transportation sector exposes us to uncertaintiesregarding transportation costs of raw materials and steel products.***

Railway transportation isour principal means of transporting raw materials and steel products to ourfacilities and to customers, as well as to ports for onward transportationoverseas. In accordance with legislation enacted in 2003, the Russian RailwaysMinistry was privatized and its assets are now owned by OAO Russian Railroads,an open joint stock company wholly-owned by the Russian government.Russian Railroads is responsible for the management of all Russian railroads.The Russian government, through the Federal Tariff Service, continues to setrail tariffs and pursue its policy of maintaining international transportationtariffs and possibly increasing domestic tariffs. Factors which may lead to anincrease in domestic tariffs include the insufficient financial transparency ofRussian Railroads, the poor state of repair of Russia’s rolling stock and thecross-subsidization of unprofitable passenger transportation sectors.Failure of Russian Railroads to upgrade its rolling stock within the next fewyears could also result in a shortage of available working rolling stock and adisruption in transportation of our materials and products. If these or otherfactors result in increased railway transport costs, our results of operationscould be materially adversely affected.

***We face numerousprotective 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 on May 1, 2004. Ourexports to Romania and Bulgaria will also fall under the quantitative limitsafter these countries join the EU in 2007. Our sales into the EU constitutedapproximately 13.0% of our steel segment revenues in 2005. The export of oursteel into the EU is an important part of our growth strategy. If EU quotas arenot increased in line with our sales growth objectives, our ability to expandour sales in the EU and pursue our growth strategy could be limited.

The United States has aquota system in place with respect to imports of hot-rolled coil and thicksteel plate. In January 2004, China imposed new anti-dumping duties oncold-rolled steel imports from Russia that are retroactive to September 2003and will last for five years. In 2005, approximately 81% of our steel segmentrevenues were derived from sales of steel products that were subject to importrestrictions. See “Item 4. Information on the Company—Steel Business—TradeRestrictions.”

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***We benefit fromRussia’s tariffs and duties on imported steel, which may be eliminated in thefuture.***

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 20% 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 this dutybecause it prevents subsidized Ukrainian exports to Russia from reducing theprices we can obtain for these products in our domestic markets. Almost all ofour sales of steel products in Russia were protected by these tariffs in 2005.These tariffs and duties may be reduced or eliminated in the future, whichcould materially adversely affect our revenues and results of operations.

According to pressreports, Russia may complete its negotiations and join the WTO in 2006. Russia’sfuture accession to the WTO could negatively affect our business and prospects.In particular, Russia’s entry into the WTO may require lowering orremoving of tariffs and duties on steel products, causing increased competitionin the domestic steel market from foreign producers and exporters. See also “—Increasingtariffs and restructuring in the energy sector could materially adverselyaffect our business.”

***Furtherappreciation in real terms of the ruble against the U.S. dollar may materiallyadversely affect our results of operations.***

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 2005, the ruble appreciated in real terms against the U.S.dollar by 10.8% according to the Central Bank of Russia, and further realappreciation of the ruble against the U.S. dollar may materially adverselyaffect our results of operations.

***Limitations on theconversion of rubles to foreign currencies in Russia could increase our costswhen making payments in foreign currencies to suppliers and creditors and couldcause us to default on our obligations to them.***

Many of our major capital expenditures are denominatedand payable in various foreign currencies, including the U.S. dollar and euro.Russian legislation currently permits the conversion of ruble revenues intoforeign currency. However, the market in Russia for the conversion of rublesinto foreign currencies is limited and may not continue to exist.

Additionally, any delay orother difficulty in converting rubles into a foreign currency to make a paymentor delay in or restriction on the transfer of foreign currency could limit ourability to meet our payment and debt obligations, which could result in theloss of suppliers, acceleration of debt obligations and cross-defaultsand, consequently, have a material adverse effect on our business, financialcondition and results of operations.

***Estimates of ourreserves 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.

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***We are subject tomining risks.***

Ourbusiness operations, like those of other mining companies, are subject to allof the hazards and risks normally associated with the exploration, developmentand production of natural resources, any of which could result in productionshortfalls or damage to persons or property. In particular, hazards associatedwith our open-pit mining 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;

·       productiondisruptions due to weather; and

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

Hazardsassociated with our underground mining operations include:

·       undergroundfires and explosions, 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 thesehazards could delay production, increase production costs and result in injuryto persons and damage to property, as well as liability for us. The liabilitiesresulting from any of these risks may not be adequately covered by insurance,and we may incur significant costs that could have a material adverse effectupon our business, results of operations and financial condition.

***More stringentenvironmental laws and regulations or more stringent enforcement of existingenvironmental laws and regulations in the jurisdictions where we operate mayhave a significant negative effect on our 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 suchhazardous waste is subject to environmental regulations, including somerequiring the clean-up of contamination and reclamation, such as requirementsfor cleaning up highly hazardous waste oil and iron slag. In addition,pollution risks and related clean-up costs are often impossible to assessunless environmental audits have been performed and the extent of liabilityunder environmental laws is clearly determinable.

Generally, there is agreater awareness in Russia of damage caused to the environment by industrythan existed during the Soviet era. For example, a news article in 2005 citedus as one of Russia’s ten worst polluters. Environmental legislation in thejurisdictions where we operate, however, is generally weaker, 

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and lessstringently enforced, than in the EU or the United States. More stringentstandards may be introduced or enforcement increased in Russia and elsewherewhere we conduct our operations. Based on the current regulatory environment inthese jurisdictions, as of December 31, 2005, we have not created anyreserves for environmental liabilities and compliance costs, other than anaccrual in the amount of $59.1** **millionfor asset retirement obligations (ARO), consistent with U.S. GAAP requirements.In addition, upon our acquisitions of Mechel Targoviste and Mechel CampiaTurzii, as part of the purchase agreements, we committed to the Romaniangovernment to invest $7.3 million and $4.6 million, respectively,into environmental protection and reclamation. Environmental obligations ofthese Romanian subsidiaries amounted to $3.7 million as of December 31,2005. 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 part or all of the production at a facility that hasviolated environmental standards. In the event that production at one of ourfacilities is partially or wholly prevented due to this type of sanction, ourbusiness could suffer and our operating results would be negatively affected.

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 Kyoto Protocol 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 could be adversely affected if we fail toobtain or renew necessary licenses and permits or fail to comply with the termsof our licenses and permits.***

Our business depends on the continuing validity of certainlicenses and the issuance of certain new licenses and our compliance with theterms thereof, including subsoil licenses for our mining operations. Regulatoryauthorities exercise considerable discretion in the timing of license issuance,renewal and monitoring licensees’ compliance with license terms. Requirementsimposed by these authorities may be costly and time-consuming and may result indelays in the commencement or continuation of exploration or productionoperations. Further, private individuals and the public at large possess rightsto comment on and otherwise engage in the licensing process, including throughintervention in courts and political pressure. Accordingly, the licenses weneed may not be issued or renewed, or if issued or renewed, may not be issuedor renewed in a timely fashion, or may involve requirements which restrict ourability to conduct our operations or to do 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 

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lead to suspension ortermination of our licenses and permits, and to administrative, civil andcriminal 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 June 2002, for a 10-year period, which isthe only subsoil license we have renewed. Of our fifteen coal subsoil licenses,seven expire on dates falling in 2012 through 2014 and eight expire on datesfalling in 2024 and 2025; our four iron ore subsoil licenses expire on datesfalling in 2009 through 2015; and our two nickel subsoil licenses expire ondates falling in 2012 and 2013. See “Item 4. Information on the Company—MiningBusiness—Mineral Reserves.”

Accordingly, these factors may seriously affect ourability to obtain or renew necessary licenses, and if we are unable to obtainor renew necessary 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.

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 licensing authorities, which areentitled to control and inspect their activities. In the event that the licensingauthorities discover a material violation by our company, we may be required tosuspend our operations or incur substantial costs in eliminating or remedyingsuch violation, which could have a material adverse effect on our business orresults 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, wewould be unable to realize our reserves, which could materially adverselyaffect our 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 subsoil licensinglaw in the summer of 1992, the status of subsoil licenses and Soviet-era miningoperations was unclear, as was the status of the regulatory authority governingsuch operations. The Russian government enacted the Procedure for Subsoil UseLicensing, or Licensing Regulation, on July 15, 1992, which came intoeffect on August 20, 1992. As was common with legislation of this time,the Licensing Regulation was passed hastily, without adequate consideration oftransition provisions, and contained numerous gaps. In an effort to address theproblems in the Licensing Regulation, the Ministry of Natural Resources issuedministerial acts and instructions that attempted to clarify and, in some cases,modify the Licensing Regulation. Many of these acts contradicted the law andwere beyond the scope of the Ministry’s authority, but subsoil licensees had nooption but to deal with the Ministry in relation to subsoil issues and complywith its ministerial acts and instructions. Thus, it is possible that licensesapplied for and/or issued in reliance on the Ministry’s acts and instructionscould be challenged by the prosecutor general’s office as being invalid. Inparticular, deficiencies of this nature subject subsoil licensees to selectiveand arbitrary governmental claims.

Legislation on subsoil rights still remains internallyinconsistent and vague, and the regulator’s 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 licensemay be suspended or terminated if the licensee does not comply with the “significant”or “material” terms of a license is an example of such a deficiency in thelegislation. However, the Ministry of Natural Resources has not issued anyinterpretive guidance on the meaning of these terms. 

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Similarly,under Russia’s civil law system, court decisions on the meaning of these termsdo not have any precedential value for future cases and, in any event, courtdecisions in this regard have been inconsistent. These deficiencies result inthe regulatory authorities, prosecutors and courts having significantdiscretion over enforcement and interpretation of the law, which may be used tochallenge our subsoil rights selectively and arbitrarily.

Moreover, during thetumultuous period of the transformation of the Russian planned economy into afree market economy in the 1990s, documentation relating to subsoil licenseswas not properly maintained and, in many cases, was lost or destroyed.Initially, during the period between the dissolution of the Soviet Union andthe privatizations of the mid-1990s, as state subsidies ceased, manymining operations were forced to shut down or scale back production. Inaddition, during this time, complete governmental planning and oversightceased, leaving the local management ill-equipped to operate these businesses,which faced severe liquidity problems. The employees, who were often unpaid formonths, had little incentive to look after the businesses. In thesecircumstances, the maintenance of documentation relating to subsoil licenses,as well as compliance with the administrative requirements of the legislationof this 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 notself-sufficient in energy resources. Domestic energy prices, which aresignificantly higher than the prices we pay in Russia, have recently increasedand may continue to increase in the future, which might hurt the profitabilityof our operations in Romania. For example, in 2005, the price of natural gasincreased by approximately 45% in Romania and is expected to continue toincrease through 2006. Shortages in energy supplies, including administrativelimitations during peak usage, may limit our production capacity and efficiencyand hinder our output. If we are unable to obtain these resources on economicterms, the operations of our Romanian subsidiaries could be materiallyadversely affected.

In addition, preparationsfor Romania’s admission into the EU will result in increased environmentalliabilities, labor costs and other expenditures for our Romanian operations. Entranceinto the EU requires the restructuring of Romania’s major metallurgicalentities, including our Romanian subsidiaries Mechel Targoviste and MechelCampia Turzii. As part of this process, individual viability plans must beagreed upon with EU consultants and incorporated into each company’s businessplans. Evidence of implementation of these plans and achievement of the targetsstated therein must be provided to investors under their privatizationcontracts. The viability plans of Mechel Targoviste and Mechel Campia Turziiinclude additional investments into technology and increased environmentalcontrols. After the restructuring is complete, key business performanceindicators must be in line with EU requirements. In addition to thecosts of complying with these requirements, Romania’s admission to the EU mayalso result in trade duties and quotas on the export of steel finished andsemi-finished products into Romania.

In connection with their acquisition, we alsocommitted to make capital investments of approximately $21.1 million atMechel Targoviste and approximately $22.7 million at Mechel Campia Turzii,as well as to maintain labor force levels for five years from the date ofacquisition of these Romanian facilities. See “Item 5. Operating and FinancialReview and Prospects—Contractual obligations and commercial commitments.”Although we have complied with these undertakings to date, our failure tocomply in the future could result in the forfeiture of part of our ownershipstake in these companies.

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In addition, since theiracquisition our Romanian enterprises suffer ongoing significant losses that areexpected to continue minimum until the end of privatization agreements. Thiscan significantly deteriorate our overall financial position and performanceand materially adversely affect your investment.

***We are controlledby two shareholders who run our business collectively and whose interests couldconflict with those of the holders of our securities.***

The Chairman of our Boardof Directors, Mr. Igor Zyuzin, and our Chief Executive Officer, Mr. VladimirIorich, own approximately 73% of our common shares. These two shareholders haveacted in concert since signing an Ownership, Control and Voting Agreement datedAugust 1, 1995, which requires them to vote the same way. See “Item 7.Major Shareholders and Related Party Transactions—Major Shareholders—Ownership,Control and Voting Agreement of August 1, 1995” for more informationregarding this agreement. This agreement gives them control over us and theability to elect a majority of the directors, appoint management, issueadditional shares and approve certain actions requiring the approval of amajority of our shareholders. In February 2006, Messrs. Zyuzin andIorich reached an agreement pursuant to which Mr. Zyuzin will purchase allof Mr. Iorich’s stake in Mechel over the course of a year. In March-May 2006,Mr. Zyuzin purchased a portion of Mr. Iorich’s stake, resulting inhis stake in Mechel increasing to 52.2% and Mr. Iorich’s stake decreasingto 20.8%. Prior to the transactions, Messrs. Zyuzin and Iorich had heldequal stakes of 42.2%. The purchase was financed by the sale of shares and amandatory exchangeable bond convertible into shares. Mr. Zyuzin mayundertake similar and other financing options for future transactions in orderto complete the purchase of Mr. Iorich’s stake. Regardless of thefinancing selected, he intends to retain at least a 51% stake in Mechel. Theinterests of these controlling shareholders could conflict with those ofholders of ADSs and materially adversely affect your investment.

***Our competitiveposition and future prospects depend on our senior managers and other keypersonnel.***

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 Chairman, and Mr. Iorich, our Chief Executive Officer, who are alsoour founding shareholders. Messrs. Zyuzin and Iorich consult extensivelywith each other before significant decisions are made and as a team haveprovided strategic direction and leadership to us. Over the course of thisyear, Mr. Iorich intends to dispose of his stake in Mechel and step downas our Chief Executive Officer.

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 of membersof our senior management team or an inability to attract, retain and motivatequalified key personnel could have a material adverse effect on our business,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 businessconsists of privatized companies, and our business strategy will likely involvethe acquisition of additional privatized companies. To the extent thatprivatization legislation is vague, inconsistent or in conflict with otherlegislation, including conflicts between federal and local privatizationlegislation, many privatizations are vulnerable to challenge, including selectivechallenges. For instance, a series of presidential decrees issued in 1991 and1992 that granted to the Moscow City government the right to adopt its ownprivatization procedures were subsequently held to be invalid by theConstitutional Court of the Russian Federation, which ruled, in part, that thepresidential decrees 

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addressedissues that were the subject of federal law. While this court ruling, intheory, did not require any implementing actions, the presidential decrees werenot officially annulled by another presidential decree until 2000. In the eventthat any title to, or our ownership stakes in, the privatized companiesacquired by us, including Chelyabinsk Metallurgical Plant, Southern UralsNickel Plant, Southern Kuzbass Coal Company and its subsidiaries, BeloretskMetallurgical Plant, Urals Stampings Plant, Korshunov Mining Plant, PortPosiet, Port Kambarka or Izhstal, are subject to challenge as having beenimproperly privatized and we are unable to defeat this claim, we risk losing ourownership interest in such company or its assets, which could materially affectour business and results of operations.

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

Our business has grownsubstantially through the acquisition and founding of companies, many of whichrequired the prior approval or subsequent notification of the Russian FederalAntimonopoly Service or its predecessor agencies. In part, relevant legislationrestricts the acquisition or founding of companies by groups of companies orindividuals acting in concert without this approval or notification. Thislegislation is vague in certain parts and subject to varying interpretations.If the Federal Antimonopoly Service were to conclude that an acquisition or thecreation of a new company was done in contravention of applicable legislationand that competition has been reduced as a result, it could seek redress,including suing for the transactions that led to the violation of competitionlaws to be declared invalid, obliging the acquirer to perform activities torestore competition, and seeking the dissolution of the company operating incontravention of antimonopoly legislation. Any of these actions could adverselyaffect our business strategy and our 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 

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othermatters in the future, we could be limited in our operational flexibility andour business, financial condition, results of operations or prospects could bematerially adversely affected.

***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 31,2005, approximately 88% 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, large unionrepresentation subjects our businesses to interruptions through strikes,lockouts or delays in renegotiations of labor contracts. Our existingarrangements with trade unions also may not be renewed on terms favorable tous. In such events, our business and results of operations could be materiallyadversely 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 theinterruption of the production of a number of our products. Additionally,depending on the severity of the property damage, we may not be able to rebuilddamaged property in a timely manner or at all. We do not maintain separatefunds or otherwise set aside reserves for these types of events. Any such lossor third-party claim for damages may have a material adverse effect onour business, results of operations and financial condition.

***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, majortransactions, meetings of the group members’ governing bodies, other corporatematters and anti-monopoly issues that, if successfully challenged on the basisof non-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.

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

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 transactionsbetween related entities and certain other types of transactions betweenindependent parties, such as foreign trade transactions or transactions withsignificant (by more than 20%) price fluctuations. The Russian transfer pricingrules are vaguely drafted, leaving wide scope for interpretation byRussian tax authorities and courts. Due to the uncertainties in interpretationof transfer pricing legislation, the tax authorities may challenge our pricesand propose adjustments. If such price adjustments are upheld by the Russiancourts and implemented, our future financial results could be adverselyaffected. In addition, we could face significant losses associated with theassessed amount of prior tax underpaid and related interest and penalties,which could have an adverse effect on our financial condition and results ofoperations. See also “—Risks Relating to Russian Legislation and the RussianLegal System—Weaknesses and changes in the Russian tax system could materiallyadversely affect our business and the value of our securities.”

**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 isdifferent from the way other jurisdictions treat ADSs. In the United States,although shares may be held in the depositary’s name or to its order, making ita “legal” owner of the shares, the ADS holders are the “beneficial,” or realowners. In U.S. courts, an action against the depositary, would not result inthe beneficial owners losing their shares. Russian law may not make the samedistinction between legal and beneficial ownership, and it may only recognizethe rights of the depositary in whose name the shares are held, not the rightsof ADS holders, to the underlying shares. Thus, in proceedings brought againsta depositary, whether or not related to shares underlying ADSs, Russian courtsmay treat those underlying shares as the assets of the depositary, open toseizure or arrest. In the past, a lawsuit was filed against a depositary bankother than Deutsche Bank Trust Company Americas seeking the seizure of variousRussian companies’ shares represented by ADSs issued by that depositary. In theevent that this type of suit were to be successful in the future against thedepositary, and the shares underlying our ADSs were to be seized or arrested,the ADS holders involved would lose their rights to such underlying 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 Federal Law on Joint Stock Companies and our charter require us to notifyshareholders no less than 30 days prior to the date of any meeting and atleast 50 days prior to the date of an extraordinary meeting 

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to elect our Board ofDirectors. 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, wewill provide the notice to the depositary. The depositary has undertaken inturn, as soon as practicable thereafter, to mail to you notice of such meeting,copies of 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.

***The price of ourshares and ADSs may be highly volatile.***

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 mining and steel 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.

***You may be unableto repatriate your earnings from our ADSs.***

We anticipate that anydividends we may pay in the future on the shares represented by the ADSs willbe declared and paid to the depositary in rubles and will be converted intoU.S. dollars by the depositary and distributed to holders of ADSs, net of thedepositary’s fees and expenses. The ability to convert rubles into U.S. dollarsis subject to the availability of U.S. dollars in Russia’s currency markets.Although there is an existing, albeit limited, 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 no viablemarket in which to hedge ruble and ruble-denominated investments.

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***ADS holders may notbe able to benefit from the United States-Russia income tax treaty.***

In accordance with Russianlegislation, dividends paid to a non-resident holder generally will be subjectto Russian withholding at a rate of 15% for legal entities and organizationsand at a rate of 30% for individuals. This tax may be reduced to 5% or 10% forlegal entities and organizations and to 10% for individuals under theConvention between the United States of America and the Russian Federation forthe Avoidance of Double Taxation and the Prevention of Fiscal Evasion withrespect to Taxes on Income and Capital (the “United States-Russia income taxtreaty”) for U.S. tax residents. However, the Russian tax rules applicableto ADS holders are characterized by significant uncertainties. In 2005, theMinistry of Finance expressed an opinion that ADS holders (rather than thedepositary) should be treated as the beneficial owners of the underlying sharesfor the purposes of the double tax treaty provisions applicable to taxation ofdividend income from the underlying shares, provided that tax residencies ofthe ADS holders are duly confirmed. However, in the absence of any specificprovisions in the Russian tax legislation with respect to the concept ofbeneficial ownership and taxation of income of beneficial owners, it is unclearhow the Russian tax authorities and courts will ultimately treat the ADSholders in this regard. Thus, we may be obliged to withhold tax at standardrates when paying out dividends, and U.S. ADS holders may be unable to benefitfrom these treaties. See “Item 10. Additional Information—Taxation—RussianIncome and Withholding Tax Considerations—United States-Russia Income TaxTreaty Procedures,” “Item 10. Additional Information—Taxation—Russian Income andWithholding Tax Considerations—Taxation of Dividends” and “Item 10. AdditionalInformation—Taxation—United States Federal Income Tax Considerations—Taxationof dividends on common shares or ADSs” for a more detailed discussion of thisissue and administration procedures.

***Capital gains fromthe sale of ADSs may be subject to Russian income tax.***

Under Russian tax legislation, gains realized bynon-resident legal entities or organizations from the disposition of Russianshares and securities, as well as financial instruments derived from suchshares, such as the ADSs, may be subject to Russian profits tax or withholdingincome tax if immovable property located in Russia constitutes more than 50% ofour assets. However, no procedural mechanism currently exists to withhold andremit this tax with respect to sales made to persons other than Russiancompanies and foreign companies with a registered permanent establishment inRussia. Gains arising from the disposition at foreign stock exchanges of theforegoing types of securities listed on these exchanges by foreign holders whoare legal entities or organizations 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. All of our directors and executive officers reside outside theUnited States, principally in Russia. All or a substantial portion of ourassets and the assets of our directors and executive officers are locatedoutside the United States. As a result, you may not be able to affect serviceof process within the United States upon us or our directors and executiveofficers or to enforce in a U.S. court judgments obtained against us or ourdirectors and executive officers in jurisdictions outside the United States,including actions under the civil liability provisions of 

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U.S. securities laws.In addition, it may be difficult for you to enforce, in original actionsbrought in courts in jurisdictions outside the United States, liabilitiespredicated 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.

**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 casessignificant legal, economic and political risks. Investors should also notethat emerging economies such as the economy of the Russian Federation aresubject to rapid change and that the information set out herein may becomeoutdated relatively quickly. Accordingly, investors should exercise particularcare in evaluating the risks involved and must decide for themselves whether,in light of those risks, their investment is appropriate. Generally, investmentin emerging markets is only suitable for sophisticated investors who fullyappreciate the significance of the risks involved and investors are urged toconsult with their own legal and financial advisors before making an investmentin the shares and ADSs.

**Economic Risks**

***The Russian economyis less stable than those of most Western countries and 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 budget deficit and government debt relative to gross domesticproduct;

·       aweak banking system providing limited liquidity to domestic enterprises;

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

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

·       widespreadtax evasion;

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·       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 August 17, 1998, as evidencedby the termination of the banking licenses of a number of major Russian banks.This further impaired the ability of the banking sector to act as a consistentsource of liquidity to Russian companies and resulted in the losses of bankdeposits 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 severe liquidityconstraints on our business.***

Russia’s banking and other financial systems are lessdeveloped or regulated in comparison with other 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. Many Russian banks currently do not meet international bankingstandards, and the transparency of the Russian banking sector in some respectsstill lags far behind internationally accepted norms. Aided by inadequatesupervision by the regulators, certain banks do not follow existing Central Bankof Russia regulations with respect to lending criteria, credit quality, loanloss reserves or diversification of exposure. 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. The serious deficienciesin the Russian banking sector, combined with the deterioration in the creditportfolios of Russian banks, may result in the banking sector being moresusceptible to market downturns or economic slowdowns, including due to Russiancorporate defaults that may occur during any such market downturn or economicslowdown. In addition, the Central Bank of Russia has from time to time revokedthe licenses of certain Russian banks, which resulted in market rumors aboutadditional bank closures and many depositors withdrawing their savings. If abanking crisis were to occur, Russian companies would be subject to severeliquidity constraints due to the limited supply of domestic savings and thewithdrawal of foreign funding sources that would occur during such a crisis.

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There is currently alimited number of sufficiently creditworthy Russian banks. We hold the bulk ofour excess ruble and foreign currency cash in Russian banks, includingsubsidiaries of foreign banks, in part, because we are required to do so byCentral Bank of Russia regulations and because the ruble is not transferable orconvertible outside of Russia. There are few, if any, safe ruble-denominatedinstruments in which we may invest our excess ruble cash. Another bankingcrisis or the bankruptcy or insolvency of the banks from which we receive orwith which we hold our funds could result in the loss of our deposits or affectour ability to complete banking transactions in Russia, which could have amaterial adverse effect on our business, financial condition and results ofoperations.

***The infrastructurein Russia is inadequate, which could 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. In May 2005,a fire and explosion in one of the Moscow power substations built in 1963caused a major power outage in a large section of Moscow and some surroundingregions. The blackout disrupted the ground electric transport, including themetro system, led to road traffic accidents and massive traffic congestion,disrupted electricity and water supply in office and residential buildings andaffected mobile communications. The trading on exchanges and the operation ofmany 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, maintainand improve these systems. These factors could have a material adverse effecton 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 foreign investmentin Russia and Russian businesses could face severe liquidity constraints,further materially adversely affecting the Russian economy. Additionally,because Russia produces and exports large amounts of oil, the Russian economyis especially vulnerable to the price of oil on the world market and a declinein the price of oil could slow or disrupt the Russian economy or undermine thevalue of the ruble against foreign currencies. Recent military conflicts andinternational terrorist activity have also significantly impacted oil and gasprices, and pose additional risks to the Russian economy. Russia is also amajor producer and exporter of metal products and its economy is vulnerable tofluctuations in world commodity prices and the imposition of tariffs and/oranti-dumping measures by the United States, the European Union or by otherprincipal 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.

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Current and future changesin the government, major policy shifts or lack of consensus between variousbranches of the government and powerful economic groups could disrupt orreverse economic 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.

***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 88sub-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 and administrativedecisions implementing them, as well as certain transactions consummatedpursuant to them, have in the past been challenged in the courts, and suchchallenges 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, which has brought normal economic activity withinChechnya to a halt and disrupted the economies of neighboring regions. Variousarmed groups in Chechnya have regularly engaged in guerrilla attacks in thatarea. Violence and attacks relating to this conflict have spread to other partsof Russia, and several terrorist attacks have been carried out by Chechenterrorists in other parts of Russia, including in Moscow. The furtherintensification of violence, including terrorist attacks and suicide bombings,or its spread to other parts of Russia, could have significant politicalconsequences, including the imposition of a state of emergency in some or allof Russia. Moreover, any terrorist attacks and the resulting heightenedsecurity measures are likely to cause disruptions to domestic commerce andexports from Russia. These factors could materially adversely affect ourbusiness and the value of the shares and ADSs.

***Crime andcorruption and negative publicity could disrupt our ability to conduct ourbusiness.***

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 describedinstances in which government officials engaged in selective investigations andprosecutions to further the commercial interests of government officials orcertain individuals. Additionally, some members of the Russian media regularlypublish disparaging articles in return for payment. The depredations oforganized or other crime, demands of corrupt officials or claims that we havebeen involved in official corruption could result in negative publicity, coulddisrupt our ability to conduct our business effectively and could thusmaterially adversely affect our financial condition and results of operationsand the value of the shares and ADSs.

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***Social instabilitycould increase support for renewed centralized authority, nationalism orviolence and thus materially adversely affect our business, financialcondition, results of 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.

**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;

·       therelative inexperience of judges and courts in interpreting legislation;

·       thelack of an independent 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.

Furthermore, several fundamental laws have onlyrecently become effective. The recent nature of much of Russian legislation,the lack of consensus about the scope, content and pace of economic andpolitical reform and the rapid evolution of the Russian legal system in waysthat may not always coincide with market developments place the enforceabilityand underlying constitutionality of laws in doubt and results in ambiguities,inconsistencies and anomalies. In addition, Russian legislation oftencontemplates implementing regulations which have not yet been promulgated,leaving substantial gaps in the regulatory infrastructure. All of theseweaknesses could affect our ability to enforce our rights under our licensesand under our contracts, or to defend ourselves against claims by others. Wecannot assure you that regulators, judicial authorities or third parties willnot challenge our compliance with applicable laws, decrees and regulations.

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***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 andstandards, the issuance and renewal of licenses, permits, approvals andauthorizations and in monitoring licensees’ compliance with the terms thereof.Russian authorities have the right to, and frequently do, conduct periodicinspections of our operations and properties throughout the year. Any suchfuture inspections may conclude that we or our subsidiaries have violated laws,decrees or regulations, and we may be unable to refute such conclusions orremedy the violations.

Our failure to comply withexisting laws and regulations or the findings of government inspections mayresult in the imposition of fines or penalties or more severe sanctionsincluding the suspension, amendment or termination of our licenses, permits,approvals and authorizations or in requirements that we cease certain of ourbusiness activities, or in criminal and administrative penalties applicable toour officers. Moreover, an agreement made or transaction executed in violationof a law may be invalidated and unwound by a court decision. Any suchdecisions, requirements or sanctions, or any increase in governmentalregulation of our operations, could increase our costs and materially adverselyaffect our business, financial condition, results of operations 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 two subsidiaries with negative net assets, Port Kambarka andKaslinsky Architectural Art Casting Plant.

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 toreorganize the operations we currently conduct through the affectedsubsidiaries. Any such liquidation could lead to additional costs, which couldmaterially adversely affect our business, financial condition, results ofoperations 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 thejudicial system and its immunity from economic, political and nationalisticinfluences in Russia remain largely untested. The court system in Russia isunderstaffed and underfunded. 

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Judgesand courts are generally inexperienced in the area of business and corporatelaw. Judicial precedents generally have no binding effect on subsequentdecisions. Not all Russian legislation and court decisions are readilyavailable 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 assets or portions thereof,potentially without adequate compensation, would have a material adverse effecton our business, financial condition, results of operations and prospects.

***Selective or arbitrary government action could have amaterial adverse effect on our business, financial condition, results ofoperations and prospects and the value of the shares and ADSs.***

Governmental authoritiesin Russia have a high degree of discretion and, at times, act selectively orarbitrarily, without hearing or prior notice, and sometimes in a manner that isinconsistent with legislation or influenced by political or commercialconsiderations. Selective or arbitrary governmental actions have reportedlyincluded the denial or withdrawal of licenses, sudden and unexpected tax auditsand claims, criminal prosecutions and civil actions. Federal and localgovernment entities have also used ordinary defects in matters surroundingshare issuances and registration as pretexts for court claims and other demandsto invalidate such issuances and registrations or to void transactions.Moreover, the government also has the power in certain circumstances, byregulation or government act, to interfere with the performance of, nullify orterminate contracts. Standard & Poor’s, a provider of independentcredit ratings, has expressed concerns that “Russian companies and theirinvestors can be subjected to government pressure through selectiveimplementation of regulations and legislation that is either politicallymotivated or triggered by competing business groups.” In this environment, ourcompetitors may receive preferential treatment from the government, potentiallygiving them a competitive advantage over us.

In addition, recently, theRussian tax authorities aggressively have brought tax evasion claims on thebasis of certain Russian companies’ use of tax-optimization schemes, and pressreports have speculated that these enforcement actions have been selective andpolitically motivated. Selective or arbitrary government action, if directed atus, could have a material adverse effect on our business, financial condition,results of operations and prospects, and the value of the shares and ADSs.

***Lack of developed corporate and securities laws andregulations in Russia could limit our ability to 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;

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·       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 howregulations, decisions and letters issued by the various regulatory authoritiesapply to our group. As a result, we may be subject to fines and/or otherenforcement measures despite our best efforts at compliance.

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

In general, minorityshareholder protection under Russian law derives from supermajority shareholderapproval requirements for certain corporate action, as well as from the abilityof a shareholder to demand that the company purchase the shares held by thatshareholder if that shareholder voted against or did not participate in votingon certain types of actions. Companies are also required by Russian law toobtain the approval of disinterested shareholders for certain transactions withinterested parties. See “Item 10. Additional Information—Charter andCertain Requirements of Russian Legislation—Description of Capital Stock—RightsAttaching to Common Shares” for a more detailed description of some of theseprotections. While these protections are similar to the types of protectionsavailable to minority shareholders in U.S. corporations, in practice, corporategovernance standards for many Russian companies have proven to be poor, andminority shareholders in Russian companies have suffered losses due to abusiveshare dilutions, asset transfers and transfer pricing practices. Shareholdermeetings have been irregularly conducted, and shareholder resolutions have notalways been respected by management. Shareholders of some companies alsosuffered as a result of fraudulent bankruptcies initiated by hostile creditors.

The supermajorityshareholder approval requirement is met by a vote of 75% of all voting sharesthat are present at a shareholders’ meeting. Thus, controlling shareholdersowning slightly less than 75% of outstanding shares of a company may have a 75%or more voting power if certain minority shareholders are not present at themeeting. In situations where controlling shareholders effectively have 75% ormore of voting power at a shareholders’ meeting, they are in a position toapprove amendments to the charter of the company or significant transactionsincluding asset transfers, which could be prejudicial to the interests ofminority shareholders. It is possible that our controlling shareholders and ourmanagement in the future may not run us and our subsidiaries for the benefit ofminority shareholders, and this could materially and adversely affect the valueof the ADSs. See “—Risks Relating to Our Business and Industry—We arecontrolled by two shareholders who run our business collectively and whoseinterests could conflict with those of the holders of our securities” for morediscussion of the control our current shareholders have over us.

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 

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and reporting requirementsor breaches of fiduciary duties to us and our subsidiaries or to ourshareholders could 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 the company’sstock may bring an action for damages on behalf of the company, Russian courtsto date do not have much experience with respect to such lawsuits. Russian lawdoes not contemplate class action litigation. Accordingly, your ability topursue legal redress against us may be limited, reducing the protectionsavailable to you as a holder of ADSs.

***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 rightsprovisions under Russian law could result in significant additional obligationson us.***

Russian lawprovides that shareholders that vote against or abstain from voting on certainmatters have the right to sell their shares to the company at market value inaccordance with Russian law. The decisions that trigger this right to sellshares 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; 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 the company’s net assets calculated in accordancewith Russian accounting standards at the time the matter at issue is votedupon, could have a material adverse effect on our business, financialcondition, results of operations and prospects.

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***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 orcustodian, then the holding of such nominee or custodian) is determined byentries in a share register and is evidenced by extracts from that register.Currently, there is no central registration system in Russia. Share registersare maintained by the companies themselves or, if a company has more than 50 shareholdersor so elects, by licensed registrars located throughout Russia. Regulationshave been issued regarding the licensing conditions for such registrars, aswell as the procedures to be followed by both companies maintaining their ownregisters and licensed registrars when performing the functions of registrar.In practice, however, these regulations have not been strictly enforced, andregistrars generally have relatively low levels of capitalization andinadequate insurance coverage. Moreover, registrars are not necessarily subjectto effective governmental supervision. Due to the lack of a central andrigorously regulated share registration system in Russia, transactions inrespect of a company’s shares could be improperly or inaccurately recorded, andshare registration could be lost through fraud, negligence, official andunofficial governmental actions or oversight by registrars incapable of compensatingshareholders for their misconduct. This creates risks of loss not normallyassociated with investments in other securities markets. Further, thedepositary, under the terms of the agreement governing the deposit of ADSs,will not be liable for the unavailability of shares or for the failure to makeany distribution of cash or property with respect thereto due to theunavailability of the shares. See “Item 10. Additional Information—Charter andCertain Requirements of Russian Legislation—Description of Capital Stock—Registrationand 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:

·       incometaxes;

·       value-addedtax, or VAT;

·       unifiedsocial tax; and

·       propertytax.

The tax environment in Russia historically has beencomplicated by the fact that various authorities have often issuedcontradictory tax legislation. This uncertainty potentially exposes us tosignificant fines and penalties and enforcement measures despite our bestefforts at compliance, and could result in a greater than expected tax burdenand the suspension or termination of our licenses.

Recently, there have been significant changes to theRussian taxation system. Global tax reforms commenced in 1999 with theintroduction of Part One of the Tax Code of the Russian Federation, or theTax Code, which sets general taxation guidelines. Since then, Russia has beenin the process of replacing legislation regulating the application of majortaxes such as corporate income tax, VAT and property tax with new chapters ofthe 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 

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with related documentationsuch as customs declarations, are subject to review and investigation by anumber of authorities, each of which may impose fines, penalties and interestcharges. Generally, in an audit taxpayers are subject to inspection withrespect to the three calendar years which immediately proceeded the year inwhich the audit is carried out. Previous audits do not completely excludesubsequent claims relating to the audited period because Russian tax lawauthorizes upper-level tax inspectorates to review the results of taxaudits conducted by subordinate tax inspectorates. In addition, on July 14,2005, the Russian Constitutional Court issued a decision that allows thestatute of limitations for tax liabilities to be extended beyond the three-yearterm set forth in the tax laws if a court determines that a taxpayer hasobstructed or hindered a tax audit. Because none of the relevant terms aredefined, tax authorities may have broad discretion to argue that a taxpayer has“obstructed” or “hindered” an audit and ultimately seek penalties beyond thethree-year term. In some instances, new tax regulations have been givenretroactive 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 to Russian companies, and 15%, if being distributed to foreigncompanies. If the receiving company itself pays a dividend, it may offset taxwithheld against its own withholding liability of the onward dividend althoughnot against any withholding made on a distribution to a foreign company. Thesetax requirements impose additional burdens and costs on our operations,including management resources.

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 currencycontrol regulations could hinder our ability to conduct our business.***

The Central Bank of Russia has from time to timeimposed various currency control regulations, and may take further actions inthe future. Furthermore, the government and the Central Bank of Russia mayimpose additional requirements on cash inflows and outflows into and out ofRussia or on the use of foreign currency in Russia, which could prevent us fromcarrying on necessary business transactions, or from successfully implementingour business strategy.

A new framework law onexchange controls took effect on June 18, 2004. This law empowers thegovernment and the Central Bank of Russia to further regulate and restrictcurrency control matters, including operations involving foreign securities andforeign currency borrowings by Russian companies. The new law also abolishedthe need for companies to obtain transaction-specific licenses from theCentral Bank of Russia, envisaging instead the implementation of generallyapplicable restrictions on currency operations. The new regulatory regimecontinues to be restrictive.

**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 in 

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Eastern and CentralEurope. Additionally, we owned a pipe mill in Croatia until August 2004,when we transferred its ownership back to the government of Croatia. As withRussia, these countries are emerging markets subject to greater political,economic, social and legal risks than more developed markets. In many respects,the risks inherent in transacting business in these countries are similar tothose in Russia, especially those risks set out above in “—Risks Relatingto the Economic Environment in Russia,” “—Risks Relating to the SocialEnvironment in Russia” and “—Risks Relating to Russian Legislation and theRussian 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 notindependently verified information we have sourced 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 besubstantially less complete or researched than those of Western countries.Official statistics may also be produced on different bases than those used inWestern countries. Any discussion of matters relating to Russia in thisdocument must, therefore, be subject to uncertainty due to concerns about thecompleteness or reliability of available official and public information. Inaddition, the veracity of some official data released by the Russian governmentmay be questionable. 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 $3.8 billion in 2005. Our mining business is focused onmining products used in the production of steel, primarily coking coal, ironore and nickel. We also produce a significant amount of steam coal. We havesubstantial coal, iron ore and nickel mining interests in Russia, with theflexibility to supply our own steel production or sell to third partiesdepending on price differentials between purchases from local suppliers andsales to foreign and domestic customers. We are capable of internally sourcingall of the coking coal, 97% of the iron ore and 49% of the nickel requirementsof our steel segment, assuming in the case of iron ore that third partiesprocess certain quantities of our iron ore into concentrate and then intopellets and sinter. In addition, we sell 58% of our coking coal concentrateproduction to third parties. We were the second largest producer of coking coalin Russia in 2005, with a 12% market share, and Russia’s second largestexporter of coking coal and coal concentrate. We also control 20% of the cokingcoal washing capacity in Russia.

Our steel business comprises the production and saleof semi-finished steel products, carbon and specialty long products, carbon andstainless flat products and value-added downstream metal productsincluding hardware, stampings and forgings. It also produces significantamounts of coke, both for internal use and for sales to third parties. We are thelargest and most comprehensive producer of specialty steels and alloys inRussia, producing 38% of total Russian specialty steel output. We are also thesecond largest producer of long products in Russia.

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 

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number 103770301896.Our principal executive offices are located at Krasnopresnenskaya Naberezhnaya12, Moscow 123610, Russian Federation. Our telephone number is +7-495-258-1828.Our Internet address is www.mechel.com. Information posted on our website isnot a part of this document. We have appointed CT Corporation Systems, 111Eight Avenue, New York, New York 10011 as our authorized agent upon whichprocess may be served for any suit or proceeding arising out of or relating toour 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, our founding shareholders have built Mechel into a large, integratedmining and steel group, comprising coal, iron ore, nickel and limestone mining,coke production, and steel production, with operations in Russia, Romania andLithuania. With each of our acquisitions, we implement improved operational andmanagement practices, and we are generally able to realize significantincreases in production 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.

Set forth below are our primary mining and steelacquisitions:

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, produced 15.6 million tonnes of coal in 2005.

In 2001, weacquired:

·       ChelyabinskMetallurgical Plant, an integrated blast furnace and BOF/EAF steel mill whichproduced 4.6 million tonnes ofraw steel, 3.8 million tonnes ofrolled products and 2.6 milliontonnes of coke in 2005 and which is located in Chelyabinsk, in the southernUrals near the border with Kazakhstan; and

·       SouthernUrals Nickel Plant, consisting of two open-pit nickel mines and a nickelprocessing facility which produced 12,616tonnes of nickel products in 2005 and which is located in Orsk, in the southernUrals.

In 2002, weacquired:

·       VyartsilyaMetal Products Plant, a hardware plant which produced 54,150 tonnes of hardware in 2005 and which is located inSortavala, Karelia, in northwest Russia close to the border with Finland;

·       BeloretskMetallurgical Plant, a hardware plant which produced a total of 533,140 tonnes of steel products in 2005,including 192,720 tonnes of wire rodand 340,420 tonnes of hardware and which is located in Beloretsk, in thesouthern Urals;

·       Pugachevlimestone quarry, consisting of a quarry and processing facility which produced2.1 million tonnes of limestone in 2005 and which is located close toBeloretsk, in the southern Urals; and

·       MechelTargoviste, a steel mill which produced 441,800 tonnes of raw steel and 334,170tonnes of rolled products in 2005 and which is located in Targoviste, Romania.

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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 86,040 tonnes of specialty steel stampingsin 2005 and which is located in Chebarkul, in the southern Urals;

·       MechelCampia Turzii, a steel mill which produced 274,920tonnes of raw steel, 139,180 tonnesof rolled products and 78,310 tonnesof hardware in 2005 and which is located in Campia Turzii, Romania;

·       KorshunovMining Plant, consisting of three iron ore mines and an iron ore concentratorplant which produced 4.5 milliontonnes of iron ore concentrate in 2005 and which is based in Zheleznogorsk-Ilimskiy,in eastern Siberia;

·       MechelNemunas, a hardware plant which produced 66,390tonnes of products in 2005 and which is located in Kaunas, Lithuania; and

·       MechelCoal Resources, a coal washing plant in Kazakhstan, which we subsequently soldin November 2005 together with our Gorbachev Mine in Kazakhstan followingour strategic purpose to focus on our Russian operations.

In 2004, weacquired:

·       PortPosiet, a port located in Russia’s Far East on the Sea of Japan and which has approximatelytwo million tonnes of cargo and 140,000 tonnesof warehousing capacity and processed 1,701,249 tonnes of cargo, mostly coal, in 2005;

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

·       Izhstal,a Russian specialty steel producer located in Izhevsk, Udmurtia, west of theUrals, which produced approximately 595,710tonnes of raw steel, 380,950 tonnesof rolled products, 38,480 tonnesof hardware and 16,980 tonnes ofstampings and forgings in 2005; 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 5.0 milliontonnes of coking coal and 3.9 milliontonnes of steam coal in 2005 from open and underground mines;

·       PortKambarka, a river port located in Kama in the Republic of Udmurtia, which processed338,906 tonnes of cargo, mostly sand and crushed stone, in 2005;

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

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

·       three subsoil licenses forthe Sorokinsky, Razvedochny and Olzherassk coal fields in Kemerovo.

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In 2006, weacquired:

·  MechelRecycling, a Chelyabinsk-based metal scrap processing company, for $6.0million, in line with our policy of ensuring the steel segment’sself-sufficiency in raw materials.

**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 of our strategy include thefollowing:

*Expandour Mining Business.**  *Weintend to build on our substantial mining experience to achieve the followinggoals:

Develop ourexisting 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 15.6 milliontonnes in 2005 to 18.9 milliontonnes in 2008, and our iron ore concentrate production from 4.5 million tonnes in 2005 to 5.0 million tonnes in 2008.

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

·       Maintainour 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 andreduce our manufacturing costs by:

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

·       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 a second-leading position in the market forsales of engineering steel and strong sales in rebar and wire rod. We intend tomaintain these positions, including through the addition of new productioncapacity achieved by targeted, cost-effective capital expenditures. We plan toincrease our rolled products output from 4.4 million tonnes as of the endof 2005 to 5.3 million tonnes as of the end of 2008, primarily at ourChelyabinsk Metallurgical Plant. Additionally, we seek to benefit from thefollowing 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.

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*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 fromhistoric post-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 productsthat we already 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, which constituted 45% of our total sales in 2005, allowus to diversify our sales and reduce our reliance on the Russian market in theevent that it were to experience a downturn.

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 all of the coking coal, 97% of the iron and 49%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 

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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 28% 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 100% of the coking coal, 97% of the iron ore and 49% of the nickelrequirements of our steel segment, assuming in the case of iron ore that thirdparties process certain quantities of our iron ore into concentrate and theninto pellets and sinter, which comprise the ultimate form of iron ore feed intothe steel making process. 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, improved flexibilityand 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 keep our raw materials costs down. Inaddition, our ability to source raw materials internally and within Russiameans that we are not exposed to any shortages in worldwide shipping capacity.

*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 our substantialexisting infrastructure can accommodate new facilities and production linesthrough brownfield development. Moreover, due to our integration, experienceand location in Russia, which has some of the largest reserves of coal and ironin the world, we are better positioned than our European competitors to secureraw materials for any increases in steel production. For example, we plan toincrease Chelyabinsk Metallurgical Plant’s raw steel and rolled steelproduction capacity from 5.1 million and 4.1 million tonnes,respectively, as of the end of 2005 to 5.4 million and 4.7 milliontonnes, respectively, in 2008.

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*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 eight countries and agents in 15additional countries. These export sales, which constituted 45.0% and 53.9% ofour total sales in 2005 and 2004, respectively, allow us to diversify oursales, provide us with additional growth opportunities and reduce our relianceon the Russian 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 construction marketin 2005 was approximately 16%.

*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 steel and coal producer. Mr. Zyuzin, oneof our founding shareholders, is our Chairman and remains significantlyinvolved in our business. Our Chief Operating Officer and future ChiefExecutive Officer, Alexey Ivanushkin, has significant experience from hisprevious positions at Glencore International and as chief executive officer atChelyabinsk Metallurgical Plant. Many of our directors and officers began theircareers in floor jobs or in mines and moved up into management positions overthe course of their careers.

**Mining Business**

Our main productscomprise coking and steam coal concentrate, steam coal, iron ore concentrateand ferronickel. Among the key advantages of our mining business is the highquality of our coking coal, the low level of volatile matters in our steam coaland our modern coal washing facilities, primarily built during the 1970s and1980s, including facilities built as recently as 2001-2002.

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**Sales of miningproducts**

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

| **Product**              | ** ** | ** **                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **               | ** ** | **(in thousands of tonnes)** | ** ** |
| Coking coal  concentrate |       | 5,013                                       |       | 5,247    |       | 4,034    |       |
| Steam coal               |       | 5,876                                       |       | 5,539    |       | 5,069    |       |
| Iron ore  concentrate    |       | 2,876                                       |       | 2,438    |       | 671      |       |
| Nickel                   |       | 11                                          |       | 9        |       | 10       |       |

 

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:

| ** **               | ** ** | **2005**                                                                                     | ** ** | **2004**   | ** ** | **2003**                    | ** ** |
|--------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|
| **Revenues**             | ** ** | ** **                                                                                   | ** ** | **Amount** | ** ** | **% of revenues** | ** ** | **Amount** | ** ** | **% of revenues** | ** ** | **Amount** | ** ** | **% of revenues** | ** ** |
| ** **               | ** ** | **(in millions of U.S. dollars, except for percentages)** | ** ** |
| Coking coal  concentrate |       | 463.0                                                                                        |       |       | 42         | %                           |       |   | 402.1 |   |   |   | 46 | % |   |   | 180.1 |   |   |   | 43 | % |   |
| Domestic Sales (%)       |       | 64                                                                                           | %          |       |       |                        |       |   | 40 | % |   |   |   |   |   |   | 87 | % |   |   |   |   |   |
| Export (%)               |       | 36                                                                                           | %          |       |       |                        |       |   | 60 | % |   |   |   |   |   |   | 13 | % |   |   |   |   |   |
| Steam Coal               |       | 273.5                                                                                        |       |       | 25         | %                           |       |   | 211.7 |   |   |   | 24 | % |   |   | 120.0 |   |   |   | 29 | % |   |
| Domestic Sales (%)       |       | 12                                                                                           | %          |       |       |                        |       |   | 13 | % |   |   |   |   |   |   | 24 | % |   |   |   |   |   |
| Export (%)               |       | 88                                                                                           | %          |       |       |                        |       |   | 87 | % |   |   |   |   |   |   | 76 | % |   |   |   |   |   |
| Iron ore concentrate     |       | 167.1                                                                                        |       |       | 15         | %                           |       |   | 113.8 |   |   |   | 13 | % |   |   | 20.1 |   |   |   | 5 | % |   |
| Domestic Sales (%)       |       | 69                                                                                           | %          |       |       |                        |       |   | 52 | % |   |   |   |   |   |   | 100 | % |   |   |   |   |   |
| Export (%)               |       | 31                                                                                           | %          |       |       |                        |       |   | 48 | % |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Nickel                   |       | 150.5                                                                                        |       |       | 14         | %                           |       |   | 108.0 |   |   |   | 12 | % |   |   | 80.1 |   |   |   | 19 | % |   |
| Domestic Sales (%)       |       | —                                                                                       |       |       |       |                        |       |   | — |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Export (%)               |       | 100                                                                                          | %          |       |       |                        |       |   | 100 | % |   |   |   |   |   |   | 100 | % |   |   |   |   |   |
| Other(1)                 |       | 40.7                                                                                         |       |       | 4          | %                           |       |   | 42.8 |   |   |   | 3 | % |   |   | 13.6 |   |   |   | 4 | % |   |
| Total                    |       | 1,094.8                                                                                      |       |       | 100        | %                           |       |   | 878.4 |   |   |   | 100 | % |   |   | 413.9 |   |   |   | 100 | % |   |
| Domestic Sales (%)       |       | 44                                                                                           | %          |       |       |                        |       |   | 33 | % |   |   |   |   |   |   | 53 | % |   |   |   |   |   |
| Export (%)               |       | 56                                                                                           | %          |       |       |                        |       |   | 67 | % |   |   |   |   |   |   | 47 | % |   |   |   |   |   |
|                          |            |                                                                                              |            |            |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Includesrevenues from transportation, distribution, construction and othermiscellaneous services provided to local customers.

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**Marketing anddistribution**

Ourmining products are marketed domestically primarily through Mechel Trading Houseand internationally through Mechel International Holdings. The following tablesets forth by percentage of sales the regions in which our mining segmentproducts were sold for the periods indicated:

| **Region**(1) | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Russia        |       | 44.3       | %          | 32.0     | %          | 54.9     | %          |
| Other CIS     |       | 13.0       | %          | 16.4     | %          | 0.1      | %          |
| Europe        |       | 31.5       | %          | 31.3     | %          | 43.7     | %          |
| Asia          |       | 9.3        | %          | 14.3     | %          | —   |       |
| Middle East   |       | 1.9        | %          | 6.0      | %          | —   |       |
| Other         |       | —     |       | —   |       | 1.3      | %          |
|          |       | 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 2005 the five largestcustomers of our mining products were Glencore International (nickel, ironore), MMK (coking coal, iron ore), ZapSib (coking coal, iron ore), GreenwayResources (coking coal) and Ural Steel (coking coal), which together accountedfor 42.9% 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 18.6% of our total cokingcoal concentrate sales and 7.9% of our total mining segment sales in 2005. 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. Mosenergo,Moscow’s electricity generating and distribution company and a subsidiary ofRAO UES, is our largest domestic customer of steam coal, accounting for 3.7% ofour total steam coal sales and 0.9% of our total mining segment sales in 2005.We ship our steam coal from our warehouses by railway directly to keycustomers, which are predominantly electric power stations. Sales contracts forsteam coal are generally concluded with customers on an annual basis.

Iron ore concentrate is shipped via railway directlyfrom Korshunov Mining Plant to customers. Our largest domestic customer,ZapSib, accounted for 53.7% of our total iron ore concentrate sales and 8.2% ofour total mining segment sales in 2005. Prices are set quarterly.

Since 2002, Mechel TradingHouse has operated its wholly-owned subsidiary, Mecheltrans, a railwayfreight and forwarding company that also arranges warehousing for our stock.Mecheltrans owns its own rolling stock, consisting of 293 open cars and 297pellet cars, and also leases 1,449 open cars and 20 pellet cars. The companytransported domestically approximately 34.3 million tonnes of our cargo in2005, approximately 80.5% of which 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, 2005, our largestmining segment customer was Glencore International, accounting for 13.9% of ourtotal mining segment sales. Glencore International’s purchases consisted ofnickel (99.0%) and iron ore (1.0%). It was also our largest customer in theyears ended December 31, 2004 and 2003, accounting for 5.0% and 19.7%,respectively, of the total mining segment sales in those periods. 

We are Russia’s second largest exporter of coking coalconcentrate. We export our coking coal concentrate primarily to Ukraine,Slovakia, Bulgaria and South Korea. In 2005, Greenway Resources was ourlargest foreign customer of coking coal concentrate, accounting for 15.4% ofour total coking coal concentrate sales and 6.5%****ofour total mining segment sales. Shipments are made by railway and by ship.

Our exports of steam coal are primarily to Japan,Slovakia, Turkey and Spain, which together accounted for 53.9% of our totalsteam coal sales and 13.5% of our total mining segment sales in 2005. Most ofthese sales are to long-standing customers, such as two Slovakian powerstations, under annual contracts with prices reviewed monthly. We also sell totraders. Steam coal is shipped to customers from our warehouses by railway and,in some cases, by ship from Russian and Ukrainian ports.

In February 2004, we acquired Port Posiet,located in Russia’s Far East on the Sea of Japan. The port has approximatelytwo million tonnes of cargo handling capacity and 140,000 tonnes of warehousingcapacity and processed 1.7 million tonnes of cargo, mostly coal in 2005.We ship primarily our steam coal and coking coal concentrate to Japan from thisport.

We also exported iron ore concentrate to China during2005, accounting for 30.5% of our total iron ore concentrate sales and 4.7% ofour total mining segment sales in 2005. We ship iron ore concentrate to Chinaby rail and by sea.

We sell all of our nickelthat we do not use internally to Glencore International, on the basis of nickelprices quoted by the London Metal Exchange, or LME, less a certain discount.The nickel is delivered by railway from Southern Ural Nickel Plant to eitherthe port of St. Petersburg or the port of Kaliningrad, and it is then forwardedon by Glencore International to 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 2005. Over the last fewyears, domestic coal mining companies have generally enjoyed a relativelystable customer base.

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We arethe second largest coking coal producer in Russia, with a 12.3% market share,and we have a 5.2% 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 2005 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                |       |                                    | 13,022     |                                                       |       |                                    | 18.6       | %                                              |       |         | 17,070     |                         |       |   | 5.7 | % |   | Kuzbass |   | EvrazHolding |   |
| Southern Kuzbass Coal  Company |       |                                    | 8,583      |                                                       |       |                                    | 12.3       | %                                              |       |         | 15,645     |                         |       |   | 5.2 | % |   | Kuzbass |   | Mechel |   |
| Raspadskaya Mine               |       |                                    | 6,395      |                                                       |       |                                    | 9.1        | %                                              |       |         | 8,612      |                         |       |   | 2.9 | % |   | Kuzbass |   | EvrazHolding(1) |   |
| Kuzbassrazrezugol              |       |                                    | 3,787      |                                                       |       |                                    | 5.4        | %                                              |       |         | 40,299     |                         |       |   | 13.4 | % |   | Kuzbass |   | Ural Mining-Metallurgical Company |   |
| Prokopievskugol                |       |                                    | 3,547      |                                                       |       |                                    | 5.1        | %                                              |       |         | 5,113      |                         |       |   | 1.7 | % |   | Kuzbass |   | NLMK |   |
| Kuzbassugol                    |       |                                    | 3,499      |                                                       |       |                                    | 5.0        | %                                              |       |         | 3,718      |                         |       |   | 1.2 | % |   | Kuzbass |   | Severstal |   |
| Mezhdurechye(2)                |       |                                    | 2,771      |                                                       |       |                                    | 4.0        | %                                              |       |         | 5,601      |                         |       |   | 1.9 | % |   | Kuzbass |   | Sibuglemet, Bagomes |   |
| Other                          |       |                                    | 28,289     |                                                       |       |                                    | 40.5       | %                                              |       |         | 203,812    |                         |       |   | 68.0 | % |   |   |   |   |   |
| Total                          |       |                                    | 69,893     |                                                       |       |                                    | 100        | %                                              |       |         | 299,871    |                         |       |   | 100 | % |   |   |   |   |   |

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Source: CDU TEK

(1)    Accountedfor by EvrazHolding on an equity basis.

(2)    We own16.1% of Mezhdurechye.

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 50.4% of total production of iron oreconcentrate.

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Thefollowing table lists the main Russian iron ore concentrate producers in 2005and 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         |       |                                       | 20,564     |                                 |       |         | 22.3       | %                            |       | Belgorod Region |   | Gazprominvestholding |   |
| Mikhailovsky GOK       |       |                                       | 15,169     |                                 |       |         | 16.4       | %                            |       | Kursk Region |   | Urals Steel |   |
| Stoylensky GOK         |       |                                       | 10,810     |                                 |       |         | 11.7       | %                            |       | Belgorod Region |   | NLMK |   |
| Karelsky Okatysh       |       |                                       | 9,123      |                                 |       |         | 9.9        | %                            |       | North-West Region |   | Severstal-Resurs |   |
| Kachkanarsky GOK       |       |                                       | 8,649      |                                 |       |         | 9.4        | %                            |       | Urals Region |   | EvrazHolding |   |
| Kovdorsky GOK          |       |                                       | 5,794      |                                 |       |         | 6.3        | %                            |       | North-West Region |   | EvroChim |   |
| Korshunov Mining Plant |       |                                       | 4,522      |                                 |       |         | 4.9        | %                            |       | Siberia |   | Mechel |   |
| Olenegorsky GOK        |       |                                       | 4,024      |                                 |       |         | 4.4        | %                            |       | North-West Region |   | Severstal-Resurs |   |
| KMAruda                |       |                                       | 1,851      |                                 |       |         | 2.0        | %                            |       | Belgorod Region |   | NLMK |   |
| Sheregeshkoe RU        |       |                                       | 1,564      |                                 |       |         | 1.7        | %                            |       | Siberia |   | EvrazHolding |   |
| Vysokogorsky GOK       |       |                                       | 1,403      |                                 |       |         | 1.5        | %                            |       | Urals Region |   | EvrazHolding |   |
| Irbinskoe RU           |       |                                       | 1,400      |                                 |       |         | 1.5        | %                            |       | Siberia |   | EvrazHolding |   |
| Bogoslovskoe RU        |       |                                       | 1,349      |                                 |       |         | 1.5        | %                            |       | Urals Region |   | Ural Mining-Metallurgical Company |   |
| Other                  |       |                                       | 6,200      |                                 |       |         | 6.7        | %                            |       |   |   |   |   |
| Total                  |       |                                       | 92,422     |                                 |       |         | 100        | %                            |       |   |   |   |   |

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Source: Rudprom

In addition, Sokolovsko-Sarbayskoye MiningAmalgamation, which is located in Kazakhstan with a capacity of16.7 million tonnes of iron ore concentrate and 8.7 million tonnes ofpellets per annum, has been a major supplier to MMK since April 2006. 

Nickel prices and demandsare driven by international markets. See “—Industry Overview—Global NickelIndustry Overview” and “—Industry Overview—Russian Nickel Industry Overview.”

**Coal production**

Southern Kuzbass Coal Company and its subsidiariesoperate five active coal mines centered around the city of Mezhdurechensk inthe southwestern part of Siberia. The mines are located in the Kuznetsky Basin,Russia’s largest coal producing region. This basin trends for approximately 300kilometers in a northwest-southeast direction and averages about 120 kilometersin width. There are four surface mines, Krasnogorsk, Tomusinsk, Olzherassk andSibirginsk, and one underground mine, Lenin. An underground mine was also addedto the Sibirginsk mine in November 2002. Production started at Lenin in1953, at Krasnogorsk in 1954, at Tomusinsk in 1959, at Sibirginsk in 1973(open-pit) and 2002 (underground) and at Olzherassk in 1980. We primarily leaseor have a right of perpetual use of the land on which our coal mines andfacilities are located.

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The table below sets forththe subsoil licenses used by our coal mines and the expiration dates thereof.
| Mine                     | ** ** | ** **                          | ** ** | **License Area**                  | ** ** | **License Holder** | ** ** | **Expiry Date**      | ** ** | **Status** | ** ** | **Area  (sq. km)** |
|--------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|--------------------|------------|----------------------|------------|------------|------------|--------------------|
| Krasnogorsk Pit          |       | Tomsk, Sibirginsk                   |       | Krasnogorsk Open Pit Mine         |       | December 2013      |       | In production        |       | 22.4       |
| Krasnogorsk Pit          |       | Sorokinsky, Tomsk,  Sibirginsk      |       | Southern Kuzbass Coal  Company    |       | November 2025      |       | In production        |       | 2.8        |
| Lenin Mine               |       | Olzherassk                          |       | Lenin Mine                        |       | November 2013      |       | In production        |       | 10.0       |
| Lenin Mine               |       | Olzherassk                          |       | Lenin Mine(1)                     |       | December 2014      |       | In production        |       | 2.9        |
| Olzherassk Pit           |       | Raspadsk, Berezovsk,  Olzherassk    |       | Olzherassk Open Pit Mine          |       | January 2014       |       | In production        |       | 10.1       |
| Olzherassk Pit           |       | Raspadsk, Berezovsk,  Olzherassk    |       | Olzherassk Open Pit Mine          |       | January 2014       |       | In production        |       | 10.1       |
| Olzherassk Pit           |       | Raspadsk                            |       | Southern Kuzbass Coal  Company    |       | December 2024      |       | In production        |       | 3.5        |
| Olzherassk Pit           |       | Berezovsk-2, Berezovsk,  Olzherassk |       | Southern Kuzbass Coal  Company    |       | December 2024      |       | In production        |       | 8.6        |
| Sibirginsk Mine          |       | Sibirginsk, Tomsk                   |       | Southern Kuzbass Coal  Company    |       | December 2024      |       | In production        |       | 5.9        |
| Sibirginsk Pit           |       | Sibirginsk, Kureinsk,  Uregoisk     |       | Southern Kuzbass Coal  Company(1) |       | January 2014       |       | In production        |       | 17.7       |
| Tomusinsk Pit            |       | Tomsk                               |       | Tomusinsk Open Pit Mine           |       | December 2013      |       | In production        |       | 6.7        |
| Erunakovsk-1             |       | Erunakovsk-1, Erunakovsk            |       | Southern Kuzbass Coal  Company    |       | July 2025          |       | Feasibility study(2) |       | 8.4        |
| Erunakovsk-3             |       | Erunakovsk-3, Erunakovsk            |       | Southern Kuzbass Coal  Company    |       | July 2025          |       | Feasibility study(2) |       | 7.1        |
| Lenin Mine               |       | Olzherassk                          |       | Southern Kuzbass Coal  Company    |       | November 2025      |       | Feasibility study(2) |       | 19.2       |
| Olzherassk Mine  and Pit |       | Razvedochny, Raspadsk               |       | Southern Kuzbass Coal Company     |       | November 2025      |       | Feasibility study(2) |       | 14.6       |

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(1)    Inprocess of re-registration due to merger of previous license holder into thiscompany.

(2)    Notincluded in our mineral reserves and deposits.

Coal is mined using traditional open-pit orunderground mining methods. Following a drilling and blasting stage, acombination of shovels and draglines is used for moving coal and waste at oursurface mines. Production at the underground mines is predominantly fromlongwall mining. After mining, depending upon the amount of impurities in thecoal, the coal is processed in a wash plant, where it is crushed and impuritiesare removed. Coking coal concentrate is then transported to steel plants forconversion to coke for use in steel-making. Steam coal is shipped to utilitieswhich use it in furnaces for 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 the periodsindicated.

| ** **                       | ** ** | **2005**                     | ** ** | **2004**                  | ** ** | **2003**   | ** ** |
|----------------------------------|------------|------------------------------|------------|---------------------------|------------|------------|------------|
| ** **                       | ** ** | **Tonnes**                   | ** ** | **% of  production** | ** ** | **Tonnes** | ** ** | **% of  production** | ** ** | **Tonnes** | ** ** | **% of  production** | ** ** |
| ** **                       | ** ** | **(tonnes in thousands)**(1) | ** ** |
| **Coking Coal**                  |       |                         |       |                      |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Sibirginsk (Pit & Mine) |       | 2,822                        |       |                      | 32.9       | %          |       | 3,000 |   |   | 32.2 | % |   | 2,868 |   |   | 33.1 | % |   |
| Tomusinsk Pit                    |       | 2,607                        |       |                      | 30.4       | %          |       | 2,660 |   |   | 28.6 | % |   | 2,727 |   |   | 31.4 | % |   |
| Olzherassk Pit                   |       | 1,581                        |       |                      | 18.4       | %          |       | 1,413 |   |   | 15.2 | % |   | 1,210 |   |   | 14.0 | % |   |
| Lenin Mine                       |       | 1,573                        |       |                      | 18.3       | %          |       | 2,236 |   |   | 24.0 | % |   | 1,871 |   |   | 21.6 | % |   |
| Total Coking Coal                |       | 8,583                        |       |                      | 100.0      | %          |       | 9,309 |   |   | 100.0 | % |   | 8,676 |   |   | 100.0 | % |   |
| **Steam  Coal**                  |       |                         |       |                      |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Krasnogorsk Pit                  |       | 5,278                        |       |                      | 74.7       | %          |       | 4,726 |   |   | 74.6 | % |   | 3,773 |   |   | 68.8 | % |   |
| Sibirginsk (Pit & Mine) |       | 1,649                        |       |                      | 23.3       | %          |       | 1,473 |   |   | 23.3 | % |   | 1,442 |   |   | 26.3 | % |   |
| Olzherassk Pit                   |       | 135                          |       |                      | 1.9        | %          |       | 136 |   |   | 2.1 | % |   | 270 |   |   | 4.9 | % |   |
| Total Steam Coal                 |       | 7,063                        |       |                      | 100.0      | %          |       | 6,335 |   |   | 100.0 | % |   | 5,485 |   |   | 100.0 | % |   |
| Total Coal                       |       | 15,646                       |       |                      |       |       |       | 15,644 |   |   |   |   |   | 14,160 |   |   |   |   |   |
| % Coking Coal                    |       |                         |       |                      | 54.9       | %          |       |   |   |   | 59.5 | % |   |   |   |   | 61.3 | % |   |
| % Steam Coal                     |       |                         |       |                      | 45.1       | %          |       |   |   |   | 40.5 | % |   |   |   |   | 38.7 | % |   |

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(1)          Tonnagesare reported on a wet basis.

***Coal washing plants***

We operate three coalwashing plants located near our coal mines in Southern Kuzbass. Of the totalcoal feed enriched by our washing plants in 2005, about 80.9%(14.2 million tonnes) was supplied by our own mining operations, and 19.1%(3,361 million tonnes) from the nearby Raspadsk and Prokopyevsk mines on atolling basis. In 2005, the capacity of our washing plants in Russia accountedfor approximately 20% of the total domestic coking coal washing capacity inRussia.

***Investments in coalcompanies***

We own 25% plus one shareof Yakutugol, a coal producer located in eastern Siberia. Yakutugol extractspredominantly coking coal, as well as steam coal, in open and undergroundmines. Yakutugol’s annual output in 2005 was approximately 8.9 million tonnesof coal consisting of 5.0 million tonnes of coking coal and3.9 million tonnes of steam coal, and it sells most of its output to theAsian Pacific region, primarily Japan, South Korea and Taiwan, mostly underlong-term contracts.

Current subsoil licenses of Yakutugolexpire in 2013, but based on the provisions of Russian legislation we believethat their extension through the end of the estimated proven and probablereserve depletion period is reasonably assured. We also believe that since the Government of Republic Sakha (Yakutia) owns amajority stake in Yakutugol, the renewal of its subsoil licenses upon theirexpiration in 2013 is virtually automatic. Consequently, in our consolidatedfinancial statements, we amortize Yakutugol’s subsoil licenses using theunits-of-production method through the end of the estimated proven and probablereserve depletion period (2031).

InMarch 2006, in response to a request for proposals fromRussian Railways OAO, we submitted a non-binding proposal regardingYakutugol and the development of the Elga coal deposit in Yakutia. Thenon-binding proposal contemplates the formation of a new company, which wouldbe named Sakhaugol OAO. We are considering several routes for the formation ofSakhaugol, one of which could be through the contribution of our 25% + 1 sharein Yakutugol and up to $300 million, in return for which we would obtain 51% ofSakhaugol. As a result, Sakhaugol would own about 70% of Yakutugol and 68.9% ofElgaugol. We cannot assure you that such proposal would be accepted andeventually implemented.

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We also own 16.1% ofMezhdurechye, a Russian coal producer which accounted for 4% of Russian cokingcoal and 2% of Russian total coal output in 2005.

**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        |                    |       |

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(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 which removethe 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.

| ** **                       | ** ** | **2005**                               | ** ** | **2004**               | ** ** | **2003**(1) | ** ** |
|----------------------------------|------------|----------------------------------------|------------|------------------------|------------|-------------|------------|
| ** **                       | ** ** | **Tonnes**                             | ** ** | **Grade  (% Fe)** | ** ** | **Tonnes**  | ** ** | **Grade  (% Fe)** | ** ** | **Tonnes** | ** ** | **Grade  (% Fe)** | ** ** |
| ** **                       | ** ** | **(tonnes in thousands)**(2) | ** ** |
| Korshunovsk ore  production      |       | 6,522                                  |       |                   | 26.7       | %           |       | 6,263 |   |   | 26.4 | % |   |   | 5,631 |   |   |   | 26.8 | % |   |
| Rudnogorsk ore  production       |       | 4,104                                  |       |                   | 35.3       | %           |       | 3,576 |   |   | 35.5 | % |   |   | 2,483 |   |   |   | 37.0 | % |   |
| Tatianinsk ore  production       |       | 707                                    |       |                   | 30.2       | %           |       | 364 |   |   | 32.5 | % |   |   | 258 |   |   |   | 31.2 | % |   |
| Total ore  production            |       | 11,333                                 |       |                   | 30.0       | %           |       | 10,203 |   |   | 29.8 | % |   |   | 8,372 |   |   |   | 30.0 | % |   |
| Iron ore concentrate  production |       | 4,522                                  |       |                   | 62.6       | %           |       | 3,876 |   |   | n/a |   |   |   | 3,509 |   |   |   | n/a |   |   |

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(1)          We have included fullyear production at Korshunov Mining Plant for 2003 although we started consolidatingits results in October 2003.

(2)          Tonnagesare reported on a wet basis.

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**Nickel ore and nickelproduction**

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:

| ** **               | ** ** | **2005**                               | ** ** | **2004**               | ** ** | **2003**   | ** ** |
|--------------------------|------------|----------------------------------------|------------|------------------------|------------|------------|------------|
| ** **               | ** ** | **Tonnes**                             | ** ** | **Grade  (% Ni)** | ** ** | **Tonnes** | ** ** | **Grade  (% Ni)** | ** ** | **Tonnes** | ** ** | **Grade  (% Ni)** | ** ** |
| ** **               | ** ** | **(tonnes in thousands)**(1) | ** ** |
| Sakhara ore  production  |       | 1,113.7                                |       |                   | 1.14       | %          |       | 1,358.4 |   |   | 1.08 | % |   |   | 1,435 |   |   |   | 1.08 | % |   |
| Buruktal ore  production |       | 901.6                                  |       |                   | 1.06       | %          |       | 1,243.6 |   |   | 1.02 | % |   |   | 1,164 |   |   |   | 1.02 | % |   |
| Total ore  production    |       | 2,015.3                                |       |                   | 1.1        | %          |       | 2,602.0 |   |   | 1.05 | % |   |   | 2,599 |   |   |   | 1.05 | % |   |
| Nickel production        |       | 12.6                                   |       |                   | n/a        |       |       | 12.7 |   |   | n/a |   |   |   | 13.5 |   |   |   | n/a |   |   |

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(1)          Tonnagesare reported on a wet basis.

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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 until January 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 ishauled to stockpiles located adjacent to the crushing and screening plant. Oreis crushed, 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 2005, approximately 52.0% of thelimestone produced at Pugachev was used internally, with 36.4% shipped toChelyabinsk Metallurgical Plant, 13.0% shipped to Southern Urals Nickel Plant,and 2.8% shipped to Izhstal, and the remaining 47.8% was sold to third parties.We are capable of internally sourcing 100% of the limestone requirements of oursteel operations.

Thetable below summarizes our limestone production for the periods indicated.

| ** **            | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|
| ** **            | ** ** | **(in thousands of tonnes)** | ** ** |
| Limestone  production |       | 2,054.0                                     |       | 509.0    |       | 522.6    |       |

 

Following the recentcommissioning****of our new crushing and screeningplant in December 2004, our total production capacity has increased to2.0 million 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 Pincock, Allen & Holt, independent mining engineers.

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. KeyInformation—Risk Factors—Risks Relating to Our Business and Industry—Deficienciesin the legal framework relating to subsoil licensing subject our licenses tothe risk of governmental challenges and, if our licenses are suspended or terminated,we would be unable to 

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realize our reserves,which could materially adversely affect our business and results of operations;”and  “—Regulatory Matters—SubsoilLicensing.”

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) isadjacent but not contained within the license boundary. In both such cases, weexpect to be able to obtain the legal right to extract such deposit in thefuture, but we have a limited history of license renewals and the Russian legalsystem provides regulatory authorities with discretion in matters of licenserenewal. See “Item 3. Key Information—Risk Factors—Risks Relating to OurBusiness and Industry—Our business could be adversely affected if we fail toobtain or renew necessary licenses and permits or fail to comply with the termsof our licenses and permits” and “Item 3. Key Information—Risk Factors—RisksRelating to the Russian Federation—Legal Risks and Uncertainties—Weaknessesrelating to the Russian legal system and Russian legislation create anuncertain environment for investment and business activity.”

Thetable below summarizes our reserves as of January 1, 2006.

| ** **  | ** ** | **Coal**                                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------|------------|------------------------------------------------------------|------------|------------|------------|------------|------------|-------------------|------------|
| **Summary** | ** ** | ** **                                                 | ** ** | **Coking** | ** ** | **Steam**  | ** ** | **Iron Ore** | ** ** | **Nickel Ore** | ** ** | **Limestone** | ** ** |
| ** **  | ** ** | **(quantities in millions of tonnes)** | ** ** |
| Reserves    |       |                                                       | 104.2      |       |       | 141.2      |       |              | 83.5       |   |   |   | 14.0 |   |   |   | 19.2 |   |   |
| Grade(%)    |       |                                                       | 42.5       | %*         |       | 57.5       | %*         |              | 27.6       | % |   |   | 1.1 | % |   |   | 55.2 | % |   |
| Deposits    |       |                                                       | 106.1      |       |       | 105.3      |       |              | 101.3      |   |   |   | 79.9 |   |   |   | 42.8 |   |   |
| Grade(%)    |       |                                                       | 50.2       | %*         |       | 49.8       | %*         |              | 28.0       | % |   |   | 1.1 | % |   |   | 55.2 | % |   |
|             |            |                                                            |            |            |            |            |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

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*                    Showspercent of the type of coal.

***Coal***

As of January 1,2006, we had coal reserves (proven and probable) totaling 245.6 milliontonnes, of which approximately 42.5% was coking coal. The table belowsummarizes coal reserves by mine.

| **Coal Reserves** | ** ** | ** **                                                    | ** ** | **Coking Coal** | ** ** | **Steam Coal** | ** ** | **Heating  Value**(1) | ** ** | **% Sulfur** | ** ** |
|------------------------|------------|---------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|-----------------------|------------|-------------------|------------|
| ** **             | ** ** | **(quantities in millions of tonnes)**(2) | ** ** |
| Krasnogorsk            |       |                                                          | —     |                 |       |                | 121.8      |                  |       |              | 5,780      |   |   |   | 0.35 | % |   |
| Tomusinsk              |       |                                                          | 13.2       |                 |       |                | —     |                  |       |              | 8,500      |   |   |   | 0.30 | % |   |
| Olzherassk             |       |                                                          | 40.0       |                 |       |                | —     |                  |       |              | 8,163      |   |   |   | 0.25 | % |   |
| Sibirginsk             |       |                                                          | 34.1       |                 |       |                | 19.4       |                  |       |              | 8,483      |   |   |   | 0.27 | % |   |
| Lenin                  |       |                                                          | 16.8       |                 |       |                | 0.0        |                  |       |              | 8,439      |   |   |   | 0.26 | % |   |
| Total                  |       |                                                          | 104.2      |                 |       |                | 141.2      |                  |       |              |       |   |   |   |   |   |   |
| % of Total             |       |                                                          | 42.5       | %                    |       |                | 57.5       | %                     |       |              |       |   |   |   |   |   |   |

----

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

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

52

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As of January 1,2006, we had coal deposits totaling 211.4 million tonnes, of whichapproximately 50.2% was coking coal. The table below summarizes coal depositsby mine.

| **Coal Deposits** | ** ** | ** **                                                    | ** ** | **Coking Coal** | ** ** | **Steam Coal** | ** ** | **Heating  Value**(1) | ** ** | **% Sulfur** | ** ** |
|------------------------|------------|---------------------------------------------------------------|------------|----------------------|------------|---------------------|------------|-----------------------|------------|-------------------|------------|
| ** **             | ** ** | **(quantities in millions of tonnes)**(2) | ** ** |
| Krasnogorsk            |       |                                                          | —     |                 |       |                | 83.7       |                  |       |              | 5,800      |   |   |   | 0.35 | % |   |
| Tomusinsk              |       |                                                          | 7.9        |                 |       |                | —     |                  |       |              | 8,500      |   |   |   | 0.30 | % |   |
| Olzherask              |       |                                                          | 12.1       |                 |       |                | —     |                  |       |              | 8,160      |   |   |   | 0.25 | % |   |
| Sibirginsk             |       |                                                          | 71.4       |                 |       |                | 21.6       |                  |       |              | 8,503      |   |   |   | 0.25 | % |   |
| Lenin                  |       |                                                          | 14.7       |                 |       |                | —     |                  |       |              | 8,439      |   |   |   | 0.26 | % |   |
| Total                  |       |                                                          | 106.1      |                 |       |                | 105.3      |                  |       |              |       |   |   |   |   |   |   |
| % of Total             |       |                                                          | 50.2       | %                    |       |                | 49.8       | %                     |       |              |       |   |   |   |   |   |   |

----

(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 $47.64 per tonne for coking coaland $20.87 per tonne for steam coal. These prices were for the saleable productso the actual prices in the cash flow were reduced to account for processrecoveries, which varied by mine. All present and future operating and capitalcosts were converted into U.S. dollars using an exchange rate of 28.3 rublesper U.S. dollar.

***Iron ore***

As of January 1,2006, we had iron ore reserves (proven and probable) totaling 83.5 milliontonnes at an average iron grade of 27.6%. The table below summarizes iron orereserves by mine.

| **Iron Ore Reserves**(1) | ** ** | ** **                          | ** ** | **Tonnes**(2) | ** ** | **Grade  (% Fe)**(3) | ** ** |
|------------------------------------|------------|-------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                         | ** ** | **(tonnes in thousands)** | ** ** |
| Korshunovsk                        |       |                                | 27,471     |          |       |                      | 25.1       | % |   |
| Rudnogorsk                         |       |                                | 51,583     |          |       |                      | 30.8       | % |   |
| Tatianinsk                         |       |                                | 4,410      |          |       |                      | 26.9       | % |   |
| Total                              |       |                                | 83,464     |          |       |                      | 27.6       | % |   |

----

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

(2)          Tonnages are reported ona dry basis.

(3)          Metallurgical recoveryis projected to be 81.9%.

As of January 1,2006, we had iron ore deposits totaling 101.3 million tonnes at an averageiron grade of 28.0%. The table below summarizes iron ore deposits by mine.

| **Iron Ore Deposits**(1) | ** ** | ** **                          | ** ** | **Tonnes**(2) | ** ** | **Grade  (% Fe)**(3) | ** ** |
|------------------------------------|------------|-------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                         | ** ** | **(tonnes in thousands)** | ** ** |
| Korshunovsk                        |       |                                | 42,429     |          |       |                      | 25.1       | % |   |
| Rudnogorsk                         |       |                                | 58,874     |          |       |                      | 30.8       | % |   |
| Tatianinsk                         |       |                                | —     |          |       |                      | —     |   |   |
| Total                              |       |                                | 101,303    |          |       |                      | 28.0       | % |   |

----

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

53

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(2)          Tonnages are reported ona dry basis.

(3)          Metallurgical recoveryis projected to be 81.9%.

Iron ore reserves anddeposits were estimated using an assumed iron ore concentrate price of $47.52per tonne for 2006, $48.23 per tonne for 2007, $39.21 per tonne for 2008, 32.14per tonne for 2009, $31.37 per tonne for 2010-2013 and $30.00 per tonnefor 2014-2027. All present and future operating and capital costs wereconverted into U.S. dollars using an exchange rate of 28.3 rubles per U.S.dollar.

***Nickel ore***

As of January 1,2006, we had nickel ore reserves (proven and probable) totaling14.0 million tonnes at an average nickel grade of 1.06%. The table belowsummarizes nickel ore reserves by mine.

| **Nickel Ore Reserves**(1) | ** ** | ** **                         | ** ** | **Tonnes**(2) | ** ** | **Grade  (% Ni)**(3) | ** ** |
|--------------------------------------|------------|------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                           | ** ** | **(tonnes in millions)** | ** ** |
| Sakhara                              |       |                               | 7.3        |          |       |                      | 1.08       | % |   |
| Buruktal                             |       |                               | 6.7        |          |       |                      | 1.03       | % |   |
| Total                                |       |                               | 14.0       |          |       |                      | 1.06       | % |   |

----

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

(2)          Tonnages are reported ona dry basis.

(3)          Metallurgical recoveryis projected to be 70%.

As of January 1,2006, we had nickel ore deposits totaling 79.9 million tonnes at anaverage nickel grade of 1.05%. The table below summarizes nickel ore deposits.

| **Nickel Ore Deposits**(1) | ** ** | ** **                         | ** ** | **Tonnes**(2) | ** ** | **Grade  (% Ni)**(3) | ** ** |
|--------------------------------------|------------|------------------------------------|------------|---------------|------------|---------------------------|------------|
| ** **                           | ** ** | **(tonnes in millions)** | ** ** |
| Sakhara                              |       |                               | 9.8        |          |       |                      | 1.07       | % |   |
| Buruktal                             |       |                               | 70.1       |          |       |                      | 1.03       | % |   |
| Total                                |       |                               | 79.9       |          |       |                      | 1.05       | % |   |

----

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

(2)          Tonnages are reported ona dry basis.

(3)          Metallurgical recoveryis projected to be 70%.

Nickel ore reserves anddeposits were estimated using an assumed nickel price of $6.70 per pound forthe period 2006-2042.****All presentand future operating and capital costs were converted into U.S. dollars usingan exchange rate of 28.3 rubles per U.S. dollar.

***Limestone***

As of January 1,2006, we had limestone reserves (proven and probable) totaling19.2 million tonnes at 55.2% CaO.

| **Limestone Reserves**(1) | ** ** | ** **                         | ** ** | **Tonnes** | ** ** | **Grade  (% CaO)** | ** ** |
|--------------------------------|------------|------------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                     | ** ** | **(tonnes in millions)** | ** ** |
| Pugachev                       |       |                               | 19.2       |       |       |                    | 55.2       | % |   |
|                                |            |                                    |            |            |            |                         |            |  |  |  |  |

----

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

54

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As of January 1,2006, we had limestone deposits totaling 42.8 million tonnes at 55.2% CaO.

| **Limestone Deposits**(1) | ** ** | ** **                         | ** ** | **Tonnes** | ** ** | **Grade  (% CaO)** | ** ** |
|--------------------------------|------------|------------------------------------|------------|------------|------------|-------------------------|------------|
| ** **                     | ** ** | **(tonnes in millions)** | ** ** |
| Pugachev                       |       |                               | 42.8       |       |       |                    | 55.2       | % |   |
|                                |            |                                    |            |            |            |                         |            |  |  |  |  |

----

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

Limestone reserves anddeposits were estimated using an assumed aggregate limestone price of $2.12 pertonne and a flux limestone price of $5.27 per tonne.****Allpresent and future operating and capital costs were converted into U.S. dollarsusing an exchange rate of 28.3 rubles per U.S. dollar.

**Steel Business**

Our steel business comprises production and sale ofsemi-finished steel products, carbon and specialty long products, carbon andstainless flat products, and value-added downstream metal productsincluding hardware, stampings and forgings. Within these product groups, we arefurther able to tailor steel grades to meet specific end-user requirements. Oursteel business is supported by our mining business, which includes coal (steamand coking coal), iron ore, nickel and limestone.

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

| ** **                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                     | ** ** | **(in thousands of tonnes)** | ** ** |
| Coke                                           |       | 2,589                                       |       | 2,942    |       | 2,617    |       |
| Coking Products                                |       | 85                                          |       | 120      |       | 127      |       |
| Pig Iron                                       |       | 3,349                                       |       | 3,880    |       | 3,143    |       |
| Semi-Finished  Steel Products, including:      |       | 1,777                                       |       | 1,623    |       | 994      |       |
| Carbon and Low-Alloyed  Semi-Finished Products |       | 1,755                                       |       | 1,601    |       | 934      |       |
| Long Steel Products,(1) including:        |       | 2,510                                       |       | 2,902    |       | 2,434    |       |
| Stainless Long Products                        |       | 12                                          |       | 18       |       | 14       |       |
| Alloyed Long Products                          |       | 123                                         |       | 139      |       | 113      |       |
| Rebar                                          |       | 1,349                                       |       | 1,229    |       | 1,281    |       |
| Wire-Rod                                       |       | 349                                         |       | 640      |       | 597      |       |
| Low-Alloyed  Engineering Steel                 |       | 676                                         |       | 877      |       | 310      |       |
| Flat Steel Products,  including:               |       | 313                                         |       | 331      |       | 356      |       |
| Stainless Flat Products                        |       | 14                                          |       | 40       |       | 47       |       |
| Carbon and Low-Alloyed  Flat Products          |       | 299                                         |       | 291      |       | 309      |       |
| Forgings, including:                           |       | 79                                          |       | 99       |       | 86       |       |
| Stainless Forgings                             |       | 3                                           |       | 4        |       | 6        |       |
| Alloyed Forgings                               |       | 14                                          |       | 18       |       | 16       |       |
| Carbon and Low-Alloyed  Forgings               |       | 62                                          |       | 76       |       | 63       |       |
| Forged Alloys                                  |       | 1                                           |       | 1        |       | 1        |       |
| Stampings                                      |       | 104                                         |       | 78       |       | 26       |       |
| Hardware,(2) including:                   |       | 558                                         |       | 560      |       | 375      |       |
| Wire                                           |       | 394                                         |       | 395      |       | 276      |       |
| Ropes                                          |       | 55                                          |       | 53       |       | 45       |       |

----

(1)   Includescalibrated rolled products of Mechel Targoviste.

(2)   Excludescalibrated rolled products of Mechel Targoviste.

55

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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 2005, 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.

| ** **                                     | ** ** | **2005**                                                                                     | ** ** | **2004**   | ** ** | **2003**                | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|
| **Revenues**                                   | ** ** | ** **                                                                                   | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** |
| ** **                                     | ** ** | **(in millions of U.S. dollars, except for percentages)** | ** ** |
| Coke                                           |       | 49.2                                                                                         |       |       | 2          | %                       |       | 39.0 |   |   | 1 | % |   | 29.5 |   |   | 2 | % |   |
| Coking Products                                |       | 17.6                                                                                         |       |       | 1          | %                       |       | 18.3 |   |   | 1 | % |   | 15.3 |   |   | 1 | % |   |
| Pig Iron                                       |       | 16.7                                                                                         |       |       | 1          | %                       |       | 37.3 |   |   | 1 | % |   | 15.4 |   |   | 1 | % |   |
| Semi-Finished Products, including:        |       | 465.0                                                                                        |       |       | 17         | %                       |       | 452.9 |   |   | 16 | % |   | 99.5 |   |   | 6 | % |   |
| Carbon and Low-Alloyed Semi-Finished  Products |       | 443.2                                                                                        |       |       | 16         | %                       |       | 445.4 |   |   | 16 | % |   | 98.4 |   |   | 6 | % |   |
| Long Steel Products, including:                |       | 1,311.1                                                                                      |       |       | 48         | %                       |       | 1,302.7 |   |   | 47 | % |   | 750.5 |   |   | 46 | % |   |
| Stainless Long Products                        |       | 44.4                                                                                         |       |       | 2          | %                       |       | 26.3 |   |   | 1 | % |   | 22.2 |   |   | 1 | % |   |
| Alloyed Long Products                          |       | 118.3                                                                                        |       |       | 4          | %                       |       | 89.1 |   |   | 3 | % |   | 43.9 |   |   | 3 | % |   |
| Rebar                                          |       | 616.8                                                                                        |       |       | 23         | %                       |       | 605.5 |   |   | 22 | % |   | 359.2 |   |   | 22 | % |   |
| Wire-Rod                                       |       | 184.6                                                                                        |       |       | 7          | %                       |       | 304.9 |   |   | 11 | % |   | 174.8 |   |   | 11 | % |   |
| Carbon and Low-Alloyed Engineering Steel  |       | 347.0                                                                                        |       |       | 13         | %                       |       | 177.0 |   |   | 6 | % |   | 107.2 |   |   | 7 | % |   |
| Flat Steel Products, including:                |       | 219.5                                                                                        |       |       | 8          | %                       |       | 233.3 |   |   | 8 | % |   | 172.9 |   |   | 11 | % |   |
| Stainless Flat Products                        |       | 45.9                                                                                         |       |       | 2          | %                       |       | 94.3 |   |   | 3 | % |   | 83.2 |   |   | 5 | % |   |
| Carbon and Low-Alloyed Flat   Products         |       | 173.6                                                                                        |       |       | 6          | %                       |       | 139.1 |   |   | 5 | % |   | 89.5 |   |   | 5 | % |   |
| Forgings, including:                           |       | 93.5                                                                                         |       |       | 3          | %                       |       | 71.6 |   |   | 3 | % |   | 67.6 |   |   | 4 | % |   |
| Stainless Forgings                             |       | 11.0                                                                                         |       |       | 0          | %                       |       | 11.2 |   |   | 0 | % |   | 12.8 |   |   | 1 | % |   |
| Alloyed Forgings                               |       | 29.8                                                                                         |       |       | 1          | %                       |       | 19.5 |   |   | 1 | % |   | 15.6 |   |   | 1 | % |   |
| Carbon and Low-Alloyed Forgings                |       | 45.8                                                                                         |       |       | 2          | %                       |       | 28.9 |   |   | 1 | % |   | 28.5 |   |   | 2 | % |   |
| Forged Alloys                                  |       | 6.9                                                                                          |       |       | 0          | %                       |       | 12.0 |   |   | 0 | % |   | 10.7 |   |   | 1 | % |   |
| Stampings                                      |       | 121.8                                                                                        |       |       | 4          | %                       |       | 83.1 |   |   | 3 | % |   | 23.5 |   |   | 1 | % |   |
| Hardware, including:                           |       | 373.8                                                                                        |       |       | 14         | %                       |       | 326.2 |   |   | 12 | % |   | 154.0 |   |   | 10 | % |   |
| Wire                                           |       | 253.9                                                                                        |       |       | 9          | %                       |       | 213.0 |   |   | 8 | % |   | 103.6 |   |   | 6 | % |   |
| Ropes                                          |       | 55.7                                                                                         |       |       | 2          | %                       |       | 52.4 |   |   | 2 | % |   | 27.0 |   |   | 2 | % |   |
| Other                                          |       | 42.3                                                                                         |       |       | 2          | %                       |       | 193.0 |   |   | 7 | % |   | 285.9 |   |   | 18 | % |   |
| Total                                          |       | 2,710.2                                                                                      |       |       | 100        | %                       |       | 2,757.5 |   |   | 100 | % |   | 1,614.1 |   |   | 100 | % |   |
|                                                |            |                                                                                              |            |            |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

56

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The following table setsforth by percentage of sales the regions in which our steel segment productswere sold for the periods indicated.

| **Region**(1) | ** ** | ** ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|
| Russia        |       | 48.0       | %          | 41.3     | %          | 48.0     | %          |
| Other CIS     |       | 5.0        | %          | 2.9      | %          | 0.5      | %          |
| Europe        |       | 29.9       | %          | 36.3     | %          | 28.4     | %          |
| Asia          |       | 8.6        | %          | 15.3     | %          | 18.1     | %          |
| Middle East   |       | 4.7        | %          | 2.3      | %          | 3.3      | %          |
| United States |       | 2.1        | %          | 1.2      | %          | 0.6      | %          |
| Other         |       | 1.7        | %          | 0.6      | %          | 1.0      | %          |

----

(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 2005 and 2004, our steel segment sales outside ofRussia were principally to Europe and Asia. Sales in Europe accounted for 29.9%and 36.3% of our total steel segment sales during these periods, respectively.European sales during these periods were largely to Switzerland (8.0% and10.9%), followed by Romania (7.6% and 7.0%), Germany (3.9% and 6.3%), Spain(2.4% and 2.1%) and Italy (1.9% and 2.4%). Sales to Switzerland primarilyconsisted of sales to Glencore International (see below). Sales in Asia accountedfor 8.6% and 15.3% of our total steel segment sales during these periods,respectively, consisting of Thailand (4.3% and 3.3%), followed by Vietnam (1.5%and 3.0%), and the Philippines (1.2% and 1.2%). Our sales to China were reducedin 2005 (dropping to 0.5% from 4.7%). Middle East sales during these periodsaccounted for 4.7% and 2.3% of our total steel segment sales during 2005 and2004, respectively. The three largest markets were Turkey (2.9% and 0.2%),Syria (0.8% and 0.5%) and United Arab Emirates (0.5% and 0.5%).

In 2005, the five largest customers of our steelsegment products were Glencore International (carbon and low alloyed semifinished products, wire rods, reinforcing bars, carbon and low alloyed flatproducts), Whittingham Company (carbon and low alloyed semi finished products),Chelyabinsk Tube Plant (carbon and low alloyed semi finished products), CMSDubai (carbon and low alloyed engineering steel, carbon and low alloyed semifinished products, wire rod, carbon and low alloyed flat products) and CathayPacific Steel Corporation (carbon and low alloyed semi finished products),which together accounted for 13.8% of our steel segment sales.

Sales of our steel products to Glencore Internationalcomprised 8.0%, 10.9% and 11.8% of our total steel segment sales in 2005, 2004and 2003, respectively, which we record as European sales. GlencoreInternational resells these steel products primarily to customers in the MiddleEast and Asia. In 2005 and 2004, customers in the Middle East accounted for 42%and 63.0%, respectively, of these sales, with most of these sales being toIran, and customers in Asia accounted for 43% and 31.8%, respectively, of thesesales. See “—Marketing and Distribution—Export Sales” below for a furtherdescription of our steel product sales to Glencore International.

57

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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**                 | ** ** | ** **                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| ** **                   | ** ** | **(in millions of U.S. dollars,  except for percentages)** | ** ** |
| Coke                         |       | 49.2                                                                                     |       | 39.0     |       | 29.5     |       |
| Domestic (%)                 |       | 100                                                                                      | %          | 100      | %          | 100      | %          |
| Export (%)                   |       | —                                                                                   |       | —   |       | —   |       |
| Coking Products              |       | 17.6                                                                                     |       | 18.3     |       | 15.3     |       |
| Domestic (%)                 |       | 89                                                                                       | %          | 92       | %          | 100      | %          |
| Export (%)                   |       | 11                                                                                       | %          | 8        | %          | —   |       |
| Pig Iron                     |       | 16.7                                                                                     |       | 37.3     |       | 15.4     |       |
| Domestic (%)                 |       | 11                                                                                       | %          | 29       | %          | 93       | %          |
| Export (%)                   |       | 89                                                                                       | %          | 71       | %          | 7        | %          |
| Semi-Finished Steel Products |       | 465.0                                                                                    |       | 452.9    |       | 99.5     |       |
| Domestic (%)                 |       | 7                                                                                        | %          | 8        | %          | 24       | %          |
| Export (%)                   |       | 93                                                                                       | %          | 92       | %          | 76       | %          |
| Long Steel Products          |       | 1,311.1                                                                                  |       | 1,302.7  |       | 750.5    |       |
| Domestic (%)                 |       | 63                                                                                       | %          | 55       | %          | 61       | %          |
| Export (%)                   |       | 37                                                                                       | %          | 45       | %          | 39       | %          |
| Flat Steel Products          |       | 219.5                                                                                    |       | 233.3    |       | 172.9    |       |
| Domestic (%)                 |       | 57                                                                                       | %          | 56       | %          | 67       | %          |
| Export (%)                   |       | 43                                                                                       | %          | 44       | %          | 33       | %          |
| Forgings                     |       | 93.5                                                                                     |       | 71.6     |       | 67.9     |       |
| Domestic (%)                 |       | 48                                                                                       | %          | 64       | %          | 64       | %          |
| Export (%)                   |       | 52                                                                                       | %          | 36       | %          | 36       | %          |
| Stampings                    |       | 121.8                                                                                    |       | 83.1     |       | 23.5     |       |
| Domestic (%)                 |       | 84                                                                                       | %          | 89       | %          | 94       | %          |
| Export (%)                   |       | 16                                                                                       | %          | 11       | %          | 6        | %          |
| Hardware                     |       | 373.8                                                                                    |       | 326.2    |       | 154.0    |       |
| Domestic (%)                 |       | 72                                                                                       | %          | 67       | %          | 78       | %          |
| Export (%)                   |       | 28                                                                                       | %          | 33       | %          | 22       | %          |
| Other                        |       | 42.3                                                                                     |       | 193.0    |       | 285.9    |       |
| Domestic (%)                 |       | 64                                                                                       | %          | 31       | %          | 25       | %          |
| Export (%)                   |       | 36                                                                                       | %          | 69       | %          | 75       | %          |
| Total                        |       | 2,710.2                                                                                  |       | 2,757.5  |       | 1,614.1  |       |
| Domestic (%)                 |       | 55                                                                                       | %          | 49       | %          | 55       | %          |
| Export (%)                   |       | 45                                                                                       | %          | 51       | %          | 45       | %          |

 

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 in construction(covers, floor plates), the automotive industry (spare parts) and pipemanufacturing and shipbuilding (non-critical applications). Our high-qualityround bars are used in various moving parts manufactured by the automotiveindustry (spare parts, gear boxes), the machinery industry (hydraulic devices,drill bits), the shipbuilding industry (forged parts), the basic materialsindustry (molds, balls for 

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crushing) and otherindustries. Our forgings and stampings are primarily used in the automotive, aerospace,petrochemical, textile and food and 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 in2005.

| **Use by Industry**      | ** ** | ** ** | ** ** | **Metal Works,  Hardware  Plants** | ** ** | **Pipe  Factories** | ** ** | **Construction** | ** ** | **Engineering** | ** ** | **Railway  Construction,  Repair** | ** ** | **Power  Generation** | ** ** | **Other  Industries**(1) | ** ** |
|------------------------------------|------------|------------|------------|-----------------------------------------|------------|---------------------|------------|------------------|------------|-----------------|------------|------------------------------------|------------|-----------------------|------------|--------------------------|------------|
| Semi-Finished  Steel Products |       |       | 34         | %                                       |       |                | 1          | %                |       |            | 9          | %                                  |       |                  | 41         | %                        |       |   | 2 | % |   |   | 0 | % |   |   | 13 | % |   |
| Long Steel  Products               |       |       | 4          | %                                       |       |                | 2          | %                |       |            | 63         | %                                  |       |                  | 22         | %                        |       |   | 1 | % |   |   | 0 | % |   |   | 8 | % |   |
| Flat Steel  Products               |       |       | 2          | %                                       |       |                | 2          | %                |       |            | 3          | %                                  |       |                  | 47         | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 46 | % |   |
| Forgings                           |       |       | 9          | %                                       |       |                | 11         | %                |       |            | 1          | %                                  |       |                  | 49         | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 31 | % |   |
| Stampings                          |       |       | 0          | %                                       |       |                | 0          | %                |       |            | 0          | %                                  |       |                  | 58         | %                        |       |   | 0 | % |   |   | 0 | % |   |   | 42 | % |   |
| Hardware                           |       |       | 21         | %                                       |       |                | 0          | %                |       |            | 18         | %                                  |       |                  | 43         | %                        |       |   | 3 | % |   |   | 2 | % |   |   | 12 | % |   |

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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. MechelInternational Holdings, our wholly owned subsidiary based in Zug, Switzerland,coordinates export sales of our steel products through its branch in Schaan,Liechtenstein. It also operates representative offices in each of our coreinternational markets.

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 March 2006, we established Mechel HardwareOOO, 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 Chelyabinsk, Chebarkul, Beloretsk and Izhevsk; and Mechel-Servicehas eight branches in Chelyabinsk, Rostov, Ufa, Kazan, Samara, Ekaterinburg,Moscow and St. Petersburg. These branches develop and service our long-standingcustomer relationships by virtue of their proximity to both production andcustomers and thereby allow our local sales forces to provide highlyspecialized and technical sales and service support to our Russian customers.

We also operate warehouses in Rostov-Don and near ourproduction facilities in Chelyabinsk, Ufa, Mezhdurechensk, Moscow, St.Petersburg and Ekaterinburg, where we sell our steel products to wholesalers ona walk-in basis. Additionally, Mechel-Service has two warehouses in Moscow,which are well placed to service the growing Moscow construction market. Werealize higher margins on these sales compared to our other sales, and weintend to open such warehouses in other large Russian metropolitan areas in thefuture. Through these sales, we also identify potential new end-user customersof our products and market our production capabilities and products directly tothem.

Mechel Trading House hasapproximately 310 employees. Mechel-Service has approximately 199 employees.Mechel Hardware has approximately 17 employees.

***Export sales***

Mostof our international steel sales are made to independent distributors, whichthen sell our products in smaller quantities to end users. We have salesoffices in the following eight countries:

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

 

We also work with agents in 15 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 2005, 2004, and 2003, we sold $217.3million, $299.5 million and $189.9 million in steel products toGlencore International, respectively, comprising 8.0%, 10.9% and 11.8% of ourtotal steel segment sales, respectively, during these periods. Starting in November 2004,steel sales to Glencore International were made pursuant to a frameworkcontract providing for the sale of a minimum of 180,000 tonnes of commoditycarbon steel products per quarter at market-based prices. This frameworkcontract extends through December 2007. The products purchased by GlencoreInternational consist of wire rod, rebar, billets, hot-rolled sheet and coil,which are then resold by Glencore International abroad, principally topurchasers in Asia and the Middle East.

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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 have approximately 66 employees.

***Distribution***

Rail transportation is used for nearly all shipmentsfrom our production facilities and warehouses to our end customers, wholesalewarehouses or sea ports. Deliveries from warehouses and ports to customers ispartially done by truck.

In April 2005, weacquired Port Kambarka, a river port located in Kama in the Republic ofUdmurtia. We ship primarily steel produced at Izhstal from this port.

**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 five largest integrated steel producers, including us, accounting for 82%of overall domestic steel output in 2005.

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

·       *EvrazHolding*, which consists of NizhnyTagil Metallurgical Plant, Zapadno-Sibirsky Metallurgical Plant (ZapSib),and Kuznetsky Metallurgical Plant, is effectively the largest producer inRussia on a consolidated basis, accounting for 21% of Russia’s total rolled products output (includingproduction of long and flat products, semi-finished products, forgings andstampings) in 2005. Like us, EvrazHolding focuses on the production of longproducts including rebars, wire rods and profiled rolled products (such asrails, beams and channels). EvrazHolding also controls iron ore producersKachkanarsky GOK and Vysokogorsky GOK and coking coal producer Yuzhkuzbassugol,and has an equity investment in Raspaskaya Mine, which produces coking coal.

·       *Severstal* had a 19% market share of Russian rolled steel production in 2005. Thecompany specializes in flat products which constitute a significant part of itsproduction. In addition, Severstal is the second-leading producer of flat productsand controls 19% of Russia’s totalproduction output. Domestic sales accounted for 53% of Severstal’s output in 2005, with the oil and gas industryand automotive sector as its leading customers. Severstal also controls UAZ, adomestic off-road car-maker, Vorkuta-Ugol and Kuzbassugol, which completelysatisfy Severstal’s coking coal requirements, and iron ore producers KarelskyOkatysh and Olenegorsky GOK.

·       *MMK* accounted for 19% of Russian rolled steel production in 2005. MMK’s product mixis comprised mostly of flat products, representing 90% of its commercial steel products output (including productionof slabs). Domestically, MMK controls a significant portion of the supplies tothe oil and gas and automotive sectors. MMK exported 51% of its output in 2005 and also produces its own iron ore. Itsproduction facilities are located in Magnitogorsk in the southern Urals.

·       *NLMK* had a 15% market share of Russian rolled steel production in 2005. Thecompany produces primarily flat products (hot-rolled and cold-rolled),including galvanized products. NLMK exported 68%of its products in 2005. Domestically, NLMK’s largest customers are in theconstruction and oil and gas industries, followed by companies in theautomotive sector. NLMK also controls iron ore 

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producer Stoilensky GOK.The company’s steel facilities are located in Lipetsk, to the southeast ofMoscow.

These five companies, including us, can be dividedinto two groups by product type. MMK, Severstal and NLMK focus mainly on flatproducts, while EvrazHolding and we produce primarily long products. Accordingto Metall-Expert, we are the leading and most comprehensive producer ofspecialty steel and alloys in Russia, and controlled 38% of total Russianspecialty steel output in 2005. We are also the second largest producer of longproducts in Russia after EvrazHolding, with significant market shares in bothcarbon 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 2005, the rebar market was dominated byMechel (35%) and EvrazHolding (44%)(excluding imported rebars from theCIS). At present, the Russian domestic market for rebar is protected fromUkrainian imports by a 21% import tariff, introduced in August 2002 forthree years.

·       *Wire rod*—There were five major producersof wire rod in Russia in 2005: Mechel (25%),EvrazHolding (35%), Severstal (20%), Nizhneserginsky MZ (10%) and MMK (9%). We produce some of the highest qualityand widest ranges of wire rod (5-10 millimeters) among Russian producers.

We were the second-leading producer in Russia ofspecialty steel long products (bearing, tool, high-speed and stainless steel)in 2005, producing 35% of the total Russian output. Our three nearestcompetitors in this market had the following market shares: OEMK (41%), ZMK(9%) and Electrostal (6%). We had significant market shares in stainless longproducts (39%), tool steel (33%) and high-speed steel (77%) in 2005.

OEMK, an integrated steel mill specializing in longcarbon and specialty steel products and our nearest specialty steel competitor,is located in the southwest of Russia and serves customers in the pipe,engineering and ball-bearing industries. Other Russian specialty steel producers,like Electrostal, lag significantly behind us in terms of overall specialtysteel production, according to Metall-Expert.

We were also the second largest producer of carbon andalloyed engineering long steel products in Russia with a 22% market share in2005, followed by OEMK (16%). Our other main competitors in this market wereZlatoustovsky MK (12%), Serov Metallurgical Plant (10%) and EvrazHolding (8%).In 2005, we were the leader in the production of nickel-containingengineering steel (30%), where we were ahead of our nearest competitors,Zlatoustovsky MK (19%), Red October Metallurgical Plant (13%) and OEMK(10%), according to Metall-Expert.

We were also Russia’s largest producer of stainlessflat products, with an 85% share of domestic production in 2005, according toChermet.

We were the second largestproducer of hardware in Russia in 2005 with a 19% market share, followingSeverstal (32%) and followed by MMK (18%). For products in which we specialize,however, our share was substantially higher. For example, we had a 60% share ofthe spring wire market and a 50% share of the high-endurance wire market during2005.

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**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 100% self-sufficient in our requirements of coking coal, withSouthern Kuzbass Coal Company having supplied 2.8 million tonnes of cokingcoal concentrate to Chelyabinsk Metallurgical Plant in 2005. 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 2005, weproduced and internally used 2.3 million tonnes of coke in our productionfacilities and produced and sold another 0.3 million tonnes of coke tothird parties. Our internal steam coal requirements are not material.

Our steel-making operations use iron ore in theform of pellets, sinter, concentrate and sinter ore. The ultimate form of theiron ore feed into the steel making process, however, consists of pellets andsinter only. In 2005, our steel-making operations used 5.3 milliontonnes of iron ore feed, approximately 56% in the form of pellets and 48% inthe form of sinter, and we internally sourced 55% of our total iron ore feedrequirements during this period. We are capable of internally sourcing 97% ofthe iron ore requirements of our steel segment, assuming that third partiesprocess certain quantities of our iron ore into concentrate and then intopellets and sinter. Our Korshunov Mining Plant supplied us with 1.6 milliontonnes of iron ore concentrate in 2005, which accounted for 100% of our totaliron ore concentrate needs in this period. Iron ore concentrate is convertedinto sinter at Chelyabinsk Metallurgical Plant. We purchase most of theremaining part of our iron ore feed, mainly in the form of pellets, fromRussian domestic suppliers such as Mikhailovsky GOK, Kostomukshinsky GOK,Lebedinsky GOK and Karelsky Okatysh, as well as Sokolovsko-SorbayskoyeMining Amalgamation in Kazakhstan, under annual contracts on market terms.

In 2005, we used approximately 3,332 tonnes of nickelin the production of stainless and other specialty steels. We sourcedapproximately 49% of our nickel requirements in 2005 from our nickel mining andsmelting operations at Southern Urals Nickel Plant. We source other nickelgrades from Norilsk Nickel, Ufaleinikel and other smaller nickel producers.

Our steel making technology is primarily based on thebasic oxygen furnaces, accounting for over half of our raw steel production.Ferrous scrap represents approximately 38.4% of feedstock, and we areapproximately 40.2% self-sufficient in this raw material, sourcing the balancefrom various scrap traders. Electric arc furnaces are the primary method ofsteel-making at Mechel Targoviste and Mechel Campia Turzii, our Romanianfacilities.

In March 2006, we acquired Mechel Recycling, aChelyabinsk-based metal scrap processing company, in line with our policy ofensuring the steel segment’s self sufficiency in raw materials.

We internally source all of our limestone requirementsfrom our Pugachev quarry. In 2005, we used approximately 1.1 milliontonnes of limestone in the production of steel.

Steel making requires significant amounts ofelectricity to power electric arc furnaces and rolling mills and to convertcoal to coke. In 2005, our operations consumed approximately 6.4 billionkWh of electricity, of which 2.4 billion kWh was used at ChelyabinskMetallurgical Plant, 3.2 billion kWh was used at other Russian facilitiesand 0.8 billion kWh was used at our Eastern European plants. ChelyabinskMetallurgical Plant and Urals Stamping Plant have cogeneration powerfacilities, which produced 1.7 billion kWh of electricity for internalconsumption in 2005, yielding 67% self-sufficiency at these plants and 28%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 2005, we consumed 5.3 billion cubic meters of blast furnace gas,1.1 billion cubic meters of coke gas and 2.5 billion cubic meters ofnatural gas.

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Large amounts of water are also required in theproduction of steel. Water is used to cool the steel, to carry away waste, tohelp produce and distribute heat and power and to dilute liquids. One of theprincipal sources of water is rivers, and many of our facilities recirculate aportion of water used for their production needs. For example, ChelyabinskMetallurgical Plant sources 53% of its water needs from a local river and therest from recycled water. Vyartsilya Metal Products Plant sources 85% of itswater needs from a local river and the rest from recycled water. UralsStampings Plant obtains 95% of its water from the public water supplies and itsown wells. Southern Urals Nickel Plant sources 77% of its water needs throughrecycling and the rest from a local river. Mechel Targoviste sources 95% of itsproduction water needs through recycling and the rest is sourced from a localriver.

Transportation costs are a significant component ofour production costs and a factor in our price-competitiveness in theexport markets. Rail transportation is our principal means of transporting rawmaterials from our mines to processing facilities and products to domesticcustomers and to ports for shipment overseas. For a description of our railwayfreight and forwarding subsidiary, see “—Steel Business—Marketing andDistribution—Distribution” above.

For adescription of how seasonal factors impact our use and reserve levels of rawmaterials see “—Seasonality” below.

**Steel productionfacilities**

We generally own, lease or have a right of perpetualuse of the properties on which our steel production facilities are located.Most of the land on which Chelyabinsk Metallurgical Plant, BeloretskMetallurgical Plant and Izhstal are located is used pursuant to a right ofperpetual use. The land on which Vyartsilya Metal Products Plant, UralsStampings Plant and Mechel Nemunas are located is leased. The land on whichMechel 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 2006. Wire-drawing workshop No. 3 ofMechel Campia Turzii is ISO 14001 certified through 2008.

***Chelyabinsk Metallurgical Plant***

Our raw steel production in Russia takes place atChelyabinsk Metallurgical Plant. Chelyabinsk Metallurgical Plant is anintegrated blast furnace and BOF/EAF steel mill that produces coke, semi-finishedsteel products, carbon and specialty steel products and forgings. Its customerbase is largely comprised of steel producers and tube manufacturers, andcustomers from the construction, engineering and ball-bearing industries. Theplant sources all of its coking coal needs from our Southern Kuzbass CoalCompany and most of its iron ore needs from our Korshunov Mining Plant and amajority of its nickel needs from our Southern Urals Nickel Plant,respectively.

ChelyabinskMetallurgical Plant’s principal production lines include a BOF workshopequipped with three converters; three EAF workshops equipped with electric arcovens, including two large ovens of 100 and 125 tonnes, respectively; vacuuminduction and plasmic furnaces; vacuum arc and electroslag remelting furnaces;three comprehensive steel treatment machines; an argon-oxygen refiningmachine; three continuous billet-casters; blooming with continuousrolling 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; and a forging and pressing workshop equipped withfive presses and forging 

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machines of 1,250-2,000 tonnes, as well as sevencoking batteries, five sintering machines and three blast furnaces. Thefollowing table sets forth the capacity, the capacity utilization rate and theplanned increase in capacity for each of Chelyabinsk Metallurgical Plant’sprincipal production areas.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Sintering                 |       | 3,040,000                                                  |       |                       | 86.0       | %                                                 |       |                               | 2,060,000  |   |   |
| Pig Iron                  |       | 3,395,000                                                  |       |                       | 98.6       | %                                                 |       |                               | —     |   |   |
| Steel-making              |       | 5,100,000                                                  |       |                       | 90.1       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 4130,000                                                   |       |                       | 92.6       | %                                                 |       |                               | —     |   |   |
| Forging and  pressing     |       | 73,000                                                     |       |                       | 90.4       | %                                                 |       |                               | —     |   |   |
| Coking                    |       | 3,100,000                                                  |       |                       | 83.5       | %                                                 |       |                               | —     |   |   |

 

***In 2005 we commissioned the first part ofa new sinter plant at Chelyabinsk Metallurgical Plant. Currently two of fourlines are operational, providing a total capacity of 2.25 million tonnesper annum. The third and fourth lines are expected to be operational by the endof 2006, bringing the total capacity of the sinter plant to 4.5 milliontonnes 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 six EAF of 25 to 28 tonnes each; 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 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Steel-making              |       | 700,000                                                    |       |                       | 85.1       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 1,000,000                                                  |       |                       | 38.1       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 98,000                                                     |       |                       | 39.3       | %                                                 |       |                               | —     |   |   |
| Forging and stamping      |       | 60,000                                                     |       |                       | 28.3       | %                                                 |       |                               | —     |   |   |

 

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 and nickelthat resulted in increase of Izhstal steel-making and rolling capacityutilization from 71% and 36% in 2004 to 85% and 38% in 2005. Hardware andforging and stamping low capacity utilization rates are explained by low demandon these products on Russian market.

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***Beloretsk Metallurgical 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 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Rolling                   |       | 553,000                                                    |       |                       | 98.3       | %                                                 |       |                               | 37,000     |   |   |
| Hardware                  |       | 323,000                                                    |       |                       | 105.4      | %                                                 |       |                               | —     |   |   |

 

***Vyartsilya Metal Products 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 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Hardware                  |       |                                                       | 68,000     |                       |       |                                              | 79.7       | %                                  |       |   | — |   |   |
|                           |            |                                                            |            |                            |            |                                                   |            |                                    |            |  |  |  |  |  |  |

 

***Urals Stampings Plant***

UralsStampings Plant is Russia’s largest producer of stampings from specialty steelsand heat-proof and titanium alloys for the aerospace, oil and gas, heavyengineering, railway transportation, power and other industries. UralsStampings Plant sources its specialty steel needs from ChelyabinskMetallurgical Plant. Urals Stampings Plant’s principal production facilitiesinclude 1.5-25 tonne swages, hydraulic presses and inker machines. Thefollowing table sets forth the capacity, the capacity utilization rate and theplanned increase in capacity for Urals Stampings Plant’s principal productionarea.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Stamping                  |       | 100,000                                                    |       |                       | 86.5       | %                                                 |       |                               | 25,000     |   |   |
|                           |            |                                                            |            |                            |            |                                                   |            |                                    |            |  |  |  |  |

 

***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 (including rebars)and hardware in Romania and the second largest producer of raw steel inRomania, according to Siderom. The plant’s customers are largely from theengineering, automotive, tool, ball-bearing, tube, hardware and constructionindustries.

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MechelTargoviste’s principal production lines include an EAF workshop equipped withtwo electric arc ovens of 75 tonne capacity each; steel vacuum processing and treatmentmachines; 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 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Steel-making              |       | 527,000                                                    |       |                       | 83.8       | %                                                 |       |                               | 20,000     |   |   |
| Forging and  pressing     |       | 37,400                                                     |       |                       | 41.1       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 780,000                                                    |       |                       | 42.8       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 67,000                                                     |       |                       | 29.3       | %                                                 |       |                               | —     |   |   |

 

Mechel Targovisteexperienced low capacity utilization rates due to high production costs anduncompetitive product quality. In September-October 2005, as part of arestructuring of the production process and lowering of production costs at theMechel Targoviste plant, an EAF workshop as well as the forging and pressingworkshops were discontinued.

***Mechel Campia Turzii***

Mechel Campia Turzii is a Romanian EAF steel mill anda leading domestic hardware plant that produces long steel products, includingcarbon and alloyed wire rod, rebar and hardware, including various types ofwire, ropes, nets, electric cables and nails, as well as carbon and low-alloyedbillets. The plant’s customers are largely from the construction andengineering 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 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Steel-making              |       | 363,000                                                    |       |                       | 75.7       | %                                                 |       |                               | —     |   |   |
| Rolling                   |       | 330,000                                                    |       |                       | 42.2       | %                                                 |       |                               | —     |   |   |
| Hardware                  |       | 100,000                                                    |       |                       | 80.0       | %                                                 |       |                               | —     |   |   |

 

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 January-February 2006, as part of arestructuring of the production process at the Mechel Campia Turzii, one EAFsteel-making workshop 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 

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capacity utilization rate and the planned increase incapacity for Mechel Nemunas’s principal production area.

| **Production Areas** | ** ** | ** **                                                 | ** ** | **Capacity  in 2005** | ** ** | **Capacity  Utilization  Rate in 2005** | ** ** | **Planned  Increase  (2006-2008)** | ** ** |
|---------------------------|------------|------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------------|------------|------------------------------------|------------|
| ** **                | ** ** | **(in tonnes except for percentages)** | ** ** |
| Hardware                  |       |                                                       | 90,300     |                       |       |                                              | 72,5       | %                                  |       |   | — |   |   |
|                           |            |                                                            |            |                            |            |                                                   |            |                                    |            |  |  |  |  |  |  |

 

**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 2005, approximately 81%of our steel segment revenues were derived from sales of steel products thatwere subject to import restrictions. We describe below the main applicabletrade restrictions in our key markets.

***European Union***

Our steel sales to the EU constituted approximately13.0% of our total steel segment revenues in 2005. The Russian government andthe European Community have an export quota system in place whereby Russianexports to the EU are limited to certain stipulated quantities for each productcategory until the end of 2006. The quota by product category is distributedbetween the Russian producers based on a procedure jointly developed by theMinistry of Economic Development and Trade of the Russian Federation and theMinistry of Industry and Energy of the Russian Federation. The procedureprovides that for each product category, a company’s export quota allocation iscalculated on the basis of shipments by the company of the particular productover the past three years to the EU market (which is given a 70% weighting),and on the company’s market share in domestic production of the particularproduct (which is given a 30% weighting). After the quotas are calculated, theRussian Ministry of Industry and Energy then confirms quota allocations, andthe Russian Ministry of Economic Development and Trade issues export licensesfor these quotas. In 2005, the quota covered approximately 12.8% of our steelsegment products exported to the EU.

In 2005, the total EU quota for Russian steel was2,041,210 tonnes, and we received 187,354 tonnes of the total quota. As quotasare granted by product category, usage of our individual quotas varied. Forexample, usage of our 2005 quota for long products other than rebar and wirerod was 92%, while usage for our wire rod quota was 79%. The EU-Russia SteelAgreement for 2006 provides for the total Russian quota to be 2,527,878 tonnes.Our quota is set at 196,813 tonnes, which includes 15,795 tonnes for flatproducts and 181,018 tonnes for long products. Our supply of wire rod to MechelNemunas, our hardware plant in Lithuania, is also subject to the EU exportquota system, and our quota for that plant is 61,500 tonnes for 2006. See “Item3. 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% is applicable for export to the EU of steel ropes and cables manufacturedby our Beloretsk Metallurgical Plant until August 2006. We expect thisanti-dumping duty to be extended for the next five years, but at a lower rate.There are no restrictions on the export of our Romanian products to the EU.

Finally, an anti-dumpinginvestigation against imports of steel wire ropes originating in Russia wasinitiated in Ukraine  in January 2006.During 2005, our Beloretsk Metallurgical Plant supplied 

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2,389 tonnesof wire ropes to Ukraine. We are presently unable to assess what impact thisinvestigation could have on our sales to Ukraine.

***China***

China’s position completelyreversed in 2005, with the country going from being a net importer of steelproducts in 2004 to being a net exporter of steel products in 2005. This changeled to the discontinuance of all of our sales to China in 2005. In order tocompensate, we sold additional cargo to neighboring countries as well as to theMiddle East. Additionally, China’s entrance into the export market (and thediscontinuance of much of its importing) led to a decrease in world marketprices for steel products because of the resulting glut of steel products beingsold on the market. In January 2006, the market consolidated in China,which resulted in Chinese mills reducing their output. This put upward pressureon prices in the Chinese market, which had fallen too fast and too far and werestarting to cause Chinese mills to suffer losses. It also became apparent thatthe price of iron ore would likely rise rather than fall, which would putadditional pressure on Chinese mills’ profitability. These developments causedthe Chinese mills to almost simultaneously and overnight stop supplying cargoto the export market. By the end of February, steel consumers realized thatthere would soon be a shortage of material in the market, which caused worldmarket prices for steel products to rise by approximately 10%. Currently, weforesee a continued strengthening of the market, but it is ultimately up to theChinese mills and how they engage the world market moving forward.

***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 $1.1 billion for our capitalexpenditures program for the five-year period of 2006 – 2010. It is targeted atexpansion of the mining segment and increasing the efficiency of the steelsegment. The split is approximately $750 million in mining and approximately$350 million in steel.

In the mining segment, in line with its target toproduce 25 million tonnes of coal in 2010, we will direct approximately $130million 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 areas of approximatelyone billion tonnes of predominantly coking coal. Other major mining projectsare also aimed at improving quality, and include the construction ofSibirginskaya coal washing plant for approximately $50 million. In the iron orebusiness, we will invest approximately $70 million in Korshunov Mining 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. Thisincludes completion of the construction of an additional continuous caster forapproximately $50 million, in line with our target to raise the proportion ofsteel produced through continuous casting from the current 38% to 60% in 2007.Other projects include a new coking battery and reconstruction of rollingfacilities.

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The following table sets out by segment and facilitythe major items of our capital expenditures currently in progress or expectedto be commenced in 2006.

| **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**                   |       |                                                                                                                                                                                                                                                                                                                                            |       |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| Expansion of  Sibirginsk Open Pit Mine              |       | Increase in coking  coal output by 1.5 million tonnes per annum                                                                                                                                                                                                                                                                                 |       |                                                                             | $          | 61.8                                  |       |                             |       | 2006                                                        |       |   |   | 2010 |   |   |
| Construction of  Sibirginsk Mine                    |       | Increase of coal  output from 1.5 million tonnes to 3 million tonnes per annum                                                                                                                                                                                                                                                                  |       |                                                                             | $          | 85.2                                  |       |                             |       | 2006                                                        |       |   |   | 2010 |   |   |
| Construction of  Sibirginsk Washing plant      |       | Increase of coal  washing capacity by 4.0 million tonnes per annum                                                                                                                                                                                                                                                                              |       |                                                                             | $          | 50.0                                  |       |                             |       | 2008                                                        |       |   |   | 2009 |   |   |
| Construction of  New Olzherassky Mine               |       | Increase in coking  coal output by 3 million tonnes per annum                                                                                                                                                                                                                                                                                   |       |                                                                             | $          | 103.5                                 |       |                             |       | 2004                                                        |       |   |   | 2010 |   |   |
| Construction of  Erunakovskaya-1 Mine          |       | Increase in coal  extraction by 1.5 million tonnes per annum                                                                                                                                                                                                                                                                                    |       |                                                                             | $          | 129.4                                 |       |                             |       | 2006                                                        |       |   |   | 2010 |   |   |
| **Korshunov Mining Plant**                          |       |                                                                                                                                                                                                                                                                                                                                            |       |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| Expansion of  Concentrate Production Facilities     |       | Development of new deposit with iron ore reserves of 53.5 million tonnes per  annum                                                                                                                                                                                                                                                             |       |                                                                             | $          | 70.0                                  |       |                             |       | 2006                                                        |       |   |   | 2010 |   |   |
| **STEEL BUSINESS**                                  |       |                                                                                                                                                                                                                                                                                                                                            |       |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| **Chelyabinsk Metallurgical Plant**                 |       |                                                                                                                                                                                                                                                                                                                                            |       |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| Construction of  Sinter Plant # 2                   |       | Increase in sinter  production capacity by 4.5 million tonnes per annum                                                                                                                                                                                                                                                                    |       |                                                                             | $          | 213.6                                 |       |                             |       | 2003                                                        |       |   |   | 2006 |   |   |
| Reconstruction of  Coking Battery #7           |       | Modernization and increase  in output by approximately 500,000 tonnes per annum of coke and 15,000 tonnes  per annum of coking products                                                                                                                                                                                                         |       |                                                                             | $          | 41.8                                  |       |                             |       | 2004                                                        |       |   |   | 2006 |   |   |
| Construction of  Long Products continuous Caster #4 |       | Increase in output of continuously cast billets by 1.2 million tonnes per annum  Reduction in steel usage  Reduction in power usage  New product development                                                                                                                                                                                    |       |                                                                             | $          | 75.4                                  |       |                             |       | 2004                                                        |       |   |   | 2006 |   |   |
| **Beloretsk Metallurgical Plant**                   |       |                                                                                                                                                                                                                                                                                                                                            |       |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| Modernization of  hardware equipment                |       | Modernization and increase  in production of copper-plated welding wire by 7,500 tonnes p.a.  Modernization and increase in production of spring wire by 8,600 tonnes p.a.  Produce new value-added features  Environmental improvements                                                                                                        |       |                                                                             | $          | 24.7                                  |       |                             |       | 2006                                                        |       |   |   | 2006/2010 |   |   |
| Modernization of  Continuous Wire Mill 150     |       | Modernization and increase in wire-rod capacity by 85,000 tonnes p.a.  Reduction in steel usage  Reduction in gas usage  Product quality improvement                                                                                                                                                                                            |       |                                                                             | $          | 17.9                                  |       |                             |       | 2006                                                        |       |   |   | 2007 |   |   |
| **Mechel Targoviste**                               | ** ** | ** **                                                                                                                                                                                                                                                                                                                                      | ** ** |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| Reconstruction of  rolling mill No. 380        |       | Increase of  rolling capacity to 350,000 tonnes p.a., better trimming quality                                                                                                                                                                                                                                                                   |       |                                                                             | $          | 35.0                                  |       |                             |       | 2006                                                        |       |   |   | 2009 |   |   |
| **Mechel Campia Turzii**                            |       |                                                                                                                                                                                                                                                                                                                                            |       |                                                                             |       |                                  |       |                             |       |                                                        |       |   |   |   |   |
| Modernization of  Hardware Production               |       | New products (low-alloyed  wire) output of 48,500 tonnes per annum  Modernization and increase of annealed and zinc-coated wire production  by 8,000 tonnes per annum Modernization and increase of nail production by  8,000 tonnes per annum Production of 8,000 tonnes per annum of wire-rod  Production of 50,000 tonnes per annum of rebar |       |                                                                             | $          | 14.3                                  |       |                             |       | 2006                                                        |       |   |   | 2006/2009 |   |   |
| Environmental Protection                            |       | Reduction of pollution                                                                                                                                                                                                                                                                                                                          |       |                                                                             | $          | 7.0                                   |       |                             |       | 2006                                                        |       |   |   | 2006/2009 |   |   |

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*                     We estimate that approximately$261.3 million of planned expenditures for these projects have been madeas of December 31, 2005. In 2005, we spent $520.6 million for capitalexpenditures.

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**Operations Improvements**

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 employeda total of 14 researchers. We also contract with third-party consultantsfrom the metallurgical industry and major Russian research institutions toproduce development concepts and conduct feasibility studies.

In addition to these activitiesperformed at our corporate level, each of Chelyabinsk Metallurgical Plant,Beloretsk Metallurgical Plant and Izhstal have specialized research divisionswith a total of 201 researchers involved in the improvement of existingtechnologies and products.

Our operations are notmaterially dependent on patents.

**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 hydrotechnical installationsand auto insurance. Sometimes our Russian subsidiaries insure real estateinterest and cargo, but it is not done in all instances and for all significantassets. Mechel Metal Supply maintains comprehensive insurance, includingmarine, liability, including products liability, and trade indemnity. MechelCampia Turzii maintains insurance that covers its employees, property, plantand equipment.

**Regulatory Matters**

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

**Licensing of Operations**

We arerequired to obtain numerous licenses, authorizations and permits from Russiangovernmental authorities for our operations. The Federal Law on Licensing ofCertain Types of Activities of August 8, 2001, as amended, as well as otherlaws and regulations, set forth the activities subject to licensing andestablish procedures for issuing licenses. In particular, some of our companiesneed to obtain licenses and 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;

·       firecontrol and security;

·       medicaloperations; and

·       transportationactivities.

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These licenses are usually issued for a period of fiveyears and may be extended upon application by the licensee. Licenses for theuse of natural resources may be issued for shorter or longer periods. Upon theexpiration of a license, it may be extended upon application by the licensee.

Regulatory authorities maintain considerablediscretion in the timing of issuing licenses and permits. The requirementsimposed by these authorities may be costly, time-consuming and may result indelays in the commencement or continuation of exploration or productionoperations. Further, private individuals and the public at large possess rightsto comment on and otherwise participate in the licensing process, includingthrough challenges in the courts. Accordingly, the licenses we need may not beissued, or if issued, may not be issued in a timely fashion, or may imposerequirements which restrict our ability to conduct our operations or to do soprofitably.

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 minerals requires a subsoil licensefrom the state authorities with respect to an identified mineral deposit, aswell as the right (through ownership, lease or other right) to use the landwhere such licensed mineral deposit is located. In addition, as discussedabove, operating permits are required with respect to specific miningactivities.

The primary law regulating subsoil licensing is theLaw on Subsoil Resources of February 21, 1992, as amended, or the SubsoilLaw, which sets out the regime for granting licenses for the exploration andproduction of mineral resources. The Procedure for Subsoil Use Licensing, orthe Licensing Regulation, adopted by Resolution of the Supreme Soviet of theRussian Federation on July 15, 1992, as amended, also regulates theexploration and production of mineral resources. According to both the SubsoilLaw and the Licensing Regulation, subsurface mineral resources are subject tothe joint jurisdiction of the federal and regional authorities.

There are two major types of licenses: (1) anexploration license, which is a non-exclusive license granting the right ofgeological exploration and assessment within the license area, and (2) aproduction license, which grants the licensee an exclusive right to produceminerals from the license area. In practice, many of the licenses are issued ascombined licenses, which grant the right to explore, assess and produceminerals from the license area. A subsoil license defines the license area interms of latitude, longitude and depth.

There are two major types of payments with respect tothe extraction of minerals: (1) periodic payments for the use of subsoilunder the Subsoil Law and (2) the minerals extraction tax under the TaxCode. Failure to make these payments could result in the suspension ortermination of the subsoil license. The Subsoil Law-mandated payments are notmaterial to our mining segment’s results of operations. The minerals extractiontax is calculated as a percentage of the value of minerals extracted. Currentlythe tax rates are 4% for coal, 4.8% for iron ore and 8% for nickel. In 2005, weincurred the minerals extraction tax in the amount of $17.5 million.

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 aparticular field is terminated early, a production 

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licensemay have a one-year term until a new licensee is determined, but is generallygranted for the term of the expected operational life of the field based on afeasibility study; and combined exploration, assessment and production licensescan be issued for the term of the expected operational life of the field basedon a feasibility study. These amendments did not affect the terms of licensesissued prior to January 2000, but permit licensees to apply for extensionsof such licenses for the term of the expected operational life of the field inaccordance with the amended Subsoil Law. The term of a subsoil license runsfrom the date the license is registered with the Russian Federal GeologicalFund.

***Issuance of licenses***

Subsoil licenses aregenerally issued by the Federal Agency for Subsoil Use. Most of the currentlyexisting production licenses owned by companies derive from(1) pre-existing rights granted during the Soviet era and up to theenactment of the Subsoil Law to state-owned enterprises that weresubsequently reorganized in the course of post-Soviet privatizations; or(2) tender or auction procedures held in the post-Soviet period. TheRussian Civil Code, the Subsoil Law and the Licensing Regulation contain themajor requirements relating to tenders and auctions. The Subsoil Law allows forproduction licenses to be issued without a tender or auction procedure only inlimited circumstances, such as instances when a mineral deposit is discoveredby the holder of an exploration license at its own expense during the explorationphase.

***Extension of licenses***

The Subsoil Law permits a subsoil licensee to requestan extension of a production license in order to complete the production fromthe subsoil plot covered by the license or the procedures necessary to vacatethe land once the use of the subsoil is complete, provided the user complieswith the terms and conditions of the license and the relevant regulations.

In order to extend a subsoil license, a company mustfile an application with the federal authorities to amend the license.

The Order of the Ministry of Natural ResourcesNo. 439-R, dated October 31, 2002, requires that the followingissues be considered by the relevant governmental authorities when determiningwhether to approve an amendment: (1) the grounds for the amendments, withspecific information as to how the amendments may impact payments by thelicensee to the federal and local budgets; (2) compliance of the licenseewith the conditions of the license; and (3) the technical expertise andfinancial capabilities that would be required to implement the conditions ofthe 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 suspended or terminated, we would be unable to realizeour reserves, which could materially adversely affect our business and resultsof operations” and “—Item 3. Key Information—Risk Factors—Risks Relating to theRussian Federation—Legal Risks and Uncertainties—Weaknesses relating to theRussian legal system and Russian legislation create an uncertain environmentfor investment and business activity.”

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***Maintenance and termination of licenses***

A license granted under the Subsoil Law is generallyaccompanied by a licensing agreement. The law provides that there be twoparties to any subsoil licensing agreement: the federal authorities and thelicensee. The licensing agreement sets out the terms and conditions for the useof the subsoil license.

Under a licensing agreement, the licensee makescertain environmental, safety and production commitments. For example, thelicensee makes a production commitment to bring the field into production by acertain date and to extract an agreed-upon volume of natural resources eachyear. The license agreement may also contain commitments with respect to socialand economic development of the region. When the license expires, the licenseemust return the land to a condition which is adequate for future use. Althoughmost of the conditions set out in a license are based on mandatoryrules contained in Russian law, certain provisions in a licensingagreement are left to the discretion of the licensing authorities and are oftennegotiated between the parties. However, commitments relating to safety and theenvironment are generally not negotiated. We expect that we will be able tomeet the commitments set forth in our licensing agreements.

The fulfillment of a license’s conditions is a majorfactor in the good standing of the license. If the subsoil licensee fails tofulfill the license’s conditions, upon notice, the license may be limited orterminated by the licensing authorities. However, if a subsoil licensee cannotmeet certain deadlines or achieve certain volumes of exploration work orproduction output as set forth in a license, it may apply to amend the relevantlicense conditions, though such amendments may be denied.

The Subsoil Law and other Russian legislation containextensive provisions for license termination. A licensee can be fined or thelicense can be suspended or terminated for the reasons noted above, forrepeated breaches of the law, upon the occurrence of a direct threat to thelives or health of people working or residing in the local area, or upon theoccurrence of certain emergency situations. A license may also be terminatedfor violations of “material” license terms. Although the Subsoil Law does notspecify which terms are material, failure to pay subsoil taxes and failure tocommence operations in a timely manner have been common grounds for limitationor termination of licenses. Consistent underproduction and failure to meetobligations to finance a project would also likely constitute violations ofmaterial license terms. In addition, certain licenses provide that theviolation by a subsoil licensee of any of its obligations may constitutegrounds 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 legislation prohibits the carrying out of anycommercial activity, including mineral extraction, on a land plot withoutappropriate land use rights. Land use rights are needed and obtained for onlythe portions of the license area actually being used, including the plot beingmined, access areas and areas where other mining-related activity isoccurring.

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

A majority of land plots in the Russian Federation areowned by federal, regional or municipal authorities which, through publicauctions or tenders or through private negotiations, can sell, lease or grantother use rights to the land to third parties.

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Companies may also have a right of perpetual use ofland that was obtained prior to the enactment of the Land Code; however, theFederal Law on Introduction of the Land Code of October 25, 2001, withcertain exceptions, requires companies using land pursuant to rights ofperpetual use either to purchase the land from, or to enter into a leaseagreement relating to, the land with the relevant federal, regional ormunicipal authority owner of the land by January 1, 2008. See “Item 3. KeyInformation—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 land lease.In order to renew a land lease agreement, the lessee must apply to the lessor(usually state or municipal authorities) for a renewal prior to the expirationof the agreement. Any lease agreement for a period equal to or longer than oneyear must 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 management and disposal of hazardous substances and waste, thecleanup of contaminated sites, flora and fauna protection and wildlifeprotection. 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 2005, we incurred such fees in the amount of $9.9 million.

***Ecological approval***

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, as amended. Conducting operations that may causedamage to the environment without state ecological approval may result in thenegative consequences described 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 

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EnvironmentalMonitoring, the Federal Agency on Subsoil Use, the Federal Agency on Forestry,the Federal Agency on Water Resources (along with their regional branches) andthe Federal Agency on Protection of Consumers Rights are involved inenvironmental control, implementation and enforcement of relevant laws andregulations. The federal government and Ministry of Natural Resources isresponsible for coordinating the activities of the regulatory authorities inthis area. Such regulatory authorities, along with other state authorities,individuals and public and non-governmental organizations, also have the rightto initiate lawsuits for the compensation of damage caused to the environment. Thestatute of limitations for such lawsuits is 20 years.

***Environmental liability***

If the operations of a company violate environmentalrequirements or cause harm to the environment or any individual or legalentity, a court action may be brought to limit or ban these operations andrequire the company to remedy the effects of the violation. Any company oremployees that fail to comply with environmental regulations may be subject toadministrative and/or civil liability, and individuals may be held criminallyliable. Courts may also impose clean-up obligations on violators in lieu of orin addition to imposing fines.

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 in accordance with the Basic Regulation on Land Reclamation,Removal, Preservation, and Rational Use of the Fertile Soil Layer, approved byOrder No. 525/67 of December 22, 1995, of the Ministry of NaturalResources. In general, our reclamation activities involve both a technicalstage and a biological stage. In the first stage, we backfill the pits, gradeand terrace mound slopes, level the surface of the mounds, and add clay rock ontop for greater adaptability of young plants. In the biological stage, we plantconifers (pine, larch, cedar) on horizontal and gently sloping surfaces, andshrubs and bushes to reinforce inclines. Russian environmental regulations donot require mines to achieve the approximate original contour (AOC) of theproperty 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 andsteel subsidiaries. Such programs include measures to aid in our adherence tothe limits imposed on air and water pollution and storage of industrial waste,introduction of environmentally friendly industrial technologies, the constructionof purification and filtering facilities, the repair and reconstruction ofindustrial water supply systems, the installation of metering systems,reforestation and the recycling of water and industrial waste. We are a memberof “Ecological Movement for Specific Activities,” a non-profit organizationwhich develops and facilitates the implementation of environmental programs andindividual projects for state and private institutions.

**Health and Safety**

Due to the nature of our business, much of our activityis conducted at industrial sites by large numbers of workers, and workplacesafety issues are of significant importance to the operation of these sites.

The principal law regulating industrial safety is theFederal Law on Industrial Safety of Dangerous Industrial Facilities of July 21,1997, as amended, or the Safety Law. The Safety Law applies, in particular, toindustrial facilities and sites where certain activities are conducted,including sites where lifting 

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machines are used, wherealloys of ferrous and non-ferrous metals are produced and where certain typesof mining is done. The Safety Law also contains a comprehensive list ofdangerous substances and their permitted concentration, and extends tofacilities and sites where these substances are used.

There are also regulations that address safety rules forcoal 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 isprohibited unless reviewed by a licensed expert and approved by the FederalService for Environmental, 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 industrial safety.In case of an accident, a special commission led by a representative of theFederal Service for Environmental, Technological and Nuclear Supervisionconducts a technical investigation of the cause. The company operating thehazardous industrial facility where the accident took place bears all costs ofan investigation. The officials of the Federal Service for Environmental,Technological and Nuclear Supervision have the right to access industrial sitesand may inspect documents to ensure a company’s compliance with safety rules.The Federal Service for Environmental, Technological and Nuclear Supervisionmay suspend or terminate operations or impose administrative liability.

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.

**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 various federallaws, such as the Law on Collective Contracts and Agreements of March 11,1992, as amended; the Federal Law on the Procedure of Settlement of CollectiveLabor Disputes of November 23, 1995, as amended; the Law on Employment inthe Russian Federation of April 19, 1991, as amended; the Federal Law onthe Fundamentals of Protection 

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of Laborin the Russian Federation of July 17, 1999, as amended; as well as certainadministrative actions undertaken at the local level.

***Employment contracts***

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 employmentcontracts 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 incompetenceor health problems;

·       changeof control of the employer;

·       repeatedfailure of the employee to fulfill his or her duties without cause;

·       employee’susage of alcohol or other intoxicants at the workplace;

·       employee’sabsence without cause;

·       anysingle gross violation by the employee of his or her duties; and

·       provisionby the employee of false documents or misleading information prior to entryinto the employment contract.

An employee dismissed from an enterprise due todownsizing or liquidation is entitled to receive compensation including aseverance payment and, depending on the circumstances, salary payments for acertain period of time.

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 ofdamages for wrongful dismissal are increasingly frequent, and Russian courtstend to support employees’ rights in most cases. Where an employee isreinstated by a court, the employer must compensate the employee for unpaidsalary for the period between the wrongful termination and reinstatement, aswell 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.

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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 generallyfour weeks. Our employees who perform underground and open-pit mining works orother work in harmful conditions may be entitled to additional paid vacationranging from six to 36 working 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. The rules definingsuch earlier retirement ages are set by the Federal Law on Labor Pensions inthe Russian Federation dated December 17, 2001, as amended.

***Salary***

The minimum monthly salaryin Russia, as established by federal law, was 600 rubles (approximately $21) in2004. Effective January 1, 2005, the statutory monthly minimum salary hasbeen increased to 720 rubles (approximately $25) and was further increasedto 800 rubles (approximately $29) on September 1, 2005 and will be furtherincreased to 1,100 rubles (approximately $40) on May 1, 2006. Although thelaw requires that the minimum wage be at or above a minimum subsistence level,the current minimum wage is generally considered to be less than a minimumsubsistence 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 of Russia, the Law on CollectiveContracts and Agreements of March 11, 1992, as amended, and the FederalLaw on the Procedure for Settlement of Collective Labor Disputes of November 23,1995, as amended, which provide for more detailed regulations relating toactivities 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 rightsand interests of its members. National trade union associations, whichcoordinate activities of trade 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;

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·       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 Lawprovides that those who violate the rights and guaranties provided to tradeunions and their officers may be subject to disciplinary, administrative andcriminal liability. 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.

***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 this document.This Item 5 contains forward-looking statements that involve risks anduncertainties. Our actual results may differ materially from those discussed inforward-looking statements as a result of various factors, including therisks described in Item 3 and under the caption “Cautionary Note RegardingForward-Looking Statements.”*

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**The Reorganization**

Mechel OAO was incorporated on March 19, 2003,under the laws of the Russian Federation in connection with a reorganization toserve as a holding company for various mining and steel companies owned by Messrs. IgorZyuzin and Vladimir Iorich or parties affiliated with them. These individualsacquired these companies at various times from 1995 to the present and haveacted in concert since that time pursuant to an Ownership, Control and VotingAgreement which requires them to vote the same way. The reorganization involvedthe contribution of these companies by these individuals to Mechel in exchangefor all the outstanding capital stock of Mechel. Many of the contributedcompanies had shareholders other than Messrs. Zyuzin and Iorich, and theseshareholders were not involved in the reorganization and continue to retainminority interests in certain of our subsidiaries.

The acquisition of thesecompanies by Mechel represents a reorganization under common control, and hasbeen accounted for in a manner akin to a pooling. Mechel’s consolidatedfinancial statements, therefore, have been prepared on the basis that Mechelexisted for all periods presented since its inception and owned these companiesto the same extent as owned by Messrs. Zyuzin and Iorich in those periods.

**Business Structure**

**Segments**

We have organizedour businesses into two segments:

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

·       the steel segment,comprising 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  |       | 93.7                       |
| Krasnogorsk Open Pit  Mine            |       | Russia     |       | Steam coal, steam coal concentrate                                                                                   |       | January 1999  |       | 88.9                       |
| Tomusinsk Open Pit Mine          |       | Russia     |       | Coking coal, steam coal                                                                                              |       | January 1999  |       | 74.4                       |
| Olzherassk Open Pit Mine         |       | Russia     |       | Coking coal, steam coal                                                                                              |       | December 1999 |       | 81.9                       |
| Southern Urals Nickel   Plant         |       | Russia     |       | Ferronickel                                                                                                          |       | December 2001 |       | 79.9                       |
| Lenin Mine                            |       | Russia     |       | Coking coal                                                                                                          |       | December 2001 |       | 79.2                       |
| Korshunov Mining  Plant               |       | Russia     |       | Iron ore concentrate                                                                                                 |       | October 2003  |       | 85.5                       |
| Port Posiet                           |       | Russia     |       | Shipping                                                                                                             |       | February 2004 |       | 93.4                       |
| 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 |       | 93.7                       |
| Vyartsilya Metal  Products Plant |       | Russia     |       | Hardware                                                                                                             |       | May 2002      |       | 93.3                       |
| Beloretsk Metallurgical  Plant   |       | Russia     |       | Long steel products, hardware, limestone(4)                                                                          |       | June 2002     |       | 90.3                       |
| Mechel Targoviste                     |       | Romania    |       | Carbon and specialty  long steel products, forgings, hardware                                                        |       | August 2002   |       | 83.7                       |
| Urals Stampings Plant                 |       | Russia     |       | Stampings                                                                                                            |       | April 2003    |       | 93.8                       |
| Mechel Campia Turzii                  |       | Romania    |       | Long steel products,  hardware                                                                                       |       | June 2003     |       | 85.2                       |
| Mechel Nemunas                        |       | Lithuania  |       | Hardware                                                                                                             |       | October 2003  |       | 100.0                      |
| Izhstal                               |       | Russia     |       | Specialty and carbon steel long products, hardware,  stampings and forgings                                          |       | May 2004      |       | 87.7                       |
| Mechel Recycling                      |       | Russia     |       | Metal scrap processing                                                                                               |       | March 2006         |       | 100.0                      |

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(1)          The percentages providedin this table are as of March 31, 2006. 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 beenpaid. We have calculated voting interests by including these preferred sharesfor subsidiaries where dividends have not been paid.

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

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(3)          Wemerged the following legal entities into Southern Kuzbass Coal Company inNovember-December 2005:

—Sibirginsk Open Pit Mine

—Kuzbass Central Processing Plant

—Siberian Central Processing Plant

We intend to merge our other coal mining subsidiariesinto Southern Kuzbass Coal Company in the future.

(4)          OurPugachev limestone quarry is owned by Beloretsk Metallurgical Plant and iswithin the steel segment.

**Intersegment sales**

We are an integratedmining and steel group. Our mining segment supplies 100% of our steel segment’scoking coal requirements, 97% of our iron requirements, and 49% 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 well as coke foruse in the production of nickel. The prices at which we record these transfersare based on market prices, and these transactions are eliminated asintercompany transactions for purposes of our consolidated financialstatements. For the years ended December 31, 2005, 2004, and 2003, miningsegment sales to the steel segment amounted to $336.6 million,$323.0 million and $185.8 million, respectively. For the years ended December 31,2005, 2004 and 2003, steel segment sales to the mining segment amounted to$56.6 million, $74.7 million and $42.3 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 theimplementation of these practices and our other integration strategies, ourmargins are initially adversely affected after each acquisition.

Following is asummary of the terms of acquisition of our primary mining and steel subsidiariesand significant investments since 2001. Each of the acquisitions was accountedfor using the purchase method of accounting, so the results of operations ofeach acquired business are included in our consolidated income statements sincetheir respective dates of acquisition of control. In certain cases where weacquired our interest in these businesses over a period of time and thuscontrol was not acquired until subsequent acquisitions of shares, until suchcontrolling stake was acquired, these businesses were accounted for using theequity method of accounting or at cost, as appropriate. 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 thesecondary market to increase our stake in Chelyabinsk Metallurgical Plant to93.7%. We have paid a total of $219.3 million for our current stake inChelyabinsk Metallurgical Plant.

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·       *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 in September 2001and increased that stake to a controlling stake in December 2001. We havesubsequently purchased shares on the secondary market to increase our stake inSouthern Urals Nickel Plant to 79.9%. We have paid a total of$10.1 million for our current stake in Southern Urals Nickel Plant.

·       *Lenin Mine.  *Lenin Mine producescoking coal. Lenin Mine was privatized by the Russian government in 1993. Weacquired a 26.9% stake in Lenin Mine through market purchases beginning from1997. We acquired another 25.0% stake as a result of our acquisition ofMezhdurechensk Coal Company in December 2001 from the Russian government.We subsequently merged Mezhdurechensk Coal Company into Southern Kuzbass CoalCompany. We have subsequently purchased shares on the secondary market toincrease our stake in Lenin Mine to 79.2%. We have paid a total of$0.3 million for our current stake in Lenin Mine.

·       *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 93.3%. We have paid a total of$0.1 million for 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 in March 2004,we acquired another 9.7% stake in Beloretsk Metallurgical Plant. During 2005 weacquired an additional stake of 0.1% in Beloretsk Metallurgical Plant, bringingour total stake to 90.3%. Beloretsk Metallurgical Plant also owns the Pugachevlimestone quarry. The regional government has a golden share in BeloretskMetallurgical Plant, giving it the right to veto certain shareholder decisionsand appoint a voting representative on the board of directors. We have paid atotal of $15.2 million for our current stake of 90.3% in BeloretskMetallurgical 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 in August 2002.At the time we acquired Mechel Targoviste, it was in bankruptcy proceedings. Theconsideration consisted of $3.5 million in cash and a commitment on ourpart to invest $21.1 million in the modernization of the plant, upgrade ofits capacity over five years and environmental protection, as well as acommitment to maintain its workforce level for five years. Under thetransaction documents, our stake in Mechel Targoviste is pledged to theRomanian government and is gradually released as we fulfill our commitments. Asa result of our fulfillment of these commitments, our stake in MechelTargoviste has increased to 83.7%. We have paid a total of $11.6 millionfor our current stake 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 in April 2003for $11.3 million in cash.

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·       *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, and we subsequently acquiredthese shares for $1.3 million, increasing our stake to 79.8%. Under thetransaction documents, our stake in Mechel Campia Turzii is pledged to theRomanian government until we fulfill our commitments. As a result of ourfulfillment of these commitments, our stake in Mechel Campia Turzii hasincreased to 85.2%. We have paid a total of $29.2 million for our currentstake 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 to December 2003,we acquired the remaining 24.9% stake in Mechel Nemunas for $1.0 millionin 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 in December 2002when it was in bankruptcy proceedings. In September 2003, a court approveda debt settlement plan. We recorded our investment in Korshunov Mining Plant atcost until we acquired control in October 2003, and have consolidated itsresults since that time. We have subsequently purchased shares on the secondarymarket to increase our stake in Korshunov Mining Plant to 85.5%. We have paid atotal of $135.7 million (including loans and advances) for our currentstake 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. In February 2006,we acquired an additional 13.4% stake in Port Posiet at auction for a purchaseprice of $1.06 million. We have paid a total of $31.0 million for ourcurrent stake in Port Posiet.

·       *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 87.7%. We have paid a total of $41.0 million for ourcurrent stake in Izhstal. The regional government has a golden share inIzhstal, giving it the right to veto certain shareholder decisions and appointa voting representative on the board of directors.

·       *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 338,906tonnes of cargo, mostly sand and crushed stone, in 2005. 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 a Chelyabinsk-basedmetal scrap processing company. We acquired a 100% stake in Mechel Recycling inMarch 2006 for $6.0 million.

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The acquisition ofChelyabinsk Metallurgical Plant in December 2001, an integrated steel millwith its own coking batteries, was our most significant steel acquisition andit is the center of our steel segment operations. Prior to its acquisition, wewere primarily a coal mining and trading company. In the year of itsacquisition, we had been running Chelyabinsk Metallurgical Plant on a contract basis,our trading operations had been selling Chelyabinsk Metallurgical Plant’sproducts and we had supplied it with most of its coking coal requirements, sowe were already familiar with its operations and customers. The addition ofBeloretsk Metallurgical Plant in June 2002, a market leader in hardware inRussia and whose products our trading operations had been selling prior to itsacquisition, significantly expanded our presence in this product category, andthis presence was also bolstered by our acquisition of Vyartsilya MetalProducts Plant in May 2002. Beloretsk Metallurgical Plant and VyartsilyaMetal Products Plant are supplied with semi-finished steel by ChelyabinskMetallurgical Plant. Our downstream product mix was also further widened by thepurchase of Urals Stampings Plant in April 2003, which uses ChelyabinskMetallurgical Plant’s specialty steel to make value-added stampings. Wefurther solidified our presence in the Russian specialty steel market by theacquisition of Izhstal in May 2004. Additionally, our Romanianacquisitions, Mechel Targoviste in August 2002, Mechel Campia Turzii in June 2003and Mechel Nemunas in October 2003, marked our expansion outside Russia.Mechel Targoviste produces specialty long products and Mechel Campia Turzii andMechel Nemunas produce hardware. Mechel Nemunas is supplied with semi-finishedsteel from our Russian operations.

**DiscontinuedOperations**

In late 2003 and the first half of 2004, we disposedof our controlling stakes in (1) Belov Insurance Company ZAO, a smallinsurance company in which we had acquired a controlling stake in 2001, and (2) UglemetbankZAO, a small bank in which we had acquired a controlling stake in 1999, totheir management and other unrelated investors. These companies provided ourcoal companies and their employees with routine banking, finance and insuranceservices. The results for these businesses have been classified as discontinuedoperations for the years ended December 31, 2003 and 2002 in ourconsolidated financial statements.

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. In September 2004,we concluded a termination agreement providing for the return to the seller ofthe Mechel Zeljezara assets, the redemption of the bank guarantee that wegranted to the government of Croatia in the amount of $4.3 million and thedonation of spare parts at Mechel Zeljezara in the amount of $1.8 million,in return for a waiver of any and all claims against us.

We started accounting forMechel Zeljezara as discontinued operations in September 2004. MechelZeljezara is currently in liquidation, which is expected to be concluded in2006. The results of operations of Mechel Zeljezara were included in theconsolidated financial statements from the date of acquisition in March 2003.For the years ended December 31, 2005 and 2004 these results werereflected in the consolidated financial statements as discontinued operations.

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**Results ofOperations**

Thefollowing table sets forth our income statement data for the years ended December 31,2005, 2004 and 2003. 

| ** **                                                                                                                     | ** ** | **Year ended December 31,**                                                   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2005**                                                                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues**                                                                                                                   | ** ** | ** **                                                                                   | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** | **Amount** | ** ** | **% of  revenues** | ** ** |
| ** **                                                                                                                     | ** ** | **(in millions of U.S. dollars, except for percentages)** | ** ** |
| Revenue, net                                                                                                                   |       | 3,804,995                                                                                    |       |   | 100.0 |   |   | 3,635,955 |   |   | 100.0 |   |   | 2,028,051 |   |   | 100.0 |   |   |
| Cost of goods  sold                                                                                                            |       | (2,469,134                                                                                   | )          |   | (64.9 | ) |   | (2,225,088 | ) |   | (61.2 | ) |   | (1,422,987 | ) |   | (70.2 | ) |   |
| Gross margin                                                                                                                   |       | 1,335,861                                                                                    |       |   | 35.1 |   |   | 1,410,867 |   |   | 38.8 |   |   | 605,064 |   |   | 29.8 |   |   |
| Selling,  distribution and operating expenses                                                                                  |       | (820,133                                                                                     | )          |   | (21.6 | ) |   | (660,060 | ) |   | (18.2 | ) |   | (407,383 | ) |   | (20.1 | ) |   |
| Operating income                                                                                                               |       | 515,728                                                                                      |       |   | 13.5 |   |   | 750,807 |   |   | 20.6 |   |   | 197,681 |   |   | 9.7 |   |   |
| Other income and  expense, net                                                                                                 |       | 10,131                                                                                       |       |   | 0.3 |   |   | 794,288 |   |   | 21.9 |   |   | (21,555 | ) |   | (1.1 | ) |   |
| Income before  income tax, minority interest, discontinued operations, extraordinary gain  and changes in accounting principle |       | 525,859                                                                                      |       |   | 13.8 |   |   | 1,545,095 |   |   | 42.5 |   |   | 176,126 |   |   | 8.6 |   |   |
| Income tax  expense                                                                                                            |       | (136,643                                                                                     | )          |   | (3.6 | ) |   | (175,776 | ) |   | (4.8 | ) |   | (47,759 | ) |   | (2.3 | ) |   |
| Minority interest  in loss (income) of subsidiaries                                                                            |       | (6,879                                                                                       | )          |   | (0.2 | ) |   | (11,673 | ) |   | (0.3 | ) |   | 18,979 |   |   | 0.9 |   |   |
| Income from continuing operations                                                                                         |       | 382,337                                                                                      |       |   | 10.0 |   |   | 1,357,646 |   |   | 37.3 |   |   | 147,346 |   |   | 7.2 |   |   |
| Loss from  discontinued operations, net of tax                                                                                 |       | (1,157                                                                                       | )          |   | — |   |   | (15,211 | ) |   | (0.4 | ) |   | (5,790 | ) |   | (0.3 | ) |   |
| Extraordinary  gain, net of tax                                                                                                |       | —                                                                                       |       |   | — |   |   | 271 |   |   | — |   |   | 5,740 |   |   | 0.3 |   |   |
| Changes in  accounting principle, net of tax                                                                              |       | —                                                                                       |       |   | — |   |   | — |   |   | — |   |   | (3,788 | ) |   | (0.2 | ) |   |
| Net income                                                                                                                     |       | 381,180                                                                                      |       |   | 10.0 |   |   | 1,342,706 |   |   | 36.9 |   |   | 143,508 |   |   | 7.0 |   |   |
|                                                                                                                                |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

***Revenues***

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 ended December 31,2005 increased by $230.0 million, or 19.1%, to $1,431.4 million from$1,201.4 million in the year ended December 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 isprimarily explained 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 to volume decreases that occurred as aresult of decreases of production volumes of these products at our ChelyabinskMetallurgical Plant caused by excess of imported stainless products on the Russianmarket;

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

·       Pigiron sales decreased  by$20.6 million, or 55.2%, primarily as a result of higher internalconsumption.

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 ended December 31,2005, compared to 51.0% in the year ended December 31, 2004. The decreasein the proportion of our export sales was largely due to a decrease in exportprices in 2005 compared to 2004.

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

Consolidated cost of goodssold was 64.8% of consolidated revenues in the year ended December 31,2005, as compared to 61.2% of consolidated revenues in the year ended December 31,2004, resulting in a decrease in the consolidated gross margin percentage inthe year ended December 31, 2005, to 35.1% from 38.8% in the year ended December 31,2004. Cost of goods sold primarily consists of costs relating to raw materials(including products purchased for resale), direct payroll, depreciation andenergy. The table below sets forth cost of goods sold and gross margin bysegment for the year ended December 31, 2005 and 2004, including as apercentage 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 operating expenses***

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 distributionexpenses consisted almost entirely of transportation expenses related to ourselling activities, and increased by $29.8 million in line with sales volumeincreases in 2005. As a percentage of mining segment revenues they remainedconstant in 2005 in comparison with 2004.

Taxes other than incometax increased by $2.4 million, or 8.7%, from $27.1 million in the yearended December 31, 2004, to $29.5 million in the year ended December 31,2005. The increase is mainly explained by the increase in penalties and finespaid to environmental agencies and other non-budgeted items at the KorshunovMining Plant.

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

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 indexation ofsalary rates to inflation at our production companies and also due to increasesin management bonuses, social expenses (including pension) increased by$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 

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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 distributionexpenses consisted almost entirely of transportation expenses related to ourselling activities, and increased as a percentage of steel segment revenuesfrom 7.3% in the year ended December 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 taxincludes property and land taxes, and other taxes. These amounted to$61.2 million in the year ended December 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 of segment revenues, these taxes increased from 1.5% to2.2%. Property and land taxes 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 inthe year ended December 31, 2004, due to an increase in the property taxbase (as a result of putting into operation new fixed assets). In 2005, anadditional tax charge of $10.0 million was recognized in certain of oursubsidiaries as a result of tax audits of previous periods. The amounts claimedby tax authorities were mainly comprised of export VAT payable and related finesand penalties.

In December 2005, wedecided to restructure the production process for each of Mechel Targoviste andMechel Campia Turzii in order to increase their efficiency and profitability.As a result of this restructuring, certain production workshops of MechelTargoviste and Mechel Campia Turzii were discontinued in early 2006, with someproperty, plant and equipment 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 doubtfulaccounts increased  by $6.8 millionfrom $(4.5) million in the year ended December 31, 2004, to$2.3 million in the year ended December 31, 2005, due to changes inour 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, office expenses and otherexpenses, increased by $13.7 million, or 8.9%, to $168.1 million inthe year ended December 31, 2005, from $154.5 million in the yearended December 31, 2004, and increased as a percentage of segment revenuesfrom 5.5% in the year ended December 31, 2004, to 6.1% in the year ended December 31,2005. Payroll and related social taxes increased by $8.4 million mainlydue to indexation of salary rates to inflation at our production companies andalso due to increases in management bonuses. Social expenses (includingpension) increased by $5.8 million due to the expansion in socialactivities of our production companies and increases in charity expenses anddonations. Rent and maintenance, business travel expenses, bank charges andoffice expenses decreased by $1.3 million primarily due to tighter controlover 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.

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***Operating income***

Operating income decreased by $235.1 million, or 31.3%,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 ended December 31,2004, to 13.6% in the year ended December 31, 2005, due to deteriorationin the gross margin percentage, which occurred as a result of increasedselling, distribution and operating expenses (including losses resulting fromwrite-offs of property, plant and equipment related to Mechel Targoviste andMechel Campia Turzii) compared to growth in consolidated revenues.

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 percentagedecreased  from 32.0% to 28.0% due to adecrease in segment gross profit margin and increases 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 ended December 31,2004. Operating margin percentage decreased from 12.9% to 4.1% due to a decrease in gross margin percentage, as wellas the increase in selling, distribution and operating expenses (includinglosses resulting from write-offs of property, plant and equipment related toMechel Targoviste and Mechel Campia Turzii).

***Other income andexpense, 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.

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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 endedDecember 31, 2005, foreign exchange loss was $37.3  million, as compared to a gain of $1.9 million inthe year ended December 31, 2004. This foreign exchange loss is primarilyattributed to losses from devaluation of our cash balances in euro accounts.

***Income tax expense***

Income tax expensedecreased  by $39.1 million to$136.6 million in the year ended December 31, 2005, from $175.8 millionin the year ended December 31, 2004, while our effective tax rateincreased  to 26.0% from 11.4%. Theincrease  in the effective tax rate in2005 is due primarily to the absence in our taxable income of the gain on thesale 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 coal companies of $8.2 million, whichwas partially offset by the share of minority shareholders in the net losses ofChelyabinsk Metallurgical Plant of $9.3 million.

***Income from continuing operations***

Income from continuingoperations in the year ended December 31, 2005, was $382.3 million, comparedto $1,357.6 million in the year ended December 31, 2004, as a resultof 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 forth above, our net incomedecreased in the year ended December 31, 2005, by $961.5 million, or71.6%, from $1,342.7 million in the year ended December 31, 2004, to$381.2 million in the year ended December 31, 2005.

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**Year ended December 31,2004, compared to year ended December 31, 2003**

***Revenues***

Consolidatedrevenues increased by $1,607.9 million, or 79.3%, to $3,636.0 millionin the year ended December 31, 2004, from $2,028.1 million in theyear ended December 31, 2003. The following table sets out revenues bysegment.

| ** **                        | ** ** | **Year ended December 31,**                                   | ** ** |
|-----------------------------------|------------|------------------------------------------------------------------------------|------------|
| **Revenues by segment** | ** ** | ** **                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                        | ** ** | **(in thousands of  U.S. dollars,  except percentages)** | ** ** |
| **Mining segment**                |       |                                                                         |       |   |   |
| To third parties                  |       | 878,417                                                                      |       | 413,943 |   |
| To steel segment                  |       | 322,992                                                                      |       | 185,813 |   |
| Total                             |       | 1,201,409                                                                    |       | 599,756 |   |
| **Steel segment**                 |       |                                                                         |       |   |   |
| To third parties                  |       | 2,757,538                                                                    |       | 1,614,108 |   |
| To mining segment                 |       | 74,651                                                                       |       | 42,250 |   |
| Total                             |       | 2,832,189                                                                    |       | 1,656,358 |   |
| Eliminations                      |       | 397,643                                                                      |       | 228,063 |   |
| Consolidated revenues             |       | 3,635,955                                                                    |       | 2,028,051 |   |
| % from mining segment             |       | 24.2                                                                         | %          | 20.4 | % |
| % from steel  segment             |       | 75.8                                                                         | %          | 79.6 | % |
|                                   |            |                                                                              |            |  |  |  |  |

 

*Mining segment*

Our total mining segment sales in the year ended December 31,2004, increased by $601.7 million, or 100.3%, to $1,201.4 millionfrom $599.8 million in the year ended December 31, 2003.

Coking coal concentrate sales to third partiesincreased by $222.0 million, or 123.2%, primarily due to price increases,as well as to a 30.1% increase in sales volume. Coking coal concentratesupplied to the steel segment increased by $96.4 million, or 70.1%,primarily as a result of an increase in the price of coking coal concentrate.Steam coal and steam coal concentrate sales to third parties increased by$91.0 million, or 76.4%, primarily due to price increases.

Nickel sales to third parties increased by$28.0 million, or 34.9%, primarily due to price increases.

We recorded iron ore sales in the mining segmentbeginning in October 2003 with our consolidation of Korshunov MiningPlant. For the year ended December 31, 2004, sales to third partiesamounted to $113.8 million and supplies to the steel segment amounted to$52.8 million, for a total of $166.7 million, and the net increase insales of iron ore was $138.3 million.

Other sales increased by $29.8 million,consisting primarily of transportation, blasting and municipal services.

These increases in mining products sales were partlyoffset by a decrease of $5.7 million in nickel supplied to the steelsegment.

Excluding intersegmentsales, export sales were 67.1% of mining segment sales in the year ended December 31,2004, compared to 45.1% in the year ended December 31, 2003. The increasein the proportion of our export sales was due to higher export prices inrelation to domestic prices (the weighted average export price of our miningproducts increased by $19.4 per tonne, whereas the weighted average 

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domesticprice of our mining products increased by $14.0 per tonne), as well asincreased export volume levels in response to the higher export prices.

*Steel segment*

Our steel segmentrevenues increased by $1,175.8 million, or 71.0%, to $2,832.2 millionin the year ended December 31, 2004, from $1,656.4 million in theyear ended December 31, 2003. The increase in steel segment revenues isprimarily explained by the following increases:

·       Rebarsales increased by $220.7 million, or 61.5%, due to price increases, andwire rod sales increased by $123.2 million, or 70.5%, due to priceincreases.

·       Salesof semi-finished products increased by $336.4 million, or 340.0%, of which61.3% was due to volume increases and 38.7% was due to price increases.

·       Hardwaresales were higher by $108.7 million, or 70.6%, including an increase inwire sales of $74.3 million, or 71.7%, an increase in rope sales of$22.6 million, or 83.7%, and an increase in nails and other hardware salesof $11.8 million, or 50.4%, of which 73.2% was due to volume increases and26.8% was due to price increases.

·       Salesof carbon and low-alloy flat products increased by $49.6 million, or55.4%, due to price increases.

·       Salesof stainless and alloyed long products increased by $19.9 million, or30.2%, due to price increases exceeding volume decreases.

·       Carbonand low-alloyed long product sales grew by $73.3 million, or 48.6%, mostlyas a result of price increases.

·       Forgingsand forged alloy sales increased by $29.4 million, or 32.1%, due to priceincreases.

·       Salesof coke and coking products to third parties increased by $14.0 million,or 31.3%, and sales to the mining segment, which uses coke in the production ofnickel, grew by $32.4 million, or 88.3%, in both cases primarily as aresult of substantial increases in the price of coke which was partly offset bya decrease in sales.

·       Pigiron sales increased by $21.9 million, or 142.2%, primarily as a result ofprice increases.

·       Stainlessflat product sales increased by $10.9 million, or 13.0%, mostly due toprice increases exceeding volume decreases.

·       Salesof other products and services, mainly products of third parties, increased by$128.0 million.

In addition to theabove, the following increases were related to acquisitions:

·       Revenuesat Urals Stampings Plant for the first three months of 2004, Mechel CampiaTurzii for the first five months of 2004 and Mechel Nemunas for the first ninemonths of 2004, which are not included in the comparative analysis by productabove, amounted to $91.1 million.

·       Revenuesat Izhstal for the year ended December 31, 2004, amounted to$149.5 million.

These increases insteel products sales were offset by sales decreases as follows:

·       Salesof MMK products in the year ended December 31, 2004 amounted to$26.4 million, which is a decrease of $196.7 million compared to$223.1 million in the year ended December 31, 2003. This decrease wasthe result of our termination in January 2004 of purchasing MMK steelproducts.

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·       Tradingsales of iron ore from Korshunov Mining Plant in the year ended December 31,2003, amounted to $36.5 million and were included in steel segment salesuntil its consolidation in October 2003; in 2004 its revenues are beingreflected in the mining segment.

Excluding intersegmentsales, export sales were 51.0% of steel segment sales in the year ended December 31,2004, compared to 44.4% in the year ended December 31, 2003. The increasein the proportion of our export sales was largely due to relatively highergrowth in our export sales volumes compared to domestic sales volumes in 2004.

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

Consolidatedcost of goods sold was 61.2% of consolidated revenues in the year ended December 31,2004, as compared to 70.2% of consolidated revenues in the year ended December 31,2003, resulting in an increase in the consolidated gross margin percentage inthe year ended December 31, 2004, to 38.8% from 29.8% in the year ended December 31,2003. Cost of goods sold primarily consists of costs relating to raw materials(including products purchased for resale), direct payroll, depreciation andenergy. The table below sets forth cost of goods sold and gross margin bysegment for the year ended December 31, 2004 and 2003, including as apercentage of segment revenues.

| ** **                                                                                 | ** ** | **Year ended  December 31, 2004**                                              | ** ** | **Year ended  December 31, 2003** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **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                                                                        |       | 557,251                                                                                       |       |                                             | 46.4       |   |   | 420,736 |   |   | 70.2 |   |   |
| Gross margin                                                                               |       | 644,158                                                                                       |       |                                             | 53.6       |   |   | 179,020 |   |   | 29.9 |   |   |
| **Steel  segment**                                                                         |       |                                                                                          |       |                                             |       |   |   |   |   |   |   |   |   |
| Cost of goods  sold                                                                        |       | 2,065,480                                                                                     |       |                                             | 72.9       |   |   | 1,230,314 |   |   | 74.3 |   |   |
| Gross margin                                                                               |       | 766,709                                                                                       |       |                                             | 27.1       |   |   | 426,044 |   |   | 25.7 |   |   |
|                                                                                            |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

*Mining segment*

Mining segment cost ofgoods sold increased by $136.5 million, or 32.4%, to $557.3 millionin the year ended December 31, 2004, from $420.7 million in the yearended December 31, 2003. Mining segment gross margin percentage increasedfrom 29.9% in the year ended December 31, 2003, to 53.6% in the year endedDecember 31, 2004. The improvement in the mining segment’s gross marginwas attributable to a substantial increase in the average sales price of coaland nickel, which increased by 77.6% and 44.4%, respectively.

*Steel segment*

Steel segment cost ofgoods sold increased by $835.2 million, or 67.9%, to $2,065.5 millionin the year ended December 31, 2004, from $1,230.3 million in theyear ended December 31, 2003. Steel segment cost of goods sold was 72.9%of segment revenues, as compared to 74.3% in the year ended December 31,2003.

***Selling, distribution and operating expenses***

Selling,distribution and operating expenses increased by $252.7 million, or 62.0%,to $660.1 million in the year ended December 31, 2004, from$407.4 million in the year ended December 31, 2003. As a percentageof consolidated revenues, selling, distribution and operating expensesdecreased to 18.2% in the year ended December 31, 2004, as compared to20.1% in the year ended December 31, 2003. Our selling, distribution andoperating expenses consist primarily of selling and distribution expenses,taxes 

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other than income tax, provision for doubtful accountsand general, administrative and other operating expenses. The table below setsforth these costs by segment for the year ended December 31, 2004 and2003, including as a percentage of segment revenues.

| ** **                                                                                | ** ** | **Year ended  December 31, 2004**                                              | ** ** | **Year ended  December 31, 2003** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **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                                                        |       | 160,578                                                                                       |       |                                             | 13.4       |   |   | 61,546 |   |   | 10.3 |   |   |
| Taxes other than  income tax                                                              |       | 27,140                                                                                        |       |                                             | 2.3        |   |   | 12,105 |   |   | 2.0 |   |   |
| Accretion expense                                                                         |       | 1,137                                                                                         |       |                                             | 0.1        |   |   | 1,677 |   |   | 0.3 |   |   |
| Provision for  doubtful accounts                                                          |       | (3,323                                                                                        | )          |                                             | (0.3       | ) |   | 76 |   |   | 0.0 |   |   |
| General,  administrative and other operating expenses                                     |       | 74,568                                                                                        |       |                                             | 6.2        |   |   | 40,166 |   |   | 6.7 |   |   |
| Total                                                                                     |       | 260,100                                                                                       |       |                                             | 21.7       |   |   | 115,570 |   |   | 19.3 |   |   |
| **Steel  segment**                                                                        |       |                                                                                          |       |                                             |       |   |   |   |   |   |   |   |   |
| Selling and distribution  expenses                                                        |       | 206,933                                                                                       |       |                                             | 7.3        |   |   | 152,432 |   |   | 9.2 |   |   |
| Taxes other than  income tax                                                              |       | 42,145                                                                                        |       |                                             | 1.5        |   |   | 32,611 |   |   | 2.0 |   |   |
| Accretion expense                                                                         |       | 944                                                                                           |       |                                             | 0.0        |   |   | 756 |   |   | 0.0 |   |   |
| Provision for  doubtful accounts                                                          |       | (4,536                                                                                        | )          |                                             | (0.2       | ) |   | 8,980 |   |   | 0.5 |   |   |
| General,  administrative and other operating expenses                                     |       | 154,471                                                                                       |       |                                             | 5.5        |   |   | 97,035 |   |   | 5.9 |   |   |
| Total                                                                                     |       | 399,957                                                                                       |       |                                             | 14.1       |   |   | 291,814 |   |   | 17.6 |   |   |
|                                                                                           |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

*Mining segment*

Selling and distribution expenses consisted almostentirely of transportation expenses related to our selling activities, andincreased as a percentage of mining segment revenues from 10.3% in the yearended December 31, 2003, to 13.4% in the year ended December 31,2004, primarily as a result of an increase in our export sales with higher costof transportation than domestic sales, partly offset by the increased use ofour own railway freight and forwarding company for our transportation needs,which we established in the end of 2002.

Taxes other than income tax increased by$15.0 million, or 124.2%, from $12.1 million in the year ended December 31,2003, to $27.1 million in the year ended December 31, 2004. Propertyand land taxes increased by $11.7 million due to an increase in the landtax base and property tax base (as a result of putting into operation new fixedassets).

Provision for doubtful accounts decreased by$3.4 million, from $0.08 million in the year ended December 31,2003, to $(3.3) million in the year ended December 31, 2004, due torecoveries and an improvement in the aging of the accounts receivable as of therespective period ends.

General, administrativeand other expenses increased by $34.4 million, or 85.7%, to$74.6 million in the year ended December 31, 2004, from$40.2 million in the year ended December 31, 2003, representing adecrease as a percentage of segment revenues from 6.7% to 6.2%. Salaries andrelated social taxes increased by $10.3 million, social expenses(including pension) increased by $11.1 million, legal and consulting fees,and insurance services increased by $2.5 million. Rent and maintenance,business travel expenses, bank charges and office expenses increased by$3.9 million, and depreciation increased by $1.1 million. Theincrease in salaries and social expenses was primarily due to the acquisitionof Korshunov Mining Plant in October 2003 and salary increases at our coalcompanies. Other expenses, including 

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penaltiesfor delays in deliveries of finished goods, security expenses and otherexpenses, increased by $5.4 million.

*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 9.2% in the year endedDecember 31, 2003, to 7.3% in the year ended December 31, 2004,primarily as a result of the increasing use of our own railway freight andforwarding company for our transportation needs, which we established at theend of 2002.

Taxes other than income tax includes property and landtaxes, and other taxes. These amounted to $42.1 million in the year ended December 31,2004, an increase of $9.5 million, or 29.2%, from $32.6 million inthe year ended December 31, 2003. As a percentage of segment revenues,these taxes declined from 2.0% to 1.5%. Property and land taxes amounted to$23.8 million in the year ended December 31, 2004, an increase of$5.4 million, or 29.5%, from $18.4 million in the year ended December 31,2003, due to an increase in the property tax base (as a result of putting intooperation new fixed assets and the acquisition of Izhstal).

Provision for doubtful accounts decreased by$13.5 million from $9.0 million in the year ended December 31,2003, to $(4.5) million in the year ended December 31, 2004, due torecoveries and an improvement in the aging of the accounts receivable 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 $57.4 million, or 59.2%, to$154.5 million in the year ended December 31, 2004, from$97.0 million in the year ended December 31, 2003, and decreased as apercentage of segment revenues from 5.9% in the year ended December 31,2003, to 5.5% in the year ended December 31, 2004. Payroll and relatedsocial taxes increased by $15.0 million, half of which was due to theacquisition of Izhstal. Social expenses (including pension) increased by$12.2 million. Rent and maintenance, business travel expenses, bankcharges and office expenses increased by $10.7 million. Professionalexpenses, which include audit, accounting, legal and engineering fees, andinsurance services increased by $2.9 million. Other expenses, includinginsurance of top management, penalties for delays in deliveries of finishedgoods, security expenses and other expenses, increased by $16.6 million.

***Operating income***

Operating income increased by $552.8 million, or279.7%, to $750.5 million in the year ended December 31, 2004, from$197.7 million in the year ended December 31, 2003. Operating incomeas a percentage of consolidated revenues increased from 9.7% in the year ended December 31,2003, to 20.6% in the year ended December 31, 2004, due to the substantialimprovement in the gross margin percentage and the relatively stable selling,distribution and operating expenses compared to growth in consolidatedrevenues.

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

| ** **                                     | ** ** | **Year ended  December 31, 2004**                                              | ** ** | **Year ended  December 31, 2003** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Operating income by segment** | ** ** | ** **                                                                                    | ** ** | **Amount**                                       | ** ** | **% of segment  revenues** | ** ** | **Amount** | ** ** | **% of segment  revenues** | ** ** |
| ** **                                     | ** ** | **(in thousands of U.S. dollars, except for percentages)** | ** ** |
| Mining segment                                 |       | 384,053                                                                                       |       |                                             | 32.0       |   |   | 63,450 |   |   | 10.6 |   |   |
| Steel segment                                  |       | 366,754                                                                                       |       |                                             | 12.9       |   |   | 134,230 |   |   | 8.1 |   |   |
|                                                |            |                                                                                               |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

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*Mining segment*

Mining segment operatingincome in the year ended December 31, 2004, increased by$320.6 million, or 505.3%, to $384.1 million from $63.5 millionin the year ended December 31, 2003. Operating margin percentage increasedfrom 10.6% to 32.0% due to significant growth in segment gross margin, partlyoffset by growth in selling, distribution and operating expenses.

*Steel segment*

Steel segment operatingincome in the year ended December 31, 2004, increased by$232.5 million, or 173.2%, to $366.8 million from $134.2 millionin the year ended December 31, 2003. Operating margin percentage increasedfrom 8.1% to 12.9% due to the increase in the gross margin percentage and thedecrease in selling, distribution and operating expenses compared to the growthin segment revenues.

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

Other income and expense, net consists of income(loss) of equity investees, interest income, interest expense, other income andforeign exchange gain. The table below sets forth these costs for the year endedDecember 31, 2004 and 2003, including as a percentage of sales:

| ** **                                            | ** ** | **Year ended  December 31, 2004**                                          | ** ** | **Year ended  December 31, 2003** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **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                  |       | 4,621                                                                                     |       |                                             | 0.1        |   |   | 1,221 |   |   | 0.1 |   |   |
| Interest income                                       |       | 2,375                                                                                     |       |                                             | 0.1        |   |   | 2,274 |   |   | 0.1 |   |   |
| Interest expense                                      |       | (51,409                                                                                   | )          |                                             | (1.4       | ) |   | (48,516 | ) |   | (2.4 | ) |   |
| Other income, net                                     |       | 836,817                                                                                   |       |                                             | 23.0       |   |   | 26,333 |   |   | 1.3 |   |   |
| Foreign exchange  gain (loss)                         |       | 1,884                                                                                     |       |                                             | 0.1        |   |   | (2,867 | ) |   | (0.1 | ) |   |
| Total                                                 |       | 794,288                                                                                   |       |                                             | 21.9       |   |   | (21,555 | ) |   | (1.1 | ) |   |
|                                                       |            |                                                                                           |            |                                                  |            |  |  |  |  |  |  |  |  |  |  |

 

The income from equity investees in the year ended December 31,2003, was related to investees of Southern Kuzbass Coal Company. Most of theincome from equity investees in the year ended December 31, 2004, relatedto Mechel Energy AG, and also included income from investees of SouthernKuzbass Coal Company.

Interest income increased by $0.1 million to$2.4 million in the year ended December 31, 2004, from $2.3 millionin the year ended December 31, 2003. Our businesses earned interest incomeon the cash balances held with financial institutions. Interest expenseincreased by $2.9 million, or 6.0%, to $51.4 million in the yearended December 31, 2004, from $48.5 million in the year ended December 31,2003. This increase related to an increase in short-term debt and long-termdebt partly offset by a reduction in interest rates, as well as to interestexpense on debt of acquired businesses of $0.9 million.

In the year ended December 31, 2004, we recordedother income of $836.8 million, primarily consisting of the following: netprofit from the sale of our shareholding in MMK for $800.0 million, gains of$18.3 million from fines and penalties forgiven due to the timely paymentof restructured prior period taxes and social charges (see note 14 to ourconsolidated financial statements), a loss of $2.0 million on the sale ofpromissory notes, a gain of $2.4 million from dividends received, and netgain of $18.1 million on other sales and other expenses.

In the year ended December 31,2004, foreign exchange gain was $1.9 million, as compared to a loss of$2.9 million in the year ended December 31, 2003.

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***Income tax expense***

Income tax expenseincreased by $128.0 million to $175.8 million in the year ended December 31,2004, from $47.8 million in the year ended December 31, 2003, and oureffective tax rate decreased to 11.4% from 27.1%. The decrease in the effectivetax rates is due primarily to an increase of our income being generated injurisdictions having lower tax rates.

***Minority interest***

Minority interest inincome of subsidiaries amounted to $11.7 million in the year ended December 31,2004, compared to a minority interest in losses of subsidiaries of$19.0 million in the year ended December 31, 2003. Minority interestin income of subsidiaries in the current period consisted primarily of theshare of minority shareholders in the net income of Chelyabinsk MetallurgicalPlant and our coal subsidiaries in the amount of $16.5 million, partlyoffset by the share of minority shareholders in the net losses of BeloretskMetallurgical Plant, Mechel Targoviste, Campia Turzii and Izhstal. Minorityinterest in losses of subsidiaries in 2003 consisted primarily of the share ofminority shareholders in the net losses of Chelyabinsk Metallurgical Plant,Beloretsk Metallurgical Plant and Mechel Targoviste in the amount of$18.3 million.

***Income fromcontinuing operations***

Income from continuingoperations in the year ended December 31, 2004, was $1,357.6 million,compared to $147.3 million in the year ended December 31, 2003, as aresult of the factors explained above.

***Loss fromdiscontinued operations***

We recognized a loss of$5.8 million in 2003 as a result of discontinued operations and loss ondisposal of our interests in Uglemetbank, a Russian bank providing bankingservices to our coal subsidiaries, and Belov Insurance Company, an insurancecompany providing life and property insurance to our coal subsidiaries, whichwe had committed to discontinue and sell as of December 31, 2002. Since wehave started accounting for Mechel Zeljezara as discontinued operations,$3.4 million of loss was recognized as loss from discontinued operationsin 2003 (see note 2(p) to our consolidated financial statements).Loss from discontinued operations incurred in 2004 was $15.2 million, allrelated to Mechel Zeljezara.

***Extraordinary gain***

In accordance with SFAS No. 141and SFAS No. 142, the excess of the fair value of net assets acquired overthe purchase price (after reducing the value of non-current assets to zero) inthe amount of $5.7 million which was related to the acquisitions ofminority interests in Mechel Campia Turzii in June 2003 was recorded asextraordinary gain, net of tax, in 2003. In 2004, gain in the amount of$0.3 million arose for the reasons set above and was related to theacquisitions of minority interests in Krasnogorsk Open Pit Mine on differentdates from October 12 through December 30, 2004.

***Changes inaccounting principle***

Upon adoption of SFAS No. 143on January 1, 2003, we recorded approximately $3.8 million, includingtax benefit, as a charge to cumulative effective changes in accountingprinciples. See note 20 to our consolidated financial statements.

***Net income***

For the reasons set forthabove, our net income increased in the year ended December 31, 2004, by$1,199.2 million, or 835.6%, from $143.5 million in the year ended December 31,2003, to $1,342.7 million in the year ended December 31, 2004.

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**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 cash flow generated by our business, as wellas 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 2010, we expect ouroverall capital expenditures to total approximately $1.1 billion,approximately 52.9% of which will be in 2006-2007 and approximately 47.1%in 2008-2010. We plan to finance our capital expenditures out of our cashflows from operations and financing activities. Our failure to undertakeplanned expenditures on production facilities could adversely affect ourability to maintain and/or enhance our competitive position and develop highermargin products.

Our total outstanding debt as of December 31,2005 and December 31, 2004 was $435.0 million and$565.0 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 2005, we paid dividendsin an amount equal to $194.2 million, which was approximately 14.5% of ourannual net income in 2004, as determined under U.S. GAAP. In March 2006,we revised our dividend policy so that we expect to pay annual dividends equalat least 50% of our annual net income, as determined under U.S. GAAP. See “Item8. Financial Information—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, in the future we are planning to increase the use of long-termdebt to finance our capital investment and acquisition projects. We do notdepend on off-balance sheet financing arrangements.

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Net cash provided byoperating activities was $618.9 million, $296.1 million and$119.9 million in the years ended December 31, 2005, 2004 and 2003,respectively. The principal reason for the constant growth of net cash providedby operating activity is better management of working capital. The operatingcash inflows are derived from payments received from sales of our mining andsteel products, reduced by cash disbursements for direct labor, raw materialsand parts, selling, distribution and operating expenses, interest expense andincome taxes.

Net cash used in investingactivities was $994.7 million in the year ended December 31, 2005,net cash provided by investing activities was $455.7 million in the yearended December 31, 2004, and net cash used in investing activities was$210.3 million in the year ended December 31, 2003. 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 2005, 2004 and 2003 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 $488.6 million,$90.7 million and $107.5 million in the years ended December 31,2005, 2004 and 2003, respectively. The cash used by investing activities in 2005included our $411.2 million investment in a 25% plus one share in Yakutugol.Capital expenditures have steadily increased and amounted to$520.6 million, $303.4 million and $116.9 million in the yearsended December 31, 2005, 2004 and 2003, respectively.

Net cash used in financingactivities was $306.9 million in the year ended December 31, 2005 andnet cash provided by financing activities was $252.3 million and$103.1 million in the years ended December 31, 2004 and 2003,respectively. In general, we rely heavily on short term debt, receivingproceeds of $1.6 billion, $0.9 billion and $0.8 billion in 2005, 2004 and 2003,respectively. In the same years, we repaid short term debt in amounts of $1.7billion, $0.9 billion and $0.7 billion, respectively. In 2005, financingactivities used cash due to a higher level of repayments of short term debt ascompared to the prior year, the payment of dividends in an amount of $194.2million, and a lower level of proceeds from long term debt as compared to theprior year. In 2004 and 2003, we and our Russian subsidiaries issued long termruble-denominated bonds, the proceeds of which were used to acquireproperty, plant and equipment and repay our short-term borrowings. In 2004, wealso completed our initial public offering, the proceeds of which amounted to$213.4 million and were used to acquire property, plant and equipment andacquire businesses.

In March 2006, weannounced our decision to place ruble-denominated bonds in an amount of up to10billion rubles. We plan to use the funds from the bond placement to refinanceour debt from previous bond issues and to finance our long term investmentprograms. The maturity will be five to seven years.

**Liquidity**

We had cash and cashequivalents of $311.8 million at December 31, 2005, and$1,024.8 million at December 31, 2004. Of these amounts,$271.4 million and $988.3 million was held in U.S. dollars, euros andother hard currencies and $40.4 million and $36.5 million was held inrubles and other currencies of the CIS and Eastern Europe, respectively.

As of December 31,2005 and 2004, we had unused credit lines of approximately $182.5 millionand $236.4 million, respectively, out of total available credit lines of$617.6 million and $801.3 million, respectively. These credit linespermit drawings at a weighted average interest rate of approximately 9.94% and9.86% at December 31, 2005, and 2004, respectively. We have not had, anddo not believe that we will have, difficulty gaining access to short-termfinancing sufficient to meet our current requirements.

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The following tablesummarizes our liquidity as of December 31, 2005, and 2004.

| **Estimated Liquidity**              | ** ** | ** **                                            | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **(in millions of U.S. dollars)** | ** ** |
| Cash and cash equivalents                 |       |                                                  | 311.8      |                        |       |                        | 1,024.8    |   |   |
| Amounts available under credit facilities |       |                                                  | 182.5      |                        |       |                        | 236.4      |   |   |
| Total estimated liquidity                 |       |                                                  | 494.3      |                        |       |                        | 1,261.2    |   |   |

 

We had a working capital of $390.2 million and$1,213.9 million as of December 31, 2005 and 2004, respectively. Asof December 31, 2005, our working capital was lower as compared to December 31,2004, primarily as a result of cash received from the sale of our stake in MMKat the end of 2004, which was spent on the acquisition of businesses, equitymethod investments and minority interests in our subsidiaries, as well ascapital expenditures in 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. However, our business may notgenerate sufficient operating cash flow and external financing sources may notbe available in an amount sufficient to enable us to service or refinance ourindebtedness or to fund other liquidity needs. Moreover, our ability to rely onsome of these alternatives could be affected by factors such as the liquidityof the Russian and other financial markets, prevailing interest rates, ourcredit rating and the Russian government’s policies regarding ruble and foreigncurrency borrowings.

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.

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**Contractualobligations and commercial commitments**

Thefollowing table sets forth the amount of our contractual obligations andcommercial commitments as of December 31, 2005.****

| ** **                                                                                                                  | ** ** | ** **                                             | ** ** | **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)                                                                                                   |       | 389,411                                                |       |                                      | 389,411    |   |   | — |   |   | — |   |   |   | — |   |   |
| Long-Term  Debt Obligations(1)                                                                                              |       | 45,615                                                 |       |                                      | —     |   |   | 43,262 |   |   | — |   |   |   | 2,353 |   |   |
| Operating Lease  Obligations(2)                                                                                             |       | 147,879                                                |       |                                      | 2,599      |   |   | 5,906 |   |   | 7,140 |   |   |   | 132,234 |   |   |
| Purchase  Obligations(3)                                                                                                    |       | 32,832                                                 |       |                                      | 32,832     |   |   | — |   |   | — |   |   |   | — |   |   |
| Restructured  Taxes Payable(4)                                                                                              |       | 41,614                                                 |       |                                      | 7,748      |   |   | 28,538 |   |   | 5,328 |   |   |   |   |   |   |
| Asset Retirement  Obligations(5)                                                                                            |       | 59,052                                                 |       |                                      | 4,236      |   |   | 10,524 |   |   | 7,243 |   |   |   | 37,049 |   |   |
| Pension and Post-retirement  Benefits(6)                                                                                    |       | 64,903                                                 |       |                                      | 9,207      |   |   | 9,208 |   |   | 10,945 |   |   |   | 35,543 |   |   |
| Short-term  Finance Lease Obligations(7)                                                                                    |       | 887                                                    |       |                                      | 887        |   |   |   |   |   |   |   |   |   |   |   |   |
| Long-term Finance  Lease Obligations(7)                                                                                     |       | 9,179                                                  |       |                                      | —     |   |   | 2,340 |   |   | 3,381 |   |   |   | 3,458 |   |   |
| Contractual commitments  to acquire plant, property and equipment, raw materials and for delivery of  goods and services(8) |       | 503,457                                                |       |                                      | 283,349    |   |   | 220,108 |   |   | — |   |   |   | — |   |   |
|                                                                                                                             |            |                                                        |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Does not includeinterest. In 2005, our interest expense was $40.8 million and we paid out$43.4 million for interest, net of amounts capitalized.

(2)          See note 21 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 $137.0 million in current periodtaxes and social contributions due as of December 31, 2005. Seenote 14 to our consolidated financial statements. This also does notinclude income taxes. In 2005, our income tax expense amounted to$136.6 million and we paid out $171.8 million in income taxes.

(5)          See note 15 to ourconsolidated financial statements.

(6)          See note 16 to ourconsolidated financial statements.

(7)          See note 17 to ourconsolidated financial statements.

(8)          See note 24 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 of acquisition(August 2002). For Mechel Campia Turzii, we committed to invest$22.7 million over a period of five years from the date of acquisition (June 2003).As of December 31, 2005, the total of unfulfilled commitments wasapproximately $12.2 million. These investments are required to be made inannual installments from the dates of their respective acquisitions, and ourinvestment commitments are secured by our shares in these subsidiaries. Inaddition, upon our acquisitions of Mechel Targoviste and Mechel Campia Turzii,as part of the purchase agreements, we committed to the Romanian government toinvest $7.3 million and $4.6 million, respectively, intoenvironmental protection and reclamation. Our environmental obligations perthese privatization agreements as of December 31, 2005 were $1.1 million.

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We have also guaranteedthe fulfillment of obligations to third parties under various debt agreements.The maximum potential amount of future payment under these guarantees as of December 31,2005 amounted to $448.7 million out of which $447.2 million related toguarantees given by us for our subsidiaries.

**Inflation**

Inflation in the RussianFederation was 12.0% in 2003, 11.7% in 2004 and 10.9% in 2005. 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, appraisals, comparisons totransactions for similar assets and liabilities and present value of estimatedfuture cash flows, among others. Since these estimates involve the use of significantjudgment, 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 

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the acquisition closing dateto finish these fair value determinations and finalize the purchase priceallocation.

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 in impairment.

For the investees accounted for under the equity method, the excess of costof the stock of those companies over the 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 notamortized, but tested for impairment at least annually and on an interim basiswhen an event occurs or circumstances change between annual tests that would more-likely-than-notresult in impairment.

As of December 31,2005, 2004 and 2003, we reported goodwill of $39.6 million,$39.4 million and $5.4 million, respectively. During the years ended December 31,2005, 2004 and 2003, 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 of December 31,2005, 2004 and 2003, the carrying amount of our mineral licenses amounted to$303.4****million, $166.5 million and$160.1 million, respectively.

**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.

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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 at December 31,2005) to 2% (applied to the part of the annual gross salary above 600,000rubles or approximately $21,000 translated at the exchange rate of the ruble tothe U.S. dollar at December 31, 2005) to the annual gross remuneration ofeach employee. UST is allocated to three social funds (including the RussianPension Fund), where the rate of contributions to the 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 31,2005, 2004 and 2003 were $47.9 million, $39.5 million and $25.9 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 pension andpost retirement plans are performed on a voluntary basis. We account for thecost 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 ratedlong-term bonds.

**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.

**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.

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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 the Impairmentor Disposal of Long-Lived Assets”, which addresses financial accountingand reporting for the impairment and disposal of long-lived assets, and SFASNo. 142, with respect to impairment of goodwill. We review the carrying valueof its long-lived assets, including property, plant and equipment, investments,goodwill, licenses to use mineral reserves (inclusive of capitalized costsrelated to assets retirement obligations (ARO)), and intangible assets, forimpairment whenever events or changes in circumstances indicate that thecarrying amount of such assets may not be fully recoverable as prescribed bySFAS No. 144 and SFAS No. 142. Recoverability of long-lived assets, excludinggoodwill, is assessed by a comparison of the carrying amount of the asset (orthe group of assets, including the asset in question, that represents thelowest level of separately-identifiable cash flows) to the total estimatedundiscounted cash flows expected to be generated by the asset or group ofassets. If the estimated future net undiscounted cash flows are less than thecarrying amount of the asset or group of assets, the asset or group of assetsis considered impaired and expense is recognized equal to the amount requiredto reduce the carrying amount of the asset or group of assets to their fairvalue. Fair value is determined by discounting the cash flows expected to begenerated by the asset, when the quoted market prices are not available for thelong-lived assets. For assets and groups of assets relating to and includingthe licenses to use mineral reserves, future cash flows include estimates ofrecoverable minerals, mineral prices (considering current and historicalprices, price trends and other factors), production levels, capital andreclamation costs, all based on the engineering life of mineplans. Recoverable minerals refer to the estimated amount that will be obtainedfrom proven and probable reserves. Estimated future cash flows are based onassumptions and are subject to risk and uncertainty.

SFAS No. 142 prohibits the amortization of goodwill and negative goodwill.Instead, goodwill is tested for impairment at least annually and on an interimbasis when an event occurs or circumstances change between annual tests thatwould more-likely-than-not result in impairment. Under SFAS No. 142, goodwillis assessed for impairment by using the fair value based method. We determinefair value by utilizing discounted cash flows. The fair value test required bySFAS No. 142 for goodwill includes a two-step approach. Under the first step,companies must compare the fair value of a “reporting unit” to its carryingvalue. A reporting unit is the level at which goodwill impairment is measuredand it is defined as an 

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operating segment or one level below itif certain 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 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 fair value of the reporting unit isallocated to all of the reporting unit’s assets and liabilities (a hypotheticalpurchase price allocation). SFAS No. 142 requirescompanies to perform the impairment test at least annually.

If goodwill and another asset (or asset group) of a reportingunit are tested for impairment at the same time, the other asset (or assetgroup) shall be tested for impairment before goodwill. If the asset group wasimpaired, 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 and changein market environment. As a result of this analysis, we concluded that noimpairment 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 ofDecember 31, 2005, the carrying value of property, plant and equipment of theseworkshops was $5.8 million for Mechel Targoviste and $6.8 million for MechelCampia Turzii and was written off in full amount. As of December 31, 2005, wereviewed the remaining property, plant and equipment of these Romaniansubsidiaries for impairment. As a result of such impairment analysis, we didnot 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,then an increase in the valuation reserve will be required, with acorresponding charge against income. On the other hand, if future taxableincome exceeds the level that has been assumed in calculating the deferred taxasset, the valuation reserve could be reduced, with a corresponding credit toincome.

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**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 SFAS No. 143,“Accounting for Asset Retirement Obligations,” which applies to legalobligations associated with the retirement and removal of long-lived assets.SFAS No. 143 requires entities to record the fair value of an assetretirement obligation (ARO) as a liability in the period when it is incurred(typically when the asset is installed at the production location). When theliability is recorded, the entity capitalizes the cost by increasing thecarrying amount of the related properties, plant and equipment. Over time, theliability is increased for the change in its present value each period, and thecapitalized cost is depreciated over the useful life of the related asset.

Uponadoption of SFAS No. 143 on January 1, 2003, we recordedapproximately $3.8 million, net of taxes, as a charge to cumulativeeffective changes in accounting principles. Application of this new accountingprinciple resulted in an increase in property, plant and equipment of$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. The following table summarizes the balancesheet impact of our initial adoption of SFAS No. 143 as of January 1,2002, computed on a pro forma basis as if the provisions of SFAS No. 143had been applied during all periods affected:

| ** **                                                      | ** ** | **Balance at  January 1, 2003**        | ** ** | **Pro forma  Balance at  January 1, 2002** | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **(in millions of U.S. dollars)** | ** ** |
| Asset retirement  cost included in the related mining assets    |       |                                                  | 7,966      |                                                           |       |   | 4,093 |   |   |
| Accumulated  depreciation of capitalized asset retirement costs |       |                                                  | (2,492     | )                                                              |       |   | (2,052 | ) |   |
| Asset retirement  cost, included in mining assets, net          |       |                                                  | 5,474      |                                                           |       |   | 2,041 |   |   |
| Asset retirement  obligation                                    |       |                                                  | 9,262      |                                                           |       |   | 4,290 |   |   |

 

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We have numerous assetremoval obligations that we are required to perform under law or contract oncean asset is permanently taken out of service. Most of these obligations are notexpected to be paid until many years into the future and will be funded fromgeneral company resources at the time of removal. Our asset retirementobligations primarily relate to our mining and steel production facilities withrelated to landfills and dump areas and our mines. The following table presentsthe movements in ARO for the year ending December 31, 2005.

| **Asset retirement obligation**      | ** ** | ** ** | ** ** | **Year ended  December 31, 2005** | ** ** |
|------------------------------------------------|------------|------------|------------|--------------------------------------------------|------------|
| Balance at beginning of  year                  |       |       | 74,977     |                                             |       |
| Liabilities incurred in  the current period    |       |       | —     |                                             |       |
| Liabilities settled in  the current period     |       |       | (2,249     | )                                                |       |
| Liabilities disposed of  in the current period |       |       | (9,091     | )                                                |       |
| Accretion expense                              |       |       | 3,248      |                                             |       |
| Revision in estimated  cash flow               |       |       | (4,501     | )                                                |       |
| Translation and other                          |       |       | (3,332     | )                                                |       |
| Balance at end of year                         |       |       | 59,052     |                                             |       |

 

**Recently Issued Accounting Pronouncements**

**Inventory costs**

In December 2004, the FASB issuedSFAS No. 151, “Inventory costs” (“SFAS No. 151”), which amendsARB 43, Chapter 4, to clarify that abnormal amounts of idle facilityexpenses, freight, handling costs and wasted materials (spoilage) should berecognized as current period expenses. In addition, SFAS No. 151 requiresthat allocation of fixed production overhead to the costs of conversion bebased on the normal capacity of the production facilities. The provisions ofSFAS No. 151 are effective for inventory costs incurred during fiscalyears beginning after June 15, 2005. We will apply the provisions of theStatement prospectively to inventory costs incurred on or after January 1,2006. The adoption of this standard is not expected to have a material impacton 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”). SFAS No. 123Restablishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services. It also addressestransactions in which an entity incurs liabilities in exchange for goods orservices that are based on the fair value of the entity’s equity instruments orthat may be settled by the issuance of those equity instruments. SFAS No. 123Rrequires a public entity to measure the cost of employee services received inexchange for an award of equity instruments based on the grant-date fair valueof the award (with limited exceptions). SFAS No. 123R is effective as ofthe beginning of the first interim or annual reporting period that begins afterJune 15, 2005. The adoption of this standard did not have a materialimpact 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 APBOpinion No. 29” (“SFAS No. 153”). SFAS No. 153 amends Opinion 29to eliminate the exception for non-monetary exchanges of similar productiveassets and replaces it with a general exception for exchanges of non-monetaryassets that 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.

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**Accounting for conditional assets retirement 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 asset retirementactivity in which the timing and/or method of settlement is conditional on afuture event that may or may not be within the control of the entity. TheInterpretation is effective for fiscal years ending after December 15,2005. The adoption of FIN 47 is not expected to have a material impact on ourfinancial position and results of operations.

**Accounting for stripping costs incurred during production in the miningindustry**

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 first reporting period in fiscal yearsbeginning after December 15, 2005. The adoption of EITF 04-6 is notexpected to have a material impact on our financial position and results ofoperations.

**Accounting for preexisting relationships between the parties to a businesscombination**

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 reachedconsensus on Issue 04-3, “Mining Assets: Impairment and BusinessCombinations” (“EITF 04-3”). EITF 04-3 relates to estimating cashflows used to value mining assets or assess those assets for impairment. Wecurrently assess impairment on the projected mine life of each projectutilizing existing technology. The adoption of EITF 04-3 in 2005 did nothave a material impact 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.

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**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 after January 1,2006, with early adoption permitted. We will begin applying the provisions ofthis statement in 2006. The adoption of SFAS No.154 is not expected to have amaterial 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 onIssue No. 04-13 “Accounting for purchases and sales of inventorywith the same counterparty” (“EITF 04-13”). EITF 04-13 relates todefining the circumstances under which two or more inventory purchase and salestransactions with the same counterparty should be viewed as a single exchangetransaction; and defining whether there are circumstances under whichnonmonetary exchanges of inventory within the same line of business should berecognized at fair value. EITF 04-13 is effective prospectively for newarrangements entered into, and modifications or renewals of existingarrangements, beginning in the first interim or annual reporting periodbeginning after March 15, 2006. We will begin applying the provisions ofthis statement in 2006. The adoption of EITF 04-13 is notexpected to have a material impact on our financial position and results ofoperations.

**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 after September 15,2006. We will begin applying the provisions of this statement in2007. The adoption of SFAS No. 156 is not expected to have a material impacton our financial position and results of operation.

**Trend Information**

**Coal industry**

The Asian countries areamong the world’s major net importers of sea-borne steam and coking coal.During 2005, their demand for coking coal was generally satisfied, and duringthe second half of the year the spot prices for coal decreased when thebottlenecks in Australia and South Africa (railway restrictions and loadingcapacities) were successfully overcome; today there is no deficit for coal onthe international markets. Announced plans for supply increases in Australiaare expected to match the expected longer-term increases in demand fromBrazil and India. That projected balance makes forecasts for coking coal pricesrelatively stable. Coking coal prices are dependent on the situation in thesteel industry, and we think they are likely to remain high in 2006, because ofgrowing worldwide steel production, mostly in Asia. The steam coal market isdriven by non-steel related factors, and we expect prices to decrease slightlyin the near future due to the growth of world’s steam coal productioncapacities, before correcting upwards in 2008, when we expect increased demandwill be driven by growth from power and industrial users, price growth for oiland gas and restocking. In terms of energy coal, we expect prices to decreaseover the next two years before increasing again in 2008. Coke supply remainsabundant due to high volumes of production in China, as well as reducedsteelmaking activity in Europe, which makes the outlook for coking coal pricesweak for the foreseeable future.

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**Iron ore industry**

The iron ore market iscurrently characterized by high demand from Asia and supply and transportationconstraints. Capacity expansions are primarily targeted to meeting the demandincrease, generated primarily in China. The outlook for the rest of 2006 andbeyond will depend on supply and demand balance in the industry, but we do not anticipatethat the increase in iron ore production will be such as to shift this balancesignificantly in the near term. We think that prices worldwide for iron orewill increase due to continuous growth of demand in China, despite of theattempts of the Chinese government to reduce steel production capacities.Moreover, Japanese steelmakers have already accepted a price increase for their2006 fiscal year, which runs from April 1 to March 31. We believethat prices for iron ore will remain at high levels until 2008, when the world’sthree major producers, CVRD, Rio Tinto Group and BHP Billiton, which togethercontrol 70% of worldwide iron ore supplies, are planning to finish capacityexpansion programs.

**Nickel industry**

Nickel prices haveincreased since 2001. We believe this increase is due primarily to the rapidgrowth in value of stainless steel and the difficulty in expanding nickelextraction capabilities. Nickel prices also were driven upwards by strikes atthe mines of two of the world’s major producers (Inco and Falconbridge),speculative trading at LME and a decrease in nickel storage stock. We believethat in 2006, nickel supply will increase as more nickel mines becomeoperational, and the demand will decrease due to a slowdown in the worldeconomy and the active use of substitutes (mostly chrome and manganese),including a reduced demand in China, where production of stainless steel isnear planned capacity. We believe that the combination of these factors willlead to a decrease in nickel prices, which we project to be in the range of$12.5-$13 thousand per tonne for 2006, a decrease of 15%-17%from 2005.

**Steel industry**

We expect the Russian steel industry to continue tobenefit from both domestic and global demand for steel. In 2005, domesticconsumption of steel products rose 10.6% year-on-year and we expect domesticconsumption to continue to grow, with engineering and construction being themain drivers of domestic demand for metal products. The construction industry,in particular, is the most dynamically developing sector, with a projectedannual growth rate of approximately 6.7% in 2006.

The global demand for steel for the last ten years hasbeen increasing by 5% per annum, and is expected to remain relatively strong inthe near term, despite a decrease in Chinese demand. More control overproduction capacity in China has already caused supplies to decrease and helpedto increase steel products prices on the Asian markets. During the period oflow steel prices, many producers reduced their outputs, which resulted inreductions in steel inventory levels. These reductions may support steel pricesin the near term, although likely not at the levels recently seen. The extentto which this happens will depend on a number of factors, including primarilythe sustainability of Asian demand in the face of a slowdown in China and theextent and pace of economic growth in Europe and the United States.

Steel prices remainedstrong through 2004, with the market beginning to deteriorate after peakingduring the first quarter of 2005 and declining through the second quarter.Prices for steel products were weak in the second half of 2005. By the end ofthe year, the decrease in world steel production outside China led to a slightdeficit of steel on the global markets, which resulted in a stabilizing ofprices at the end of 2005. In 2006, world steel production is expected to growby 5%, while the consumption growth is predicted to grow only 4%, a combinationthat should lead to a continued weakening of steel prices throughout 2006. Weexpect steel prices in Russia to generally track international 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 export of iron ore concentrate will decrease, and most of our iron oreconcentrate production will be supplied to the sinter plant at ChelyabinskMetallurgical Plant. We believe that this expected increase in our miningsegment may help to counter-balance the expected downturn in steelprices. Overall, our steel segment, in the context of declining steel pricesand minor increases, if any, in our steel production, we expect our steelsegment sales to decline.

**Inventory**

Overall, our inventory was$546.6 million at December 31, 2005, as compared to$568.5 million at December 31, 2004. The slight decrease is mainlyexplained by the decrease of steel segment stock due to the decrease of cost ofproduction in the fourth quarter of 2005 due to a decrease in raw materialscosts (mainly coal and iron ore).

**Costs**

Our steel costs per tonne should remain relatively stable,as higher production volumes, cost savings from the continuing integration ofour recent steel acquisitions and efficiency and output gains arising as aresult of the targeted capital expenditure program, particularly at ChelyabinskMetallurgical Plant, help to offset increasing payroll costs and raw materialprices and potential increases in electricity and natural gas tariffs.Specifically, as we continue to introduce operational and technical changes atour plants allowing us to better integrate their products, we expect to bebetter able to control our cost increases. The new sinter plant at Chelyabinskwill allow us to substantially increase our ability to internally source ouriron ore feed requirements, without the need to utilize third-party processing,while the increasing use of continuous casters should provide both efficiencyand production increases. We also expect these technology improvements toreduce our energy requirements per tonne, partially reducing the impact ofpotential increases in electricity and natural gas tariffs.

Within our mining segment,we expect our coal costs per tonne to increase gradually as a result ofincreasing payroll and materials costs, while nickel costs per tonne shouldremain relatively stable in 2006. We expect our iron ore costs per tonne toremain relatively stable in 2006.

**Seasonality**

Seasonal effects have a relatively limited impact onour results. Nonetheless, slowing of demand and, thus, a reduction in salesvolumes (and a concomitant 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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***Item 6.*   Directors, Senior Managementand Employees**

**Directors andExecutive Officers**

Ourdirectors and executive officers include:

| **Name**                 | ** ** | ** ** | ** ** | **Year of  Birth**                                   | ** ** | **Position** |
|--------------------------|------------|------------|------------|------------------------------------------------------|------------|--------------|
| Igor V. Zyuzin(1)        |       | 1960       |       | Chairman                                             |
| Vladimir F. Iorich(1)(2) |       | 1958       |       | Director and Chief  Executive Officer                |
| Alexey G. Ivanushkin(2)  |       | 1962       |       | Director and Chief  Operating Officer                |
| Sir Andrew M. Wood(3)(4) |       | 1940       |       | Director                                             |
| Roger I. Gale(3)         |       | 1952       |       | Director                                             |
| A. David Johnson(3)      |       | 1937       |       | Director                                             |
| Serafim V. Kolpakov      |       | 1933       |       | Director                                             |
| Alexander E. Yevtushenko |       | 1947       |       | Director                                             |
| Valentin V. Proskurnya   |       | 1945       |       | Director                                             |
| Alex Polevoy             |       | 1973       |       | Chief Financial Officer                              |
| Vladimir I. Tytsky       |       | 1950       |       | Senior Vice  President—Strategy and Integration |
| Vladimir A. Polin        |       | 1962       |       | Senior Vice  President—Production               |
| Boris G. Nikishichev     |       | 1946       |       | Senior Vice  President—Mining                   |
| Andrey Parkhomchouk      |       | 1972       |       | Senior Vice President—Sales and Procurement     |

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(1)          Party to the Ownership,Control and Voting Agreement dated August 1, 1995. See “Item 7. MajorShareholders and Related Party Transactions—Major Shareholders” and “Item 3.Key Information—Risk Factors—Risks Relating to Our Business and Industry—We arecontrolled by two shareholders who run our business collectively and whoseinterests could conflict with those of the holders of our securities.”

(2)          Mr. Ivanushkin willassume the title of Chief Executive Officer when Mr. Iorich will have disposedof his stake in Mechel and stepped down as our Chief Executive Officer.

(3)          Member of the AuditCommittee of the Board of Directors.

(4)   Sir Andrewhas informed us that he does not intend to continue serving on our board ofdirector after his current term expires in June 2006.

**Igor V. Zyuzin** hasbeen the Chairman of our Board of Directors since March 2003, when Mechelwas organized. Mr. Zyuzin also serves as the Chairman of the Board ofDirectors of our Southern Kuzbass Coal Company, a position he has held since May 1999.From 1997 to 1999, Mr. Zyuzin was the Chairman of the Board of Directorsof Mezhdurechensk Coal Company, which was merged into Southern Kuzbass CoalCompany, and a member of the Board of Directors of Kuzbass Central ProcessingPlant. Mr. Zyuzin has over 16 years of experience in the coal miningindustry and holds a degree in coal mining from Tula Polytechnic Institute. Mr. Zyuzinalso has a degree in coal mining engineering economics. Mr. Zyuzinbeneficially owns 52.2% of our common shares.

**Vladimir F. Iorich**has been our Chief Executive Officer since January 2004 and member of ourBoard of Directors since March 2003. From 1995 through 2004, Mr. Iorichhas served as the President of Mechel Trading AG, overseeing our export salesand financing. From 2001 to 2004, he served as a member of the Board ofDirectors of MMK, a major Russian steel producer. Mr. Iorich has over23 years of engineering, marketing and management experience in the coalmining industry, and holds a degree in engineering and economics from KuzbassTechnical University. From 1995 through 2004, Mr. Iorich was the Directorof Conares Holding AG. Mr. Iorich beneficially owns 20.8% of our commonshares.

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**Alexey G. Ivanushkin** has been our Chief Operating Officer since January 2004and a member of our Board of Directors since March 2003. Mr. Ivanushkinserved as our Chief Executive Officer from March 2003 until January 2004.From December 1999 to April 2002, Mr. Ivanushkin served as theGeneral Director of our Chelyabinsk Metallurgical Plant. From 1993 to November 1999,he was the director of the ferrous metals and ferroalloy department of theMoscow office of Glencore International AG, an international diversifiednatural resources group from whom we acquired Chelyabinsk Metallurgical Plant. Mr. Ivanushkingraduated from the Moscow State University of Foreign Relations (MGIMO) with adegree in economics and international affairs.

**Sir Andrew M. Wood**has been a member of our Board of Directors since October 2004. He is alsocurrently Chairman of the Board of the Russo-British Chamber of Commerce,a Director of the Foreign and Colonial Investment Trust, and a Director of ThePBN Company. Sir Andrew retired from the British Diplomatic Service in 2000after serving as Ambassador to Moscow from 1995 to 2000 and Ambassador toBelgrade from 1985 to 1989. This latest posting in Moscow was the third of hispostings to Russia’s capital, where he began his diplomatic career in 1964. Healso twice served in the British Embassies in both Washington, DC, andBelgrade. Sir Andrew has acted as adviser to the British Prime Minister, TonyBlair, on Russian investment issues and has worked with a number ofmultinationals at the CEO and board level, including BP, GlaxoSmithKline,Diageo and Renaissance Capital. He is a member of the Advisory Council of theBritish Consultants and Construction Bureau, and has worked closely with theConfederation of British Industry on Russia-related matters. Sir Andrewreceived his B.A. and M.A. from King’s College, Cambridge.

**Roger I. Gale** hasbeen a member of our Board of Directors since October 2004. Mr. Galeis currently Chairman of the Board of Directors and Chief Executive Officer ofWavecrest Group Enterprises Limited, a communications service provider. He isalso a founder and director of Starnorth Limited, a communications and mediaconsultancy. From 1999 to 2001, he was Chairman and co-founder of End2EndWireless Limited, a wireless access services provider. From 1996 to 1998, Mr. Galewas Chief Executive Officer of AIG-Brunswick Capital Management, a$300 million Russian investment fund. From 1988 to 1996, Mr. Galeworked for the International Finance Corporation, or IFC, including as theChief of IFC’s Resident Mission to the Russian Federation from 1991 to 1996. Mr. Galealso worked for the Asian Development Bank for nine years, and has lectured ineconomics at the University of New England (Australia) and Lincoln College (NewZealand). Mr. Gale holds a Higher National Diploma from The RoyalAgricultural College and holds a Master of Economics from the University of NewEngland.

**A. David Johnson**has been a member of our Board of Directors since October 2004. Mr. Johnsonis currently Chairman of the Board of Directors of Joy Mining MachineryUK Ltd., a leading global supplier of underground mining systems andservices, a position he has held since 2002. From 1990 to 2002, Mr. Johnsonwas Managing Director of Joy Mining Machinery UK Ltd. From 1986 to 1990, Mr. Johnsonwas the Managing Director of Dosco Overseas Engineering, a UK-based miningequipment manufacturer, where he began as a mining engineer in 1960. He alsoworked at the UK National Coal Board from 1953 to 1960. Mr. Johnson is JoyMining Machinery’s representative on both the Coal Industry Advisory Board andthe World 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 since June 2004. Since 1992, Dr. Kolpakovhas served as President of the International Metallurgists Union, a steelindustry-focused research organization. From 1991 to 1992, he was VicePresident of the Advanced Materials Association in Moscow, a public consultingand research organization. From 1985 to 1991, Dr. Kolpakov was Minister ofMetallurgy of the USSR and, from 1978 to 1985, First Deputy Minister and DeputyMinister of Metallurgy of the USSR. From 1970 to 1978, he was the GeneralDirector of Novolipetsk Iron and Steel Works, a 

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Russian integrated steelmill, where he began as a foreman in 1963. Dr. Kolpakov graduated from theMoscow Institute of Steel and Alloys with an engineering degree and is a Doctorof Technical Sciences. He is a member of the International Engineering Academy,the Engineering Academy of Russia (holding the position of Vice President) andthe Presidium of Academy of Information Technologies and Processes. Dr. Kolpakovhas invented more than 400 steel-making technology improvements, andauthored over 500 scientific publications. He has received a number ofgovernment awards, including the State Prize of the USSR in 1981 and 1985, thePrize of the Council 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 since June 2004. From 2001 to2004, Dr. Yevtushenko served as First Vice President of Sokolovskaya OAO,a holding company for a group of Russian coal mining and engineeringenterprises. From 1999 to 2000, he was President of the General Committee ofInter-State Eurasian Association of Coal and Metals. From 1992 to 1999, Dr. Yevtushenkowas First Deputy Fuels and Energy Minister of the Russian Federation. From 1973to 1991 he worked in various positions, including as General Director atRaspadskaya Mine in Kuzbass, one of the Soviet Union’s largest coal mines. Dr. Yevtushenkograduated from the Siberian Metallurgical Institute with a degree in miningengineering. He is a Doctor of Engineering and a member of Academy of MiningSciences of Russia. Dr. Yevtushenko is the author of more than 50scientific publications, including “Mineral Resources of the Coal Industry ofRussia,” a study for which he was awarded the 2002 Science and Technology Prizeof the Russian government. He has received a number of government awards,including the title of Honorable Miner of the Russian Federation in 1997.

**Valentin V. Proskurnya**has been a member of our Board of Directors since March 2003. Prior to April 2005,Mr. Proskurnya served as a member of the Board of Directors of MMK, amajor Russian steel producer. Mr. Proskurnya also serves as a member ofthe Board of Directors of our subsidiaries Chelyabinsk Metallurgical Plant andSouthern Kuzbass Coal Company. 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. Proskurnyaserved as the First Deputy Director of our Southern Kuzbass Coal Company, incharge of economic and financial analysis. Mr. Proskurnya has over37 years of engineering, financial and management experience in the coalmining industry and holds a degree in labor economics from the Higher School ofTrade Unions. Mr. Proskurnya has been decorated with all three grades ofthe “Miner’s Glory” order by the Russian government. In addition, in 1996, theRussian government awarded him the title of Honorable Economist of the RussianFederation.

**Alex Polevoy**has been our****Chief Financial Officer since October 2005. From 2004to August 2005, Mr. Polevoy served as the Director of the CorporateAudit Department of TNK-BP Management, a holding company for oil-relatedcompanies. From 2001 to 2004, he held the position of Head of Monitoring andControl Group of TNK-BP Management. Mr. Polevoy graduated from NorthernAlberta Institute, Canada, with a degree in management and accounting.

**Vladimir I. Tytsky**has been our Senior Vice President—Strategy and Integration since March 2003.He was also a member of our Board of Directors from March 2003 to June 2004.From 2002 to 2003, Mr. Tytsky also served as Deputy General Director ofMechel Trading House, in charge of marketing and sales. From 1972 through 2002,he occupied various positions at Chelyabinsk Metallurgical Plant, including10 years as the Deputy General Director—Marketing and Sales. Mr. Tytskyholds a degree in chemistry and technology from Dnepropetrovsk MetallurgyInstitute.

**Vladimir A. Polin**has been our Senior Vice President—Production since July 2003. From August 2002until June 2003, Mr. Polin served as the Executive Director—FirstDeputy General Director of our Beloretsk Metallurgical Plant. From September 2001to August 2002, Mr. Polin was Sales Director at ChelyabinskMetallurgical Plant. Mr. Polin has almost 20 years of floor andmanagement experience in the 

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manufacture and marketingof steel products, and holds a degree in metallurgy from ChelyabinskPolytechnic University.

**Boris G. Nikishichev**has been our Senior Vice President—Mining since February 2005. From April 2004to January 2005, Mr. Nikishichev was the Deputy General Director ofRaspadskaya Coal Company ZAO, a large coal mining company located in Kusbass,Russia. From 1998 to 2004, Mr. Nikishichev was the First Vice President,Sokolovskaya Holding Company. In addition, from 1999 to 2004, Mr. Nikishichevwas the First Vice President of Mining Industrialists of Russia, anon-commercial partnership. Mr. Nikishichev has over 35 years ofmining industry experience. Mr. Nikishichev holds a doctorate in miningproduction from Moscow State Mining University.

**Andrey Parkhomchouk** has been our Senior Vice President—Sales andProcurement since January 2006. From June 2004 to January 2006,Mr. Parkhomchouk was the Director of our Department of Steel ProductsSales and Procurement. From June 2003 to June 2004, Mr. Parkhomchoukwas the Deputy Director for Sales in Mechel Trading House. From December 2001to June 2003, Mr. Parkhomchouk headed the Beloretsk branch of MechelTrading House and hardware department of Mechel Trading House. From 1999 to2001, Mr. Parkhomchouk worked in sales in certain of our other companies,including positions in the marketing department of Chelyabinsk MetallurgicalPlant. Mr. Parkhomchouk graduated from the Chelyabinsk State TechnicalUniversity with a degree in engineering. Mr. Parkhomchouk also holds anMBA from the Higher School of Business of the Moscow State University.

All of our directors wereelected on June 28, 2005 , and their terms expire on the date of our nextannual shareholders’ meeting, which will take place on or prior to June 30,2006. The business address for all our directors and executive officers isKrasnopresnenskaya Naberezhnaya 12, Moscow 123610, Russian Federation.

**Compensation**

Our directors andexecutive officers were paid an aggregate of $5.0 million for services inall capacities provided to us during 2005. The total amount set aside forpension, retirement and other similar benefits for our directors and executiveofficers as of December 31, 2005, was $0.03 million. Our directors andexecutive officers are also provided with voluntary medical insurance and theuse of wireless services.

**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 for one-yearterms and may be re-elected an unlimited number of times. Our Board ofDirectors currently consists of nine members, five of whom are independent. TheBoard of Directors is responsible for our overall management, except mattersreserved for our shareholders. See “Item 10. Additional Information—Charter andCertain Requirements of Russian Legislation—General Meetings of Shareholders”for more information regarding the competence of our shareholders’ meetings.Some of the members of our Board of Directors, as well as the members of theboards of directors of our subsidiaries, serve pursuant to contracts. Thesecontracts do not provide for any benefits upon termination of theirdirectorship.

**Audit Committee**

Our audit committeeconsists of Roger Gale, Sir Andrew Wood and David Johnson, each of whom is anon-management member. Our audit committee operates pursuant to a bylaw, whichis available at 

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www.mechel.com.The purpose of this committee is to assist the Board with its oversightresponsibilities regarding:

·       the quality and integrityof our financial statements;

·       our compliance with legaland regulatory requirements;

·       theindependent auditor’s qualifications and independence; and

·       the performance of ourinternal 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 reviewcommission are nominated and elected by our shareholders for a term of oneyear. A director may not simultaneously be a member of the review commission.Our review commission currently has three members: Dmitry Kletsky, LyudmilaRadishevskaya and Eleonora Zolotareva. The powers and duties of our reviewcommission were determined by regulations approved by our shareholders’meeting.

**Corporate GovernancePrinciples**

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:

·  the Charter;

·  the Bylaw on the Board of Directors;

·  the Bylaw on the General Meeting ofShareholders;

·  the Bylaw on the General Director;

·  the Bylaw on the Audit Committee of the Boardof Directors;

·  the Code of Business Conduct and Ethics; and

·  the Bylaw on the Prohibition and Prevention ofInsider Trading.

These documents are available at www.mechel.com.

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.

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**Employees**

At December 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         | % |   |
| Southern Kuzbass  Coal Company                  |       | Russia           |       | Coal                      |       |                      | 12,928     |                 |       |             | 88         | % |   |
| Izhstal                                         |       | Russia           |       | Steel                     |       |                      | 10,043     |                 |       |             | 95         | % |   |
| Beloretsk  Metallurgical Plant                  |       | Russia           |       | Steel                     |       |                      | 8,065      |                 |       |             | 96         | % |   |
| Mechel Campia Turzii                            |       | Romania          |       | Steel                     |       |                      | 5,024      |                 |       |             | 95         | % |   |
| Mechel Targoviste                               |       | Romania          |       | Steel                     |       |                      | 4,676      |                 |       |             | 96         | % |   |
| Southern Urals  Nickel Plant                    |       | Russia           |       | Nickel                    |       |                      | 4,327      |                 |       |             | 91         | % |   |
| Korshunov Mining  Plant                         |       | Russia           |       | Iron  Ore                 |       |                      | 4,308      |                 |       |             | 93         | % |   |
| Urals Stampings  Plant                          |       | Russia           |       | Steel                     |       |                      | 2,957      |                 |       |             | 96         | % |   |
| Vyartsilya Metal  Products Plant                |       | Russia           |       | Steel                     |       |                      | 471        |                 |       |             | 0          | % |   |
| Mechel Nemunas                                  |       | Lithuania        |       | Steel                     |       |                      | 375        |                 |       |             | 0          | % |   |
| Port Posiet                                     |       | Russia           |       | Shipping                  |       |                      | 337        |                 |       |             | 97         | % |   |
| Mechel Trading  House                           |       | Russia           |       | Sales  and Distribution   |       |                      | 310        |                 |       |             | 0          | % |   |
| Mechel                                          |       | Russia           |       | Corporate                 |       |                      | 220        |                 |       |             | 0          | % |   |
| Mechel-Service                                  |       | Russia           |       | Sales  and Distribution   |       |                      | 199        |                 |       |             | 0          | % |   |
| Mechel International  Holdings and subsidiaries |       | Switzerland      |       | Sales  and Distribution   |       |                      | 66         |                 |       |             | 0          | % |   |
| Other                                           |       | Russia, CIS |       | Coal,  Steel              |       |                      | 410        |                 |       |             | 0          | % |   |
| Total                                           |       |             |       |                      |       |                      | 78,426     |                 |       |             | 88         | % |   |

 

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 SmeltingTrade Union of Russia, employees of Urals Stamping Plant are members of RussianTrade Union of Machinists, and employees of Southern Kuzbass Coal Company aremembers of Russian Independent Trade Union of Coal Industry Workers and ofRussian Independent Trade Union of Miners. Employees of Port Posiet are membersof Russian Independent Trade Union of Dockers. Employees of Mechel Targovisteare members of Independent Trade Union of Mechel Targoviste.

We consider ourrelationship with our employees to be good.

**Management ShareBonus and Share Option Plans**

We are considering establishing a share bonus planand/or share option plan for officers and key employees. If we establish suchplans, we will set aside treasury shares in an amount not exceeding 2% of ouroutstanding common shares. The common shares to be delivered under these plansare currently owned by our wholly-owned subsidiary, Mechel InternationalHoldings. See “Item 7. Major Shareholders and Related Party Transactions—MajorShareholders.”

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***Item7.****                         *MajorShareholders and Related Party Transactions

**Major Shareholders**

Thefollowing table sets forth information regarding the beneficial ownership ofour shares as of May 18, 2006, based on our share register and certainadditional information provided by our major shareholders:

| **Name of Beneficial Owner** | ** ** | ** **  | ** ** | **Number of  Shares** | ** ** | **%** | ** ** |
|---------------------------------------------|------------|-------------|------------|----------------------------|------------|-------|------------|
| Igor V. Zyuzin(1)                           |       | 217,350,062 |       | 52.2                       | %          |
| Vladimir F.  Iorich(2)                      |       | 86,451,007  |       | 20.8                       | %          |
| Mechel  International Holdings AG(3)        |       | 12,996,208  |       | 3.1                        | %          |
| Free float(4)(5)                            |       | 99,473,468  |       | 23.9                       | %          |
| Total                                       |       | 416,270,745 |       | 100.00                     | %          |

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(1)          Mr. Zyuzin isChairman of our Board of Directors. See “Item 6—Directors, Senior Managementand Employees—Directors and Executive Officers.” His business address isKrasnopresnenskaya Naberezhnaya 12, Moscow 123610, Russian Federation. Of theshares beneficially owned by Mr. Zyuzin, 50,926,280.5 shares are heldthrough Conares Holding AG, a company he owns on an equal basis with Mr. Iorich.Mr. Zyuzin is a party to the Ownership, Control and Voting Agreement datedAugust 1, 1995. Mr. Zyuzin’s ownership includes 41,585,892 shares(including in the form of GDSs) owned by Calridge Limited, a company whollyowned by Mr. Zyuzin. Calridge Limited has pledged 20,454,545 shares in theform of GDSs to UBS AG (London Branch) in connection with its MandatoryExchangeable Notes due 2009, and has transferred 14,161,347 of these shares inthe form of GDSs to UBS Limited pursuant to a Stock Lending Agreement.

(2)          Mr. Iorich 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 Krasnopresnenskaya Naberezhnaya 12, Moscow 123610, RussianFederation. Of the shares beneficially owned by Mr. Iorich, 50,926,280.5shares are held through Conares Holding AG, a company he owns on an equal basiswith Mr. Zyuzin. Mr. Iorich is a party to the Ownership, Control andVoting Agreement dated August 1, 1995.

(3)          Mechel InternationalHoldings is wholly-owned by us. In our U.S. GAAP consolidated financialstatements, these shares are considered treasury shares.

(4)          We believe our directorsand executive officers as a group, other than Messrs. Zyuzin and Iorich,own less than 1% of our shares.

(5)          Includes sharesunderlying our ADSs and GDSs. As of May 18, 2006, 28,733,201 ADSs and 3,137,933GDSs were outstanding.

None of our shareholdershave voting rights different from any other holders of our shares. Based on ourshare register, we believe we are not directly or indirectly owned orcontrolled by another corporation or government, and that there are noarrangements the operation of which may result in a change of control otherthan as described below. In February 2006, Messrs. Zyuzin and Iorichreached an agreement pursuant to which Mr. Zyuzin will purchase Mr. Iorich’sentire stake in Mechel over the course of a year. In March-May 2006, Mr. Zyuzinpurchased a portion of Mr. Iorich’s stake, resulting in his stake inMechel increasing to 52.2% and Mr. Iorich’s stake decreasing to 20.8%.Prior to this transaction, Messrs. Zyuzin and Iorich had held equal stakesof 42.2%. Mr. Zyuzin intends to retain at least a 51% stake in Mechelafter the completion of the purchase of Mr. Iorich’s remaining stake.

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**Ownership, Controland Voting Agreement of August 1, 1995**

Our principalshareholders, Igor Zyuzin and Vladimir Iorich, have acted in concert since 1995pursuant to an Ownership, Control and Voting Agreement which requires them tovote the same way. The agreement also requires them to take all actions statedtherein on the basis of the principal of parity, including the following:

·       jointinvestment activities, which are defined in the agreement as acquisitions ofassets in the industry and service sectors;

·       totake all actions in relation to the management of joint assets pursuant only tomutual agreement;

·       inthe event that the parties cannot agree upon an action relating to a jointasset, to dispose of the asset and evenly split the benefits arising from thedisposition;

·       todistribute all profits, income and other tangible and/or intangible benefitsfrom their investment activity evenly;

·       tomaintain their ownership parity with respect to their combined stake in theassets acquired pursuant to the agreement so that, at all times, they own equalstakes in such assets (or, in the event that they do not own equal stakes, toensure that the principle of parity remains in place with respect to the rightsof, and benefits owed to, the party owning a lesser stake); and

·       toconduct all matters and/or relations between them that are not reflected in theagreement in accordance with the principle of parity.

The agreement is governed by the laws of Switzerland.Any dispute arising out of or in connection with the agreement will be settledby arbitration in accordance with the Swiss Rules of InternationalArbitration.

See also “Item 3. KeyInformation—Risk Factors—Risks Relating to Our Business and Industry—We arecontrolled by two shareholders who run our business collectively and whoseinterests could conflict with those of the holders of our securities.”

**Related PartyTransactions**

See note 9 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.

During the course of its liquidation, Mechel Zeljezara was exposedto potential tax claims. These tax claims resulted from the free transfer ofits assets to the Croatian Privatization Fund. We estimate that thepotential claims will not exceed $10.9 million and $14.0 million with respectto income tax and value added tax, respectively. We have not accrued for theseamounts in our consolidated financial statements as of December 31, 2005.

Korshunov Mining Plant is currently contesting in court $8.6 million in taxclaims related to mineral extraction tax for 2005. With respect to$1.9 million of these claims (relating to periods January-March 2005), inMay 2006 the court ruled in favor of the tax authorities. It is highly probablethat the court will rule in favor of the tax authorities with respect to theremaining claims of $6.9 million. We intend to 

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contest the May 2006 decision (as well assimilar decisions in the future) by appealing to higher courts. Tax authoritiesmay also claim additional severance tax in the amount of $5.5 million inconnection with their audits of 2002-2004 tax years, which are nowproceeding. We have not accrued for these amounts in our consolidated financialstatements as of December 31, 2005.

In April 2006, we became aware of unasserted claims related to ourChelyabinsk Metallurgical Plant’s non-compliance with certain pollution norms.While we have not been provided with any official information, we believe thata loss contingency is possible, but not probable. At present the risk cannot bereliably measured, but if the claims are issued, the amounts of fines andpenalties may be significant. We have not accrued for this risk in ourconsolidated financial statements as of December 31, 2005.

See note 24(b) and (d) toour consolidated financial statements for more details.

**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.”

Dividend payments,if any, must be recommended by our board of directors and approved by ourshareholders. In particular, dividends may be declared only out of net profitscalculated under Russian accounting standards and as long as the followingconditions 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 since December 31,2005.

***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 two most recent years.

| ** **           | ** ** | **ADSs** | ** ** | **Common Shares** | ** ** |
|----------------------|------------|----------|------------|------------------------|------------|
| ** **           | ** ** | **High** | ** ** | **Low**                | ** ** | **High** | ** ** | **Low** | ** ** |
| April 2006      |       | $        | 27.84      |                   | $          | 25.61 |   | $ | 9.20 |   | $ | 8.50 |   |
| March 2006      |       | $        | 28.23      |                   | $          | 23.86 |   | $ | 9.30 |   | $ | 8.40 |   |
| February 2006   |       | $        | 30.95      |                   | $          | 28.19 |   | $ | 10.20 |   | $ | 9.65 |   |
| January 2006    |       | $        | 29.00      |                   | $          | 24.98 |   | $ | 9.55 |   | $ | 8.45 |   |
| December 2005   |       | $        | 29.60      |                   | $          | 23.47 |   | $ | 9.72 |   | $ | 7.75 |   |
| November 2005   |       | $        | 30.80      |                   | $          | 26.35 |   | $ | 9.90 |   | $ | 8.97 |   |
| 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 |   |
| Fourth Quarter  2004 |       | $        | 22.45      |                   | $          | 15.79 |   | $ | 17.00 |   | $ | 2.85 |   |
| Third Quarter  2004  |       | —   |       | —                 |       | $ | 3.80 |   | $ | 1.40 |   |
| 2005                 |       | $        | 36.51      |                   | $          | 21.05 |   | $ | 11.20 |   | $ | 7.75 |   |
| 2004                 |       | $        | 22.45      |                   | $          | 15.79 |   | $ | 17.00 |   | $ | 1.40 |   |

 

***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 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 requires us to dispose of any of our shares that we acquirewithin one year of their acquisition or, failing that, reduce our chartercapital. We refer to such shares as treasury shares for purposes hereof.Russian legislation does not allow for the voting of such treasury shares. Anyof our shares that are owned by our subsidiaries are not considered treasuryshares under Russian law (*i.e.*, they areconsidered outstanding 

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shares), and we are ableto vote such shares and dispose of such shares without any further corporateactions by our shareholders or board of directors, provided that such disposalsare not major or interested party transactions. Mechel International Holdings,a wholly-owned subsidiary, owns 3.2% of our common shares. In our U.S.GAAP consolidated financial statements included elsewhere in this document,these shares are considered treasury shares (*i.e.*,they are considered not outstanding).

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;

·       participatein shareholders’ meetings and vote on all matters of shareholders’ competence;

·       transfervoting rights to its representative on the basis of a power of attorney;

·       participatein the election and dismissal of members of the board of directors and thereview commission;

·       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:

·        reorganization;

·        conclusionof a major transaction, as defined under Russian law; and

·        amendmentof our charter that restricts the holder’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 minutes of the management boardmeetings; 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 during an opensubscription in an amount proportionate to their existing shareholding. Inaddition, the Joint Stock Companies Law provides shareholders with a preemptiveright to purchase shares or securities convertible into shares during a closedsubscription if the shareholders voted against or did not participate in the votingon the decision approving such subscription. The preemptive right does notapply to a closed subscription to existing shareholders provided that suchshareholders may each acquire a whole number of shares or securitiesconvertible into shares being placed in an amount proportionate to theirexisting holdings. We must provide shareholders with written notice of theproposed sale of shares at least 45 days prior to the offering, during whichtime shareholders may exercise their preemptive rights.

***Dividends***

The Joint Stock Companies Law and our charter setforth the procedure for determining the quarterly and annual dividends that wedistribute to our shareholders. Dividends are recommended to a shareholders’meeting by the board of directors, and approved by the shareholders’ meeting bya majority vote. A decision on quarterly dividends must be taken within threemonths of the end of the respective quarter; a decision on annual dividendsmust be taken at the annual general shareholders’ meeting. The dividendapproved at the shareholders’ meeting may not be more than the amountrecommended by the board of directors. Dividends are distributed to holders ofour shares as of the record date for the shareholders’ meeting approving thedividends. See “—General Meetings of Shareholders—Notice and Participation.”Dividends are not paid on treasury shares.

The Joint StockCompanies Law allows dividends to be declared only out of net profitscalculated under Russian accounting standards and as long as the following conditionshave 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 on liquidation***

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 another entity.The entity capable of determining such decisions is called an “effectiveparent.” The entity whose decisions are capable of being so determined iscalled an “effective subsidiary.” The 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 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.

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In addition, an effectiveparent is secondarily liable for an effective subsidiary’s debts if aneffective subsidiary becomes insolvent or bankrupt resulting from the fault ofan effective parent only when the effective parent has used the right to give bindinginstructions, knowing that the consequence of carrying out this action would beinsolvency of this effective subsidiary. This is the case no matter how theeffective parent’s capability to determine decisions of the effectivesubsidiary arises, such as through ownership of voting securities or bycontract. In these instances, other shareholders of the effective subsidiarymay claim compensation for the effective subsidiary’s losses from the effectiveparent that caused the effective subsidiary to take any action or fail to takeany action knowing that such action or failure to take action would result inlosses.

***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 25% or more 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) feesof up to 10% are paid to intermediaries, in which case the fees paid may bededucted from the price. The price may not be set at less than the nominalvalue 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

·       priorregistration of a share issuance with the FSFM;

·       publicdisclosure of information relating to the share issuance; and

·       following the placement ofthe shares, registration and public disclosure of the results of the placementof shares.

***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 receipt of our notice, repayment of all amounts due to them, aswell as compensation for damages.

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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 marketvalue within one year of their repurchase or, failing that, the shareholdersmust decide to cancel such shares and decrease the charter capital. Repurchasedshares do not bear voting rights.

The Joint StockCompanies Law allows us to repurchase our shares only if, at the time ofrepurchase:

·       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 “NIKoil” currentlymaintains our shareholder register. In March 2006, our Board of Directorsdecided to transfer our shareholder register from NIKoil to Open Joint StockCompany “Regional Independent Registrar,” which will become 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, 

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fundedthrough mandatory annual transfers of at least 5% of our statutory net profitsuntil the reserve fund has reached the 5% requirement.

**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;

·       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 holding companies, commercial or industrial groups, orother associations of 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;

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·       anyissuance of shares or securities convertible into common shares by closedsubscription; 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 50% quorum requirement is not met,another shareholders’ meeting with the same agenda may (and, in the case of anannual meeting, must) be scheduled and the quorum requirement is satisfied ifshareholders (or their representatives) accounting for at least 30% of theissued voting shares are present at that meeting.

The annualshareholders meeting must be convened by the board of directors between March 1and June 30 of each year, and the agenda must include the following items:

·       electionof the members of the board of directors;

·       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;

·       appointmentof an independent auditor; and

·       appointmentof members to the review commission.

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 theshareholders by absentee ballot contemplates the determination of shareholders’opinions on issues 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.

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***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 least50 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 “RossiyskayaGazeta”, a Russian language newpaper. Only those items that were set out in theagenda 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 a shareholders’ meeting to elect theboard of directors, not more than 65 days before the date of the 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;

·       byabsentee ballot; or

·       by delegating the right tofill out the absentee ballot to an authorized representative.

**Board of Directors**

The Joint Stock Companies Law and our charter providesthat our entire board of directors is up for election at each annual generalshareholders’ meeting and that our board of directors is elected throughcumulative voting. Under cumulative voting, each shareholder may cast anaggregate number of votes equal to the number of voting shares held by suchshareholder multiplied by the number of persons to be elected to our board ofdirectors, and the shareholder may give all such votes to one candidate orspread them between two or more candidates. Before the expiration of theirterm, the directors may be removed as a group at any time without cause by amajority vote of a shareholders’ meeting.

The Joint Stock Companies Law requires at least afive-member board of directors for all joint stock companies, at least a seven-memberboard of directors for a joint stock company with more than 1,000 holders ofvoting shares, and at least a nine-member board of directors for a joint stockcompany with more than 10,000 holders of voting shares. Only natural persons(as opposed to legal entities) are entitled to sit on the board. Members of theboard of directors are not required to be shareholders of the company. Theactual number of directors is determined by the company’s charter or decisionof the shareholders’ meeting. Our charter provides that our board of directorsshall consist of nine members, and the majority of our directors shall beindependent.

The Joint StockCompanies Law generally prohibits the board of directors from acting on issuesthat fall within the exclusive competence of the general shareholders’ meeting.Our board of directors has the power to direct the general management of thecompany, 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;

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·       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;

·       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 Party Transactions**

Under the Joint Stock Companies Law, certaintransactions defined as “interested party transactions” require approval bydisinterested directors or shareholders of the company. “Interested partytransactions” include transactions involving a member of the board of directorsor member of any executive body of the company, any person that owns, togetherwith any affiliates, at least 20% of a company’s issued voting stock or anyperson who is able to direct the actions of the company, if that person, orthat person’s spouse, parents, children, adoptive parents or children, brothersor sisters or affiliates, is:

·       aparty to, or beneficiary of, a transaction with the company, whether directlyor as a representative or intermediary;

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·       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, suchperson’s spouse, parents, children, adoptive parents or children, brothers orsisters 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;

·       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 

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indirectly),of property having a value of 25% or more of the balance sheet value of theassets of a company as determined under Russian accounting standards as of thelatest reporting date preceding the transaction, with the exception oftransactions completed in the ordinary course of business or transactionsinvolving the placement of common shares or securities convertible into commonshares. Major transactions involving assets ranging from 25% to 50% of thebalance sheet value of the assets of a company require unanimous approval byall members 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 legislation requires that any person thatintends, either individually or together with its affiliates, to acquire 30% ormore (including, for such purposes, the shares already owned by this person orits affiliates) of the common shares of a company having more than 1,000holders of common shares must give at least 30, but no more than 90, days’prior written notice to the company. Additionally, the Joint Stock CompaniesLaw provides that a person acquiring either individually, or together with itsaffiliates, 30% or more (including, for such purposes, the shares already ownedby this person or its affiliates) of the common shares of a company with morethan 1,000 holders of common shares, within 30 days of acquiring theshares, must offer to buy all of the common shares or securities that areconvertible into common shares at a market price which shall not be lower thanthe weighted average price of the common shares over the six months before thedate of acquisition. These requirements also apply to any acquisitions of eachsubsequent 5% or more of the issued common shares of a company by a personalready holding (together with its affiliates) over 30% of the issued commonshares of such company. If the acquirer fails to observe these requirements, itwill be limited to voting only those shares it purchased in compliance withthese requirements. The requirement to make a buyout offer of securities may bewaived in a company’s charter or by a resolution adopted by a majority vote ofa shareholders’ meeting, excluding the votes of the acquirer (and itsaffiliates). Our charter does not contain a waiver of, and our shareholdershave not waived, this requirement.

Effective July 1,2006, the above requirements of Russian legislation will be modified asfollows:

·       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.

·       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, at a price determined based on a weighted marketprice of the shares, or on a price supplied by an independent appraiser if theshares have no or insufficient trading history. From the moment of acquisitionof 30% or more of the shares until the moment of delivery of an offer to thesecurity holders, the person making an offer and its affiliates will be able toregister for quorum and vote only 30% of the shares of the company (regardlessof the size of their actual holdings). These rules are also applied (orreapplied) to acquisitions resulting in a person or a group of persons owningmore than 50% and 75% of a company’s outstanding shares.

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·       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.

***Approval of the Russian Federal Antimonopoly Service***

Pursuant to Russianantimonopoly legislation, transactions exceeding a certain amount, involvingcompanies with a combined value of the assets under Russian accountingstandards that exceeds a certain threshold or companies registered as havingmore than a 35% share of a certain commodity market, and which would result ina shareholder (or a group of affiliated shareholders) holding more than 20% ofthe voting capital stock of the company or more than 10% of the total assets ofthe company, or in a transfer between such companies of assets or rights toassets, the value of which exceeds a certain amount, must be approved inadvance by the Federal Antimonopoly Service.

***Notification of 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.

**Exchange Controls**

The Federal Law onCurrency Regulation and Currency Control which came into effect as of June 18,2004, empowers the government and the Central Bank of Russia to regulate andrestrict certain foreign currency operations, including certain types ofpayments in foreign currency, operations involving foreign securities(including ADSs) and domestic securities (including our common shares), as wellas certain types of settlements in rubles between residents and non-residentsof Russia.

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**Capital import andexport restrictions**

Pursuant to theFederal Law on Currency Regulation and Currency Control, the government and theCentral Bank of Russia have the power to restrict, in particular, the followingoperations:

·       investments(not involving the acquisition of securities) by Russian residents intoparticipatory interests in joint ventures with foreign investors or acquiredfrom foreign investors;

·       acquisitionof Russian securities by foreign investors and foreign securities by Russianinvestors;

·       grantsor receipts of loans and credits between residents and non-residents of Russia;

·       paymentsfor export-import transactions with settlement over 180 days (and inlimited cases, from over three to five years) following completion; and

·       theopening by Russian residents of bank accounts outside Russia and the transfersby Russian residents to such accounts of their funds from domestic accounts.

Restrictions thatmay be introduced include:

·       therequirement for Russian residents to register their accounts in foreign bankswith Russian tax authorities prior to the opening of such accounts (the “priorregistration requirement”);

·       therequirement to perform the operations listed above through special bankingaccounts with authorized Russian banks (the “requirement to use a specialaccount”); and

·       the requirement to depositin a special non-interest bearing account with an authorized Russian bank (the “reservationrequirement”) a monetary sum of:

·        upto 100% of the amount of the foreign currency operation in question for aperiod of time not exceeding 60 days; or

·        upto 20% of the amount of the foreign currency operation in question for a periodof time not exceeding one year.

As of the date hereof, the prior registrationrequirement has been introduced in respect of foreign currency accounts inbanks located in countries which are not members of the Organization forEconomic Cooperation and Development (“OECD” and the Financial Action TaskForce on Money Laundering (“FATF”) established by the G-7, and in respectof ruble accounts in banks located in countries which are members of OECD orFATF.

As of the datehereof, the requirement to use a special account has been introduced in respectof acquisitions of Russian securities by foreign investors and foreignsecurities by Russian investors and in respect of the grant or receipt of loansand credits between residents and non-residents of Russia. In particular, thefollowing operations are subject to the requirement to use special accounts:

·       thereceipt by residents of Russia from non-residents of foreign currency and rubleloans and credits with maturities of three years or less;

·       theacquisition of foreign securities (such as ADSs) by Russian investors; and

·       theacquisition of Russian securities (such as our shares) by foreign investors.

As of the datehereof, the reservation requirement has been introduced, in particular, inrespect of:

·       investmentsby Russian residents into participatory interests in joint ventures withforeign investors or acquired from foreign investors in the amount of 25% ofthe sum of the performed currency transaction for 15 days;

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·       thereceipt by residents of Russia of foreign currency and ruble loans and creditswith maturities of three years or less, in the amount of 2% of the loan/creditfor one year;

·       theacquisition of foreign securities (such as ADSs) by Russian investors, in theamount of 25% of the sum paid for the securities for 15 days;

·       pre-paymentby Russian residents for the import of works, services and rights tointellectual property to be transferred by non-residents more than180 days following the pre-payment, in the amount of 10% of the sum ofpre-payment, excluding the value of the consideration received fromnon-residents, for a period of time not exceeding 15 days; and

·       transferof funds by Russian companies and individual entrepreneurs from their accountsin Russian banks to their accounts in foreign banks, in the amount of 25% ofthe sum of the transfer for 15 days (except for transfers to supportforeign representative offices of Russian companies).

Up to $150,000 worth of foreign securities in onecalendar year may be purchased by Russian individuals from non-residentswithout any of the above restrictions.

While at presentrestrictions imposed on foreign currency operations are limited in scope, thestatutory powers of the government and the Central Bank of Russia enable themto:

·  increase the reservation requirements by anincrease in the amount and/or the period of reservation; and/or

·  extend the reservation requirements and otherrestrictions to other types of foreign currency operations envisaged by theFederal Law on Currency Regulation and Currency Control.

Additionally, Russiancompanies must repatriate 100% of their receivables from the export of goodsand services (with a limited number of exemptions concerning, in particular,certain types of secured financing) and convert 10% of export receivables inforeign currency into rubles within seven days of the date on which they werereceived (also with a number of exemptions). Furthermore, certain types ofcross-border operations may be performed only in rubles, including, forexample, transactions with domestic securities, such as our shares, betweenresidents and non-residents of Russia. These requirements increase balances inour ruble-denominated accounts and, consequently, our exposure tocurrency devaluation risk.

**Restrictions on theremittance of dividends, interest or other payments to non-residents**

The Federal Law on Foreign Investments in the RussianFederation of July 9, 1999, specifically guarantees foreign investors theright to repatriate their earnings from Russian investments. However, theevolving Russian exchange control regime may materially affect your ability todo so.

Ruble dividends on commonshares may be paid to the depositary or its nominee and converted into U.S.dollars by the depositary for distribution to owners of ADSs withoutrestriction. Also, ADSs may be sold by non-residents of Russia for U.S. dollarsoutside Russia without regard to Russian currency control laws as long as thebuyer is not a Russian resident for currency control purposes. However, theability to convert rubles into U.S. dollars is also subject to the availabilityof U.S. dollars in Russia’s currency markets. Although there is an existingmarket 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 no market for the conversion of rubles into foreign currencies outside ofRussia and no viable market in which to hedge ruble and ruble-denominatedinvestments.

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**Taxation**

The followingdiscussion describes the material U.S. federal and Russian income andwithholding tax consequences to a beneficial owner of common shares or ADSs. Noopinion of counsel will be issued with respect to the following discussion and,therefore, such discussion is not based on an opinion of counsel. A resident ofthe United States for purposes of the United States-Russia income taxtreaty that is fully eligible for benefits under the United States-Russiaincome tax treaty is referred to herein as a “U.S. holder.” Subject to certainprovisions of the United States-Russia income tax treaty relating tolimitations on benefits, you generally will be a resident of the United Statesfor treaty purposes 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 Russian legal system and Russianlegislation create an uncertain environment for investment and businessactivity” and “Item 3. Key Information—Risk Factors—Risks Relating to theRussian Federation—Legal Risks and Uncertainties—Weaknesses and changes in theRussian tax system could materially adversely affect our business and the valueof our securities.”

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 2005, we are not a passive foreign 

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investment company for thecurrent taxable year and we will not become a passive foreign investmentcompany in the future. However, passive foreign investment company, foreignpersonal holding company and foreign investment company determinations are madeannually and may involve facts that are not within our control. If we were apassive foreign investment company, materially adverse consequences couldresult for investors who are “United States persons” as defined in the UnitedStates Internal Revenue Code of 1986.

The following discussion isnot 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 ofinterpretive guidance. Russian tax authorities have not provided any guidanceregarding the treatment of ADS arrangements, and there can be no certainty asto how the Russian 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 of theUnited States-Russia income tax treaty. If the Russian tax authoritieswere not to treat U.S. holders as the beneficial owners of the underlyingshares, then the benefits discussed below regarding the United States-Russiaincome tax treaty would not be available to U.S. holders. See “Item 3. KeyInformation—Risk Factors—Risks Relating to Our Shares and ADSs and the TradingMarket—ADS holders may not be able to benefit from the United States-Russiaincome tax treaty.”

Russian tax law and procedures are also not welldeveloped, and local tax inspectors have considerable autonomy and ofteninterpret tax rules without regard to the rule of law. Both thesubstantive provisions of Russian tax law and the interpretation andapplication of those provisions by the Russian tax authorities may be subjectto more rapid and unpredictable change than in jurisdictions with moredeveloped capital markets.

Currently, the Russiangovernment is in the process of replacing the existing tax legislation with acomprehensive Tax Code, but it is unclear when this process will be completedand how U.S. holders would be affected. As of January 1, 1999, Part 1(General) of the Tax Code went into effect. This law defines the generalprinciples of taxation in Russia, defines the legal status of taxpayers and taxagencies and determines general rules of tax filings and tax control, aswell as procedures for challenging tax agencies. Importantly, after the priorLaw on Fundamentals of the Tax System of the Russian Federation was repealed, Part 1 specifies all the taxes that can beimposed by federal and local authorities. Further, as of January 1, 2001,four chapters (value-added taxes, excise tax, individual income tax andunified social tax) of Part 2 of the Tax Code went into effect. The ProfitTax Chapter and Mineral Extraction Tax of the Tax Code became effective as of January 1,2002.

***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 

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allow us to withhold atreduced rates under applicable double tax treaties provided that all of thenumerous 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.

***Taxation of capital gains***

U.S. holdersgenerally should not be subject to any Russian income or withholding taxes inconnection with the sale, exchange, or other disposition of ADSs or commonshares outside of Russia if the shares or ADSs are not sold to a Russianresident. Sales or other dispositions of ADSs or common shares to Russianresidents, however, may be subject to Russian income or withholding taxes, andfor such a sale by a U.S. holder, the Russian resident purchaser may berequired to withhold 20% to 30% of any gain realized on the sale. However,there is no mechanism by which a Russian purchaser would be able to effect thiswithholding upon purchasing ADSs from a U.S. holder in connection with the saleof ADSs on the New York Stock Exchange.

U.S. holders maybe able to claim the benefits of a reduced rate of withholding under the UnitedStates-Russia income tax treaty on the disposition of common shares orADSs to Russian residents, or obtain a refund of any withheld amounts at ratesdifferent from those provided in the treaty, by relying on the United Sates-Russiaincome tax treaty and complying with the appropriate procedures describedbelow.

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 tax treaty 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, social securitynumber, tax return form number and the tax period for which certification is required,to: IRS-Philadelphia Accounts Management Center, U.S. Residency CertificationRequest, P.O. Box 16347, Philadelphia, Pennsylvania 19114-0447.The procedures for obtaining certification are described in greater detail inInternal Revenue Service Publication 686. As obtaining the requiredcertification from the Internal Revenue Service may take at least six to eightweeks, U.S. holders should apply for such certification as soon as possible.

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 

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budget. Under theprovisions of the Tax Code the refund of the tax should be effected within onemonth after the submission of the documents. However, procedures for processingsuch claims have not been clearly established, and there is significantuncertainty 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 is a citizen or resident of the UnitedStates, a corporation (including any entity treated as a corporation for U.S.federal income tax purposes) created or organized in or under the laws of theUnited States or a political subdivision thereof, an estate the income of whichis subject to U.S. tax regardless of its source, or a trust, if a U.S. courtcan exercise primary supervision over the administration of the trust and oneor more U.S. persons can control all substantial trust decisions or, if thetrust was in existence on August 20, 1996 and has properly elected tocontinue to be treated as a U.S. person. If a partnership (including any entitytreated as a partnership for U.S. federal income tax purposes) is a beneficialowner of ADSs or common shares, the U.S. federal income tax treatment of apartner in the partnership will generally depend on the status of the partnerand the activities of the partnership. Since your U.S. federal income andwithholding tax treatment may vary depending upon your particular situation,you may be subject to special rules not discussed below. Special rules willapply, for example, if you 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 theoutstanding 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 common shares 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 

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federal income taxprinciples. For taxable years beginning after December 31, 2002, andbefore January 1, 2009, if you are a non-corporate taxpayer, suchdividends should be 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. Non-corporate U.S. holdersare strongly urged to consult their own tax advisors as to the applicability ofthe lower capital gains rate to dividends received with respect to ADSs orcommon shares. Distributions in excess of our current or accumulated earningsand profits will be applied against and will reduce your tax basis in commonshares or ADSs and, to the extent in excess of such tax basis, will be treatedas gain from a sale or exchange of such common shares or ADSs. You should beaware that we do not intend to calculate our earnings and profits for U.S.federal income tax purposes and, unless we make such calculations, you should assumethat any distributions with respect to common shares or ADSs generally will betreated as a dividend, even if that distribution would otherwise be treated asa return of capital or as a capital gain pursuant to the rules describedabove. If you are a corporation, you will not be allowed a deduction fordividends received in respect of distributions on common shares or ADSs, whichis 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 of thatamount 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.

A dividend distributionwill be treated as foreign source income and will generally be classified as “passiveincome” or, in some cases, “financial services income” for U.S. foreign taxcredit purposes. For taxable years beginning after December 31, 2006,dividends will generally constitute “passive category income” but could, in thecase of certain U.S. holders, constitute “general category income.” The rules relatingto the determination of the foreign tax credit, or deduction in lieu of theforeign tax credit, are complex and you should consult your own tax advisorswith respect to those rules.

***Taxation on sale or exchange of common 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 

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capital assets in yourhands and will be long-term capital gain or loss if the common shares or ADSshave been held for more than one year. If you are an individual, such realizedlong-term capital gain is generally subject to a reduced rate of U.S. federalincome tax. Limitations may apply to your ability to offset capital lossesagainst 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.

***Information reporting and backup withholding***

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 backupwithholding has occurred. Holders that are not U.S. persons generally are notsubject to information reporting or backup withholding, but such holders may berequired to 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 Reference Room at100 F Street, NE, Washington, DC 20549. You can obtain information on theoperation 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 and 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,commodity 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 

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this remeasurement processis to 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).”

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 change relatedto 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 is significantlylimited. Further, our ability to convert Russian rubles and Romanian leis intoother currencies in Russia and Romania, respectively, is subject to rules thatrestrict the purposes for which conversion and the payment in foreigncurrencies are allowed.

We regularly 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 InternationalHoldings, our Swiss wholly owned subsidiary. This derivative was not designatedas a hedge for accounting purposes. Such forward transactions amounted to$65.2 million during the year ended December 31, 2005. We intend tocontinue to engage in such 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, 2005.

| **Balance as of December 31, 2005**           | ** ** | ** **                                             | ** **   | **U.S. Dollar** | ** ** | **Ruble**    | ** ** | **Euro**    | ** ** | **Lei**      | ** ** | **Other**  | ** ** | **Total**    | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------------|--------------|----------------------|------------|--------------|------------|-------------|------------|--------------|------------|------------|------------|--------------|------------|
| ** **                                                             | ** ** | **(in thousands of U.S. dollars)** | ** **   |
| **Current Assets:**                                                    |       |                                                   |         |                 |       |         |       |        |       |         |       |       |       |         |       |
| Cash and cash  equivalents                                             |       |                                                   | 107,169      |                 |       | 32,607       |       | 164,784     |       | 900          |       | 6,315      |       | 311,775      |       |
| Trade  receivables, net                                                |       |                                                   | 50,540       |                 |       | 42,774       |       | 31,133      |       | 13,484       |       | 2,718      |       | 140,649      |       |
| Due from related  parties                                              |       |                                                   | 1,002        |                 |       | 3,471        |       | —      |       | —       |       | —     |       | 4,473        |       |
| Deferred income  taxes                                                 |       |                                                   | —       |                 |       | 8,893        |       | —      |       | —       |       | 72         |       | 8,965        |       |
| Current assets on  discontinued operations                             |       |                                                   |         |                 |       |         |       |        |       |         |       | 88         |       | 88           |       |
| Prepayments and  other current assets                                  |       |                                                   | 16,709       |                 |       | 325,541      |       | 974         |       | 1,878        |       | 1,880      |       | 346,982      |       |
| **Total current assets**                                               | ** ** | ** **                                             | **175,421**  | ** **           | ** ** | **413,286**  | ** ** | **196,890** | ** ** | **16,262**   | ** ** | **11,073** | ** ** | **812,931**  | ** ** |
| **Current Liabilities:**                                               |       |                                                   |         |                 |       |         |       |        |       |         |       |       |       |         |       |
| Short-term  borrowings and current maturities of long-term debt        |       |                                                   | (164,280     | )                    |       | (205,076     | )          | (16,571     | )          | (3,376       | )          | (108       | )          | (389,411     | )          |
| Accounts payable and  accrued expenses:                                |       |                                                   |         |                 |       |         |       |        |       |         |       |       |       |         |       |
| Advances received                                                      |       |                                                   | (14,139      | )                    |       | (32,913      | )          | (2          | )          | (313         | )          | —     |       | (47,367      | )          |
| Accrued expenses  and other current liabilities                        |       |                                                   | (18,334      | )                    |       | (58,348      | )          | —      |       | (2,128       | )          | (595       | )          | (79,405      | )          |
| Pension obligations, current portion                                   |       |                                                   | —       |                 |       | (8,189       | )          | —      |       | —       |       | —     |       | (8,189       | )          |
| Current liabilities of discontinued operations                         |       |                                                   | —       |                 |       | —       |       | —      |       | —       |       | (109       | )          | (109         | )          |
| Taxes and social charges payable                                       |       |                                                   | (25,150      | )                    |       | (116,635     | )          | —      |       | (2,779       | )          | (152       | )          | (144,715     | )          |
| Trade payables to  vendors of goods and services                       |       |                                                   | (27,967      | )                    |       | (145,955     | )          | (1,451      | )          | (34,352      | )          | (504       | )          | (210,228     | )          |
| Due to related  parties                                                |       |                                                   | (201         | )                    |       | (2,736       | )          | —      |       | —       |       | —     |       | (2,937       | )          |
| Asset retirement  obligation                                           |       |                                                   | —       |                 |       | (3,409       | )          | —      |       | (827         | )          | —     |       | (4,236       | )          |
| Deferred income  taxes                                                 |       |                                                   | (5,058       | )                    |       | (21,500      | )          | —      |       | —       |       | —     |       | (26,557      | )          |
| Finance lease liabilities                                              |       |                                                   | —       |                 |       | (887         | )          | —      |       | —       |       | —     |       | (887         | )          |
| Deferred revenue                                                       |       |                                                   | (55,127      | )                    |       | (140         | )          | —      |       | —       |       | —     |       | (55,267      | )          |
| **Total current liabilities**                                          | ** ** | ** **                                             | **(310,255** | **)**                | ** ** | **(595,786** | **)**      | **(18,024** | **)**      | **(43,774**  | **)**      | **(1,467** | **)**      | **(969,307** | **)**      |
| **Long-term Liabilities:**                                             |       |                                                   |         |                 |       |         |       |        |       |         |       |       |       |         |       |
| Restructured  taxes and social charges payable, net of current portion |       |                                                   | —       |                 |       | (28,079      | )          | —      |       | (5,787       | )          | —     |       | (33,866      | )          |
| Long-term  debt, net of current portion                                |       |                                                   | (180         | )                    |       | (8,860       | )          | —      |       | (36,575      | )          | —     |       | (45,615      | )          |
| Pension  obligations, net of current portion                      |       |                                                   | —       |                 |       | (40,072      | )          | —      |       | (3,437       | )          | —     |       | (43,510      | )          |
| Asset retirement  obligation, net of current portion                   |       |                                                   | —       |                 |       | (51,886      | )          | —      |       | (2,930       | )          | —     |       | (54,816      | )          |
| Due to related  parties                                                |       |                                                   | —       |                 |       | —       |       | —      |       | —       |       | —     |       | —       |       |
| Deferred income  tax                                                   |       |                                                   | (359         | )                    |       | (94,701      | )          | —      |       | (10,421      | )          | —     |       | (105,481     | )          |
| Finance lease liabilities                                              |       |                                                   | —       |                 |       | (9,179       | )          | —      |       | —       |       | —     |       | (9,179       | )          |
| Other long-term  liabilities                                           |       |                                                   | —       |                 |       | —       |       | —      |       | —       |       | —     |       | —       |       |
| **Total long-term liabilities**                                        | ** ** | ** **                                             | **(539**     | **)**                | ** ** | **(232,778** | **)**      | **—**  | ** ** | **(59,151**  | **)**      | **—** | ** ** | **(292,467** | **)**      |
| Minority interest                                                      |       |                                                   | —       |                 |       | (107,018     | )          | —      |       | (20,817      | )          | —     |       | (127,834     | )          |
| **Net monetary assets (liabilities)**                                  | ** ** | ** **                                             | **(135,374** | **)**                | ** ** | **(522,295** | **)**      | **178,866** | ** ** | **(107,480** | **)**      | **9,605**  | ** ** | **(576,677** | **)**      |

 

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Thetable below summarizes our debt position by currency and rate method.

| ** **            | ** ** | **U.S. Dollar**                                   | ** ** | **Ruble** | ** ** | **Euro** | ** ** | **Lei** | ** ** | **Lit** | ** ** | **Total** | ** ** |
|-----------------------|------------|--------------------------------------------------------|------------|-----------|------------|----------|------------|---------|------------|---------|------------|-----------|------------|
| ** **            | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| Total debt  including |       |                                                   | (170,967   | )         |       | (207,427 | )          | (16,570 | )          | (39,953 | )          | (108      | )          | (435,025 | ) |
| Fixed-rate debt       |       |                                                   | (164,460   | )         |       | (31,357  | )          | (16,570 | )          | (39,953 | )          | (108      | )          | (252,448 | ) |
| Variable-rate  debt   |       |                                                   | (6,507     | )         |       | (176,070 | )          | —  |       | —  |       | —    |       | (182,576 | ) |

 

**Interest rate risk**

Our interest rate exposure results mainly from debtobligations. At December 31, 2005, we had $252.4 million infixed-rate borrowings and $182.5 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. Once the market in Russia for hedging instruments matures, wewill assess our options for hedging interest rate risks and may enter into sucharrangements.

The table below presentsthe principle cash flows and related range of interest rates, by expectedmaturity dates, of our fixed-rate debt obligations as of December 31,2005.

| ** **                        | ** ** | ** **                                             | ** ** | **Expected maturity date as of December 31,** | ** ** | ** ** | ** ** | **Annual   Interest   rate   (Actual at   December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------|------------|
| ** **                        | ** ** | **Currency**                                           | ** ** | **2006**                                                                    | ** ** | **2007**   | ** ** | **2008**                                                           | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| **Fixed-rate U.S. dollar  debt:** |       |                                                   |       |                                                                        |       |       |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| BNP                               |       | U.S. dollar                                            |       | 125,970                                                                     |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 125,970 |   | 4.28%-6.31% |   |
| Raiffeisenbank                    |       | U.S. dollar                                            |       | 13,292                                                                      |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 13,292 |   | 4.45%-5.45% |   |
| Hypo Vereinsbank                  |       | U.S. dollar                                            |       | 11,506                                                                      |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 11,506 |   | 5.95%-6.00% |   |
| Fortis Bank                       |       | U.S. dollar                                            |       | 5,134                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 5,134 |   | 8.50% |   |
| VPB AG                            |       | U.S. dollar                                            |       | 2,480                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 2,480 |   | 6.38% |   |
| BCP Bank                          |       | U.S. dollar                                            |       | 2,148                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 2,148 |   | 6.09%-7.14    |   |
| ING bank                          |       | U.S. dollar                                            |       | 1,805                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 1,805 |   | 5.81% |   |
| Die Erste Vienna                  |       | U.S. dollar                                            |       | 868                                                                         |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 868 |   | 6.95% |   |
| Distrigaz                         |       | U.S. dollar                                            |       | 705                                                                         |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 705 |   | 24,00% |   |
| APAPS                             |       | U.S. dollar                                            |       | 188                                                                         |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 188 |   | 28.00% |   |
| Darlehen Saros  Consulting        |       | U.S. dollar                                            |       | 140                                                                         |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 140 |   | 10.00% |   |
| UBS                               |       | U.S. dollar                                            |       | 44                                                                          |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 44 |   | 7.25% |   |
| Other banks                       |       | U.S. dollar                                            |       | —                                                                      |       | 181        |       | —                                                             |       |   | — |   |   |   | — |   |   | 181 |   | —    |   |
| Total                             |       |                                                   |       | 164,280                                                                     |       | 181        |       | —                                                             |       |   | — |   |   |   | — |   |   | 164,461 |   |   |   |
| **Fixed-rate euro debt:**         |       |                                                   |       |                                                                        |       |       |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Raiffeisenbank                    |       | Euro                                                   |       | 8,181                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 8,181 |   | 5.40%-5.55% |   |
| BCR                               |       | Euro                                                   |       | 2,823                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 2,823 |   | 5.50%-10.27% |   |
| Fortis Bank                       |       | Euro                                                   |       | 2,056                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 2,056 |   | 8.00% |   |
| Electrica                         |       | Euro                                                   |       | 1,413                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 1,413 |   | 24.00% |   |
| Bank SEB Vilniaus                 |       | Euro                                                   |       | 1,186                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 1,186 |   | 4.00% |   |
| Hypo Vereinsbank                  |       | Euro                                                   |       | 631                                                                         |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 631 |   | 4.35% |   |
| STEIERMÄRKISCHE              |       | Euro                                                   |       | 280                                                                         |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 280 |   | 6.00% |   |
| Total                             |       |                                                   |       | 16,570                                                                      |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 16,570 |   |   |   |
| **Fixed-rate ruble debt:**        |       |                                                   |       |                                                                        |       |       |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Gazprombank                       |       | Ruble                                                  |       | 17,719                                                                      |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 17,719 |   | 8.63%-11.00% |   |
| Uralsib                           |       | Ruble                                                  |       | 8,686                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 8,686 |   | 7.00% |   |
| Bonds                             |       | Ruble                                                  |       | 4,703                                                                       |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 4,703 |   | 7.00% |   |
| Promissory notes                  |       | Ruble                                                  |       | 15                                                                          |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 15 |   | —    |   |
| Promissory notes                  |       | Ruble                                                  |       | 4                                                                           |       | —     |       | —                                                             |       |   | — |   |   |   | — |   |   | 4 |   | —    |   |

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| Other                    |   | Ruble  |   | 230     |   | — |   | — |   |   | — |   |   |   | — |   |   | 230     |   | 11.00% |   |
|--------------------------|--------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---------|--------|--------|--------|
| Total                    |   |   |   | 31,357  |   | — |   | — |   |   | — |   |   |   | — |   |   | 31,357  |   |   |   |
| **Fixed-rate lei debt:** |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |
| Electrica                |   | Lei    |   | —  |   | 17,021 |   | — |   |   | — |   |   |   | — |   |   | 17,021  |   | 24.00% |   |
| Minwork                  |   | Lei    |   | —  |   | — |   | 12,716 |   |   | — |   |   |   | — |   |   | 12,716  |   | 28.00% |   |
| Distrigaz                |   | Lei    |   | —  |   | 5,268  |   | — |   |   | — |   |   |   | — |   |   | 5,268   |   | 24.00% |   |
| Raiffeisenbank           |   | Lei    |   | 3,379   |   | — |   | — |   |   | — |   |   |   | — |   |   | 3,379   |   | 7.95%  |   |
| APAPS                    |   | Lei    |   | —  |   | — |   | 1,569  |   |   | — |   |   |   | — |   |   | 1,569   |   | 28.00% |   |
| Total                    |   |   |   | 3,379   |   | 22,289 |   | 14,285 |   |   | — |   |   |   | — |   |   | 39,953  |   |   |   |
| **Fixed-rate chf debt:** |   |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |    |   |   |   |
| VPB AG                   |   | Chf    |   | 108     |   | — |   | — |   |   | — |   |   |   | — |   |   | 108     |   | 6.00%  |   |
| Total                    |   |   |   | 108     |   | — |   | — |   |   | — |   |   |   | — |   |   | 108     |   |   |   |
| Total debt:              |   |   |   | 215,694 |   | 22,469 |   | 14,285 |   |   | — |   |   |   | — |   |   | 252,450 |   |   |   |

 

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 31,2005.

| ** **                           | ** ** | ** **                                             | ** ** | **Expected maturity date as of December 31,** | ** ** | ** ** | ** ** | **Average annual  Interest  rate  (Actual at  December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Currency**                                           | ** ** | ** 2006 **                                                        | ** ** | **2007**   | ** ** | **2008**                                                                    | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** | **   2005   ** | ** ** |
| ** **                           | ** ** | **(in thousands of U.S. dollars)** | ** ** |
| **Variable-rate U.S. dollar  debt:** |       |                                                   |       |                                                                        |       |       |       |                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Vneshtorgbank                        |       | U.S. dollar                                            |       | —                                                                      |       |       | —     |                                                                        |       | 6,507 |   |   | — |   |   |   | — |   |   | 6,507 |   |   | 9.73 | % |   |   |
| Total                                |       |                                                   |       | —                                                                      |       |       | —     |                                                                        |       | 6,507 |   |   | — |   |   |   | — |   |   | 6,507 |   |   |   |   |   |   |
| **Variable-rate ruble debt:**        |       |                                                   |       |                                                                        |       |       |       |                                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Bonds                                |       | Ruble                                                  |       | —                                                                      |       |       | —     |                                                                        |       | — |   |   | — |   |   |   | 2,353 |   |   | 2,353 |   |   | 7.00 | % |   |   |
| Bonds                                |       | Ruble                                                  |       | 104,230                                                                     |       |       | —     |                                                                        |       | — |   |   | — |   |   |   | — |   |   | 104,230 |   |   | 11.75 | % |   |   |
| Bonds                                |       | Ruble                                                  |       | 69,487                                                                      |       |       | —     |                                                                        |       | — |   |   | — |   |   |   | — |   |   | 69,487 |   |   | 8.91 | % |   |   |
| Total                                |       |                                                   |       | 173,717                                                                     |       |       | —     |                                                                        |       | — |   |   | — |   |   |   | 2,353 |   |   | 176,070 |   |   |   |   |   |   |
| Total debt:                          |       |                                                   |       | —                                                                      |       |       | —     |                                                                        |       | 6,507 |   |   | — |   |   |   | 2,353 |   |   | 182,576 |   |   |   |   |   |   |

 

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.

**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 whenthe reseller delivers the products to the end customers. Historically, theseselling price adjustments occur within an eight- to 16-week periodfrom the date the products are delivered to the reseller. We had 113,978 tonnesof our steel products and 2,052 tonnes of our 

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nickelproducts as of December 31, 2005 in the distribution channel for which wereceived prepayments in the amount of $55.1 million. See “Item 5.Operating and Financial Review and Prospects—Critical Accounting Policies andEstimates—Revenue recognition.”

**Equity price risk**

As of December 31, 2005, we had other minor costmethod investments in equity of various Russian companies. These investmentsare exposed to market risk of fluctuations in equity prices.

These investments are shares of Russian companies thatare not publicly traded and, accordingly, their market values are notavailable. Currently, it is not practicable for us to estimate the fair valuesof 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.

We do not use derivativeinstruments or any other arrangements to manage our equity price risks.

***Item 12.****                  *Description of 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

**Use of Proceeds**

On October 4, 2004, we filed a registrationstatement on Form F-1 (Registration No. 333-119497) underthe Securities Act of 1933, as amended, with the SEC with respect to an initialpublic offering of our shares in the form of ADSs. The Registration Statementwas declared effective on October 28, 2004, and the offering was completedon November 3, 2004. All of the 11,100,553 ADSs offered by us and the2,775,138 ADSs offered by the selling shareholders in the offering at aninitial offering price of $21.00 per ADS were sold. The selling shareholderssold an additional 2,081,354 ADSs on December 1, 2004 pursuant to theover-allotment option. The underwriters of the offering were UBS Limited,J.P. Morgan Securities Ltd., Morgan Stanley & Co.International Limited and Troika Dialog (Bermuda) Ltd. The net proceeds tous from the offering were approximately $213.4 million, after deducting$12.2 million in underwriting discounts and commissions and$7.5 million in regulatory, legal, accounting and other miscellaneous feesand expenses.

InNovember and December of 2004 and in the first five months of 2005,we used approximately all of our net proceeds for the following purposes:

| **Use**                                                                                                        | ** ** | ** ** | ** ** | **Approximate  Amount  2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------------------------|------------|
| Construction of  plant, building and facilities and purchase and installation of machinery  and equipment |       |       | $          | 106.7                         |       |   |
| Acquisition of  25% plus one share of Yakutugol                                                                |       |       | $          | 106.7                         |       |   |
| **Total**                                                                                                      |       |       | $          | 213.4                         |       |   |

 

None of the net proceedsto us from our initial public offering were paid, directly or indirectly, toany of our directors, officers or general partners or any of their associates,or to any persons owning ten percent or more of any class of our equitysecurities, or to any of our affiliates.

***Item15.****                  *Controlsand Procedures

We are committed to maintaining disclosure controlsand procedures designed to ensure that information required to be disclosed inour Exchange Act reports is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourchief executive officer and chief financial officer, as appropriate, to allowfor timely decisions regarding required disclosure. As required byRules 13a-15 and 15d-15 under the Securities Exchange Act of1934, management, with the participation of our chief executive officer andchief financial officer, has evaluated the effectiveness of our disclosurecontrols and procedures as of the end of the period covered by this report. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily is required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures and implementing controls and procedures based on the application ofmanagement’s judgment.

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In connection with the audit of our consolidatedfinancial statements for the year ended December 31, 2005, we and ourindependent registered public accounting firm identified material weaknessesregarding various elements of our internal control over financial reporting.The Public Company Accounting Oversight Board’s Auditing Standard No. 2defines a material weakness as a significant deficiency, or combination ofsignificant deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected. As a result of the material weaknesses, our chiefexecutive officer and chief financial officer concluded that, as of December 31,2005, the end of the period covered by this report, our disclosure controls andprocedures were not effective to ensure that information required to bedisclosed in the reports we file or submit under the Exchange Act is recorded,processed, summarized, and reported, within the time periods specified in theSEC’s rules and forms.

The followingmaterial weaknesses in our internal control over financial reporting have beenidentified:

·       wedo not have an adequate system of internal control over the preparation of ourU.S. GAAP consolidated financial statements to ensure that material errors donot occur in their preparation;

·       wedo not have an adequate system of internal controls at our Swiss subsidiaries,which conduct our export sales;

·       wedo not have a unified, comprehensive accounting and financial reporting systemfor U.S. GAAP reporting purposes to reduce to an acceptable level thelikelihood that misstatements will be prevented or detected in a timely basis;and

·       wedo not have adequate accounting resources and expertise in respect of thepreparation of our U.S. GAAP consolidated financial statements.

The first material weakness was initially identifiedby our independent registered accounting firm during the course of their auditof our U.S. GAAP consolidated financial statements for the year ended December 31,2003. Despite our implementation of certain improvements, several materialaudit adjustments to the U.S. GAAP consolidated financial statements wereidentified, which resulted from errors in certain underlying data andmisapplication of certain accounting principles.

The second material weakness results from the factthat we do not have a set of fully formalized and documented controls forroutine operations at our Swiss subsidiaries. For non-routine and judgmentalprocesses, controls are either informal or do not exist.

The third material weakness results from the fact thatthere is no automated process in place to support the transformation of thestatutory financial statements of our subsidiaries into U.S. GAAP consolidatedfinancial statements, and that some of our subsidiaries use different financialreporting systems in the preparation of their statutory financial statements.The preparation of our U.S. GAAP consolidated financial statements is a manualprocess which involves (1) the transformation of these statutory financialstatements into U.S. GAAP consolidated financial statements through accountingadjustments and (2) a consolidation of all these stand-alonestatutory financial statements. Moreover, the use of different financialreporting systems creates significant inefficiencies and additional costs.

The fourth material weakness was initially identifiedby our independent registered accounting firm during the course of their auditof our U.S. GAAP consolidated financial statements for the year ended December 31,2003. The insufficient number of professional personnel in our internationalreporting department results in, among other things, untimely identification ofsignificant accounting issues and affects our ability to implement anappropriate system of internal control over financial reporting. Furthermore,any future acquisitions may compound the current shortage of professionalpersonnel without adequate planning.

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These material weaknesseswere considered in determining the audit procedures performed by ourindependent registered public accounting firm in their audit of our annualconsolidated financial statements and thus led them to perform additionalprocedures and verifications. As a result, these deficiencies did not affectthe report of our independent registered public accounting firm on our annualconsolidated financial statements included herein.

We have taken and continueto take steps to correct the material weaknesses reported by our independentregistered public accounting firm. In April 2006, we started implementing an ITsystem aimed at the automation of the US GAAP transformation process fromstatutory accounts. In respect of our Swiss subsidiaries, starting December 2005we hired an external consultant to identify major material weaknesses anddevelop a remediation plan to be implemented within one year. In addition,during last several months we have made some changes in personnel and in theorganizational structure of our Swiss subsidiaries. We also plan to increase staffingin the financial department at our Swiss subsidiaries with qualified personnel.Senior management is determined to spend significant effort during 2006 onimplementing the requirements of Section 404 of the Sarbanes-Oxley Act and increasestaffing in the internal control department.

Although we have undertaken the foregoing initiatives,the existence of a material weakness is an indication that there is more than aremote likelihood that a material misstatement of our financial statements willnot be prevented or detected in a future period. In addition, we cannot assureyou that we will not in the future identify further material weaknesses orsignificant deficiencies in our internal control over financial reporting thatwe have not discovered to date. We are taking steps to refine our internalcontrol over financial reporting pursuant to Section 404 of the Sarbanes-OxleyAct, which will take effect beginning with the year ending December 31,2006, and the efficacy of the steps we have taken to date and the steps we arestill in the process of completing is subject to continued management reviewsupported by confirmation and testing by management and by our internalauditors, as well as audit committee oversight. As a result, additional changeswill be made to our internal control over financial reporting. See “Item 3. KeyInformation—Risk Factors—Our independent registered public accounting firmreported material weaknesses in our internal control over financial reportingand we may not be able to remedy these material weaknesses or prevent futurematerial weaknesses. If we fail to do so there is a more than remote likelihoodthat a material misstatement of the annual or interim statements will not beprevented or detected.”

Other than the foregoingsteps, since the date of the evaluation supervised by our management, therehave been no material changes in our disclosure controls and procedures, or ourinternal control over financial reporting, that have materially affected, orare reasonably likely to materially affect, our disclosure controls andprocedures or our internal control over financial reporting.

***Item16A.  **** *Audit Committee 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.

***Item16B.  **** *Code of Ethics

We have adopted a code ofbusiness conduct and ethics that applies to our directors, officers andemployees. It is available at www.mechel.com.

***Item16C.  **** *Principal Accountant 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, 2005, forwhich audited financial statements appear in 

154

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this Annual Report on Form 20-F. Thefollowing table presents the aggregate fees for professional services and otherservices rendered by Ernst & Young LLC in 2005 and 2004, respectively.

| ** **          | ** ** | **Year ended  December 31,**            | ** ** |
|---------------------|------------|---------------------------------------------------|------------|
| ** **          | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **          | ** ** | **(in thousand of  U.S. dollars)** | ** ** |
| Audit Fees          |       | $                                                 | 4,693.3    |   | $ | 6,506.1 |   |
| Audit-Related  Fees |       | —                                            |       | — |   |
| Tax Fees            |       | —                                            |       | 133.6 |   |
| All Other Fees      |       | $                                                 | 7.1        |   | — |   |
| Total               |       | $                                                 | 4,700.4    |   | $ | 6,639.7 |   |

 

**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. Other audit fees of $7.1 thousand charged to us in 2005include training to our personnel of $4.1 thousand and fees for access to accountingresearch system of $3.0 thousand.

**Tax fees**

Tax services include,among others, tax consultation related to proposed and consummatedtransactions, restructuring, personal taxation and general tax consultation.

**Other fees**

For the years ended December 31,2005 and 2004, no fees were incurred for services rendered by Ernst &Young LLC, other than the services described under “Audit services,” “ and “Taxservices.”

**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 Ernst &Young LLC for all audit and non-audit services, including tax services.All audit and tax services rendered by Ernst & Young LLC in 2005 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.  **** *Exemptions from the Listing Standards for AuditCommittees

None.

155

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***Item16E.  **** *Purchases of Equity Securities by the Issuer andAffiliated Purchasers

We did not repurchase anyshares or ADSs in 2005.

156

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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, 2005 and 2004                                                          |   | F-3 |
| Consolidated Income Statements  for the years ended December 31, 2005, 2004 and 2003                                   |   | F-4 |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2005, 2004 and 2003                            |   | F-5 |
| Consolidated Statements of  Changes in Shareholders’ Equity for the years ended December 31, 2005,  2004 and 2003 |   | 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  August 19, 2005.                                                                                                                                                                                             |
| 3.1              |       | Agreement on Ownership, Control and Exercise of  Voting Rights dated August 1, 1995, between Igor V. Zyuzin and Vladimir  F. Iorich (incorporated herein by reference to Exhibit 9.1 to the  Registration Statement on Form F-1, No. 333-119497) |
| 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                                                                                                    |

 

157

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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/ VLADIMIR F. IORICH |
|   |       | Vladimir F. Iorich |
|   |       | *Chief Executive Officer* |

 

**Date: May 22, 2006**

158

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**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**

| **REPORT OF INDEPENDENT REGISTERED  PUBLIC ACCOUNTING FIRM**                                                                   |   | F-2 |
|--------------------------------------------------------------------------------------------------------------------------------|--------|-----|
| **CONSOLIDATED BALANCE SHEETS  AS OF DECEMBER 31, 2005 AND 2004**                                                         |   | F-3 |
| **CONSOLIDATED INCOME STATEMENTS  FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**                                  |   | F-4 |
| **CONSOLIDATED STATEMENTS OF  CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**                      |   | F-5 |
| **CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE  YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003** |   | F-7 |
| **NOTES TO THE CONSOLIDATED FINANCIAL  STATEMENTS**                                                                            |   | F-8 |

 

----

| **** | ** ** | **** |
|------|------------|------|

 

**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, 2005 and 2004,and the related consolidated statements of income, shareholders’ equity, andcash flows for each of the three years in the period ended December 31,2005. 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 Accounting Oversight Board (United States). Thosestandards required that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. We were not engaged to perform an audit of the Group’s internalcontrol over financial reporting. Our audits included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Group’s internal control over financialreporting. Accordingly we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

As more fully described in Note 3(g) to theconsolidated financial statement, 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 statement referred to abovepresent fairly, in all material respects, the consolidated financial position ofthe Group at December 31, 2005 and 2004, and the consolidated results ofits operations and its cash flows for each of the three years in the periodended December 31, 2005, in conformity with accounting principlesgenerally accepted in the United States.

As discussedin Note 15 to the financial statements, effective January 1, 2003, theGroup adopted Statement of Financial Accounting Standards No. 143, “Accountingfor Asset Retirement Obligations”.
| ****                 |
|----------------------|
| April 17,  2006 |
| Moscow, Russia       |

 

F-2

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**MECHEL OAO (formerly Mechel Steel Group OAO)Consolidated Balance Sheets(in thousands of U.S. dollars, except share amounts)**

| ** **                                                                                                                                                                            | ** ** | **Notes**  | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** **    |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|---------------|
| **ASSETS**                                                                                                                                                                            |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                            | ** ** | ** ** | **4**      | ** **                  | ** ** | ** **                  | **$**         | **311,775** |   | ** ** | ** ** | $ | 1,024,761 |   |   |
| Accounts  receivable, net of allowance for doubtful accounts of $17,509 in 2005 and  $20,850 in 2004                                                                             | ** ** | ** ** | **5**      |                        | ** ** | ** **                  | **140,649**   |   |   |   | 135,597 |   |   |
| Due from related  parties                                                                                                                                                             | ** ** | ** ** | **9**      |                        | ** ** | ** **                  | **4,473**     |   |   |   | 16,474 |   |   |
| Inventories                                                                                                                                                                           | ** ** | ** ** | **6**      |                        | ** ** | ** **                  | **496,658**   |   |   |   | 568,545 |   |   |
| Deferred cost of  inventory in transit                                                                                                                                                | ** ** | ** ** | **3**      | **(r)**                     | ** ** | ** **                  | **49,893**    |   |   |   | — |   |   |
| Current assets of  discontinued operations                                                                                                                                            | ** ** | ** ** | **2**      | **(n)**                     | ** ** | ** **                  | **88**        |   |   |   | 1,247 |   |   |
| Deferred income  taxes                                                                                                                                                                | ** ** | ** ** | **19**     |                        | ** ** | ** **                  | **8,965**     |   |   |   | 7,491 |   |   |
| Prepayments and  other current assets                                                                                                                                                 | ** ** | ** ** | **7**      |                        | ** ** | ** **                  | **346,981**   |   |   |   | 349,090 |   |   |
| Total current  assets                                                                                                                                                                 |       |       |       |                        | ** ** | ** **                  | **1,359,483** |   |   |   | 2,103,205 |   |   |
| Long-term  investments in related parties                                                                                                                                             | ** ** | ** ** | **8**      |                        | ** ** | ** **                  | **408,709**   |   |   |   | 9,270 |   |   |
| Other long-term  investments                                                                                                                                                          | ** ** | ** ** | **8**      |                        | ** ** | ** **                  | **16,148**    |   |   |   | 66,663 |   |   |
| Non-current assets  of discontinued operations                                                                                                                                        | ** ** | ** ** | **2**      | **(n)**                     | ** ** | ** **                  | **97**        |   |   |   | 165 |   |   |
| Intangible assets,  net                                                                                                                                                               | ** ** | ** ** | **10**     |                        | ** ** | ** **                  | **7,590**     |   |   |   | 6,379 |   |   |
| Property, plant  and equipment, net                                                                                                                                                   | ** ** | ** ** | **11**     |                        | ** ** | ** **                  | **1,508,984** |   |   |   | 1,274,722 |   |   |
| Mineral licenses,  net                                                                                                                                                                | ** ** | ** ** | **12**     |                        | ** ** | ** **                  | **242,006**   |   |   |   | 166,483 |   |   |
| Deferred income  taxes                                                                                                                                                                | ** ** | ** ** | **19**     |                        | ** ** | ** **                  | **17,487**    |   |   |   | 11,940 |   |   |
| Goodwill                                                                                                                                                                              | ** ** | ** ** | **2**      | **(o)**                     | ** ** | ** **                  | **39,580**    |   |   |   | 39,441 |   |   |
| **Total  assets**                                                                                                                                                                     |       |       |       | ** **                  | ** ** | ** **                  | **$**         | **3,600,083** |   | ** ** | ** ** | $ | 3,678,268 |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                         |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Short-term  borrowings and current portion of long-term debt                                                                                                                          | ** ** | ** ** | **13**     | ** **                  | ** ** | ** **                  | **$**         | **389,411** |   | ** ** | ** ** | $ | 348,880 |   |   |
| Accounts payable and accrued expenses:                                                                                                                                                |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Advances received                                                                                                                                                                     |       |       |       |                        | ** ** | ** **                  | **47,367**    |   |   |   | 94,964 |   |   |
| Accrued expenses  and other current liabilities                                                                                                                                       |       |       |       |                        | ** ** | ** **                  | **79,405**    |   |   |   | 68,147 |   |   |
| Taxes and social  charges payable                                                                                                                                                     | ** ** | ** ** | **14**     |                        | ** ** | ** **                  | **144,715**   |   |   |   | 145,527 |   |   |
| Trade payable to  vendors of goods and services                                                                                                                                       |       |       |       |                        | ** ** | ** **                  | **210,228**   |   |   |   | 186,233 |   |   |
| Due to related  parties                                                                                                                                                               | ** ** | ** ** | **9**      |                        | ** ** | ** **                  | **2,937**     |   |   |   | 3,748 |   |   |
| Current  liabilities of discontinued operations                                                                                                                                       | ** ** | ** ** | **2**      | **(n)**                     | ** ** | ** **                  | **109**       |   |   |   | 30 |   |   |
| Asset retirement  obligation, current portion                                                                                                                                         | ** ** | ** ** | **15**     |                        | ** ** | ** **                  | **4,236**     |   |   |   | 8,219 |   |   |
| Deferred income  taxes                                                                                                                                                                | ** ** | ** ** | **19**     |                        | ** ** | ** **                  | **26,557**    |   |   |   | 26,521 |   |   |
| Deferred revenue                                                                                                                                                                      | ** ** | ** ** | **3**      | **(r)**                     | ** ** | ** **                  | **55,267**    |   |   |   | 760 |   |   |
| Pension obligations,  current portion                                                                                                                                                 | ** ** | ** ** | **16**     |                        | ** ** | ** **                  | **8,189**     |   |   |   | 6,261 |   |   |
| Finance lease  liabilities, current portion                                                                                                                                           | ** ** | ** ** | **17**     |                        | ** ** | ** **                  | **887**       |   |   |   | — |   |   |
| Total current  liabilities                                                                                                                                                            |       |       |       |                        | ** ** | ** **                  | **969,308**   |   |   |   | 889,290 |   |   |
| Long-term debt,  net of current portion                                                                                                                                               | ** ** | ** ** | **13**     |                        | ** ** | ** **                  | **45,615**    |   |   |   | 216,113 |   |   |
| Restructured taxes  and social charges payable, net of current portion                                                                                                                | ** ** | ** ** | **14**     |                        | ** ** | ** **                  | **33,866**    |   |   |   | 87,364 |   |   |
| Asset retirement  obligations, net of current portion                                                                                                                                 | ** ** | ** ** | **15**     |                        | ** ** | ** **                  | **54,816**    |   |   |   | 66,758 |   |   |
| Pension  obligations, net of current portion                                                                                                                                          | ** ** | ** ** | **16**     |                        | ** ** | ** **                  | **43,510**    |   |   |   | 40,720 |   |   |
| Deferred income taxes                                                                                                                                                                 | ** ** | ** ** | **19**     |                        | ** ** | ** **                  | **105,481**   |   |   |   | 105,330 |   |   |
| Other long-term  liabilities                                                                                                                                                          |       |       |       |                        | ** ** | ** **                  | **—**    |   |   |   | 240 |   |   |
| Finance lease  liabilities, net of current portion                                                                                                                                    | ** ** | ** ** | **17**     |                        | ** ** | ** **                  | **9,179**     |   |   |   | — |   |   |
| Commitments and  contingencies                                                                                                                                                        | ** ** | ** ** | **24**     |                        |       |                        |          |   |   |   |   |   |   |
| Minority interests                                                                                                                                                                    | ** ** | ** ** | **2**      | **(p)**                     | ** ** | ** **                  | **127,834**   |   |   |   | 214,824 |   |   |
| **SHAREHOLDERS’ EQUITY**                                                                                                                                                         |       |       |       |                        |       |                        |          |   |   |   |   |   |   |
| Common shares (10  Russian rubles par value; 497,969,086 shares authorized, 416,270,745 shares issued and  403,118,680 shares outstanding as of December 31, 2005 and 2004) | ** ** | ** ** | **18**     |                        | ** ** | ** **                  | **133,507**   |   |   |   | 133,507 |   |   |
| Treasury shares,  at cost (13,152,065 common shares as of December 31, 2005 and 2004)                                                                                            |       |       |       |                        | ** ** | ** **                  | **(4,187**    | **)** |   |   | (4,187 | ) |   |
| Additional paid-in  capital                                                                                                                                                           |       |       |       |                        | ** ** | ** **                  | **321,864**   |   |   |   | 304,404 |   |   |
| Accumulated other  comprehensive income                                                                                                                                               |       |       |       |                        | ** ** | ** **                  | **42,046**    |   |   |   | 93,687 |   |   |
| Retained earnings                                                                                                                                                                     |       |       |       |                        | ** ** | ** **                  | **1,717,244** |   |   |   | 1,530,218 |   |   |
| Total  shareholders’ equity                                                                                                                                                      |       |       |       |                        | ** ** | ** **                  | **2,210,474** |   |   |   | 2,057,629 |   |   |
| **Total  liabilities and shareholders’ equity**                                                                                                                                  |       |       |       | ** **                  | ** ** | ** **                  | **$**         | **3,600,083** |   |   |   | $ | 3,678,268 |   |   |

 

See accompanying notes to consolidated financial statements

F-3

----

**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**  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| Revenue, net  (including related party amounts of $65,431, $68,806 and $211,943 during  2005, 2004 and 2003, respectively)       |       |       |       |                                       |       | **$** | **3,804,995** |   | $ | 3,635,955 |   | $ | 2,028,051 |   |
| Cost of goods sold  (including related party amounts of $74,795, $12,756 and $212,492 during  2005, 2004 and 2003, respectively) |       |       |       |                                       |       | **(2,469,134** | **)** | (2,225,088 | ) | (1,422,987 | ) |
| Gross profit                                                                                                                     | ** ** | ** ** | ** ** |                                       | ** ** | **1,335,861** |   | 1,410,867 |   | 605,064 |   |
| Selling, distribution and  operating expenses:                                                                                   | ** ** | ** ** | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling and  distribution expenses                                                                                               | ** ** | ** ** | ** ** |                                       | ** ** | **(450,238** | **)** | (367,514 | ) | (213,977 | ) |
| Taxes other than  income tax                                                                                                     | ** ** | ** ** | **20**     | ** **                                 | ** ** | **(90,683** | **)** | (69,285 | ) | (44,716 | ) |
| Accretion expense                                                                                                                | ** ** | ** ** | **15**     | ** **                                 | ** ** | **(3,248** | **)** | (2,081 | ) | (2,433 | ) |
| Loss on write-off  of property, plant and equipment                                                                              | ** ** | ** ** | **3**      | **(l)**                                    | ** ** | **(12,667** | **)** | — |   | — |   |
| (Provision for)  recovery of doubtful accounts                                                                                   | ** ** | ** ** | **5**      | ** **                                 | ** ** | **(3,569** | **)** | 7,859 |   | (9,056 | ) |
| General,  administrative and other operating expenses                                                                            | ** ** | ** ** | **21**     | ** **                                 | ** ** | **(259,728** | **)** | (229,039 | ) | (137,201 | ) |
| Total selling,  distribution and operating expenses                                                                              | ** ** | ** ** | ** ** |                                       | ** ** | **(820,133** | **)** | (660,060 | ) | (407,383 | ) |
| Operating income                                                                                                                 | ** ** | ** ** | ** ** |                                       | ** ** | **515,728** |   | 750,807 |   | 197,681 |   |
| *Other income and (expense):*                                                                                                    |       |       |       |                                       |       |   |   |   |   |   |   |
| Income from equity  investments                                                                                                  | ** ** | ** ** | **8**      | ** **                                 | ** ** | **12,426** |   | 4,621 |   | 1,221 |   |
| Interest income                                                                                                                  | ** ** | ** ** | ** ** |                                       | ** ** | **10,049** |   | 2,375 |   | 2,274 |   |
| Interest expense                                                                                                                 | ** ** | ** ** | ** ** |                                       | ** ** | **(40,829** | **)** | (51,409 | ) | (48,516 | ) |
| Other income, net                                                                                                                | ** ** | ** ** | **22**     | ** **                                 | ** ** | **65,920** |   | 836,817 |   | 26,333 |   |
| Foreign exchange  (loss) gain                                                                                                    | ** ** | ** ** | ** ** |                                       | ** ** | **(37,435** | **)** | 1,884 |   | (2,867 | ) |
| Total other income  and (expense), net                                                                                           | ** ** | ** ** | ** ** |                                       | ** ** | **10,131** |   | 794,288 |   | (21,555 | ) |
| Income before  income tax, minority interest, discontinued operations, extraordinary gain  and change in accounting principles   |       |       |       |                                       |       | **525,859** |   | 1,545,095 |   | 176,126 |   |
| Income tax expense                                                                                                               | ** ** | ** ** | **19**     | ** **                                 | ** ** | **(136,643** | **)** | (175,776 | ) | (47,759 | ) |
| Minority interest  in (income) loss of subsidiaries                                                                              | ** ** | ** ** | **2**      | **(p)**                                    | ** ** | **(6,879** | **)** | (11,673 | ) | 18,979 |   |
| Income from  continuing operations                                                                                               | ** ** | ** ** | ** ** |                                       | ** ** | **382,337** |   | 1,357,646 |   | 147,346 |   |
| Loss from discontinued  operations, net of tax                                                                                   | ** ** | ** ** | **2**      | **(n)**                                    | ** ** | **(1,157** | **)** | (15,211 | ) | (5,790 | ) |
| Extraordinary  gain, net of tax                                                                                                  | ** ** | ** ** | **2**      | **(p)**                                    | ** ** | **—** |   | 271 |   | 5,740 |   |
| Income before  cumulative effect of change in accounting principle                                                               |       |       |       |                                       |       | **381,180** |   | 1,342,706 |   | 147,296 |   |
| Change in accounting  principle, net of tax                                                                                      | ** ** | ** ** | **15**     | ** **                                 | ** ** | **—** |   | — |   | (3,788 | ) |
| **Net  income**                                                                                                                  | ** ** | ** ** | ** ** | ** **                                 | ** ** | **381,180** | ** ** | **1,342,706** | ** ** | **143,508** | ** ** |
| Currency  translation adjustment                                                                                                 | ** ** | ** ** | ** ** |                                       | ** ** | **(53,822** | **)** | 49,116 |   | 46,921 |   |
| Adjustment of  available-for-sale securities                                                                                     | ** ** | ** ** | ** ** |                                       | ** ** | **2,181** |   | (2,350 | ) | — |   |
| **Comprehensive  income**                                                                                                        | ** ** | ** ** | ** ** | ** **                                 | ** ** | **$** | **329,539** | ** ** | **$** | **1,389,472** | ** ** | **$** | **190,429** | ** ** |
| Basic and diluted  earnings per share:                                                                                           | ** ** | ** ** | **18**     | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings per share  from continuing operations                                                                                   | ** ** | ** ** | ** ** |                                       | ** ** | **$** | **0.95** |   | $ | 3.63 |   | $ | 0.39 |   |
| Loss per share  effect of discontinued operations                                                                                | ** ** | ** ** | ** ** |                                       | ** ** | **(0.00** | **)** | (0.04 | ) | (0.01 | ) |
| Earnings per share  effect of extraordinary gain                                                                                 | ** ** | ** ** | ** ** |                                       | ** ** | **0.00** |   | 0.00 |   | 0.02 |   |
| Earnings per share  effect of a change in accounting  principle                                                                  |       |       |       |                                       |       | **0.00** |   | 0.00 |   | (0.01 | ) |
| Net income per  share                                                                                                            | ** ** | ** ** | ** ** |                                       | ** ** | **$** | **0.95** |   | $ | 3.59 |   | $ | 0.39 |   |
| Weighted average number  of shares outstanding                                                                                   | ** ** | ** ** | ** ** |                                       | ** ** | **403,118,680** |   | 373,971,312 |   | 366,178,815 |   |

 

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**  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ***Cash  Flows from Operating Activities***                                               | ** ** |       | ** ** | ** **                                 |       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                | ** ** |       | ** ** | ** **                                 |       | **$** | **381,180** | ** ** | $ | 1,342,706 |   | $ | 143,508 |   |
| *Adjustments to reconcile net income to net cash provided  by operating activities:*      | ** ** |       | ** ** | ** **                                 |       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation                                                                              | ** ** |       | ** ** |                                       |       | **147,117** |   | 120,444 |   | 83,980 |   |
| Depletion and  amortization                                                               | ** ** |       | ** ** |                                       |       | **20,483** |   | 17,376 |   | 17,709 |   |
| Foreign exchange loss  (gain)                                                             | ** ** |       | ** ** |                                       |       | **37,435** |   | (1,884 | ) | 2,867 |   |
| Deferred income taxes                                                                     | ** ** |       | ** ** |                                       |       | **(12,535** | **)** | (11,217 | ) | (6,905 | ) |
| Provision for (recovery  of) doubtful accounts                                            | ** ** |       | ** ** |                                       |       | **3,569** |   | (7,859 | ) | 10,011 |   |
| Inventory write-down                                                                      | ** ** |       | ** ** |                                       |       | **5,938** |   | 2,183 |   | 4,624 |   |
| Accretion expense                                                                         | ** ** |       | ** ** |                                       |       | **3,248** |   | 2,081 |   | 2,433 |   |
| Loss on write-off of  property, plant and equipment                                       | ** ** |       | ** ** |                                       |       | **12,667** |   | — |   | — |   |
| Minority interest                                                                         | ** ** |       | ** ** |                                       |       | **6,879** |   | 11,673 |   | (18,980 | ) |
| Effect of change in  accounting principle                                                 | ** ** |       | ** ** |                                       |       | **—** |   | — |   | 3,788 |   |
| Income from equity  investments                                                           | ** ** |       | ** ** |                                       |       | **(12,426** | **)** | (4,621 | ) | (1,221 | ) |
| Non-cash interest on  long-term tax and pension liabilities                               | ** ** |       | ** ** |                                       |       | **13,749** |   | 11,425 |   | 13,302 |   |
| Loss on sale of property,  plant and equipment                                            | ** ** |       | ** ** |                                       |       | **1,801** |   | 5,736 |   | 4,111 |   |
| Gain on sale of long-term  investments                                                    | ** ** |       | ** ** |                                       |       | **(2,743** | **)** | (803,405 | ) | (2,417 | ) |
| Loss from discontinued  operations                                                        | ** ** |       | ** ** |                                       |       | **1,157** |   | 15,211 |   | 5,790 |   |
| Gain on accounts payable  with expired legal term                                         | ** ** |       | **22**     | ** **                                 |       | **(23,347** | **)** | (1,250 | ) | (1,400 | ) |
| Gain on forgiveness of  fines and penalties                                               | ** ** |       | **22**     | ** **                                 |       | **(38,383** | **)** | (18,296 | ) | (9,588 | ) |
| Stock-based compensation  expense                                                         | ** ** |       | ** ** |                                       |       | **—** |   | 1,400 |   | 2,200 |   |
| Amortization of  capitalized costs on bonds issue                                         | ** ** |       | ** ** |                                       |       | **1,553** |   | 1,525 |   | 835 |   |
| Pension service cost and  amortization of prior year service cost                    | ** ** |       | ** ** |                                       |       | **2,511** |   | 2,187 |   | — |   |
| Extraordinary gain                                                                        | ** ** |       | ** ** |                                       |       | **—** |   | (271 | ) | (5,740 | ) |
| Net change before changes in working capital                                              | ** ** |       | ** ** |                                       |       | **549,853** |   | 685,144 |   | 248,907 |   |
| *Changes in working capital items, net of effects  from acquisition of new subsidiaries:* | ** ** |       | ** ** | ** **                                 |       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accounts receivable                                                                       | ** ** |       | ** ** |                                       |       | **23,602** |   | (2,831 | ) | (4,031 | ) |
| Inventories                                                                               | ** ** |       | ** ** |                                       |       | **14,614** |   | (170,726 | ) | (97,783 | ) |
| Trade payable to vendors  of goods and services                                           | ** ** |       | ** ** |                                       |       | **60,087** |   | (1,305 | ) | (14,468 | ) |
| Advances received                                                                         | ** ** |       | ** ** |                                       |       | **(46,269** | **)** | 4,902 |   | 13,316 |   |
| Accrued taxes and other  liabilities                                                      | ** ** |       | ** ** |                                       |       | **14,868** |   | 4,176 |   | 19,328 |   |
| Settlements with related  parties                                                         | ** ** |       | ** ** |                                       |       | **12,658** |   | 1,253 |   | (12,815 | ) |
| Current assets and  liabilities of discontinued operations                                | ** ** |       | ** ** |                                       |       | **57** |   | (4,134 | ) | (17,036 | ) |
| Deferred revenue and cost  of inventory in transit,  net                                  | ** ** |       | ** ** |                                       |       | **4,624** |   | (22,607 | ) | 13,949 |   |
| Other current assets                                                                      | ** ** |       | ** ** |                                       |       | **(15,219** | **)** | (197,734 | ) | (29,509 | ) |
| Net cash provided by  operating activities                                                | ** ** |       | ** ** |                                       |       | **618,875** |   | 296,137 |   | 119,858 |   |
|                                                                                           |            |            |            |                                            |            |  |  |  |  |  |  |  |  |  |

 

F-5

----

**MECHEL OAO (formerly Mechel Steel Group OAO)Consolidated Statements of Cash Flows (Continued) (in thousands of U.S. dollars)**

 

| ** **                                                                                              | ** ** | ** ** | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|
| ** **                                                                                              | ** ** | **Notes**  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ***Cash Flows from Investing  Activities***                                                             | ** ** |       | ** ** |                                       |       | ** ** |   |   |   |   |   |
| Acquisition of  subsidiaries, less cash acquired                                                        | ** ** |       | ** ** |                                       |       | **(3,497** | **)** | — |   | (20,919 | ) |
| Acquisition of minority  interest in subsidiaries                                                       | ** ** |       | **2**      | **(p)**                                    |       | **(73,936** | **)** | (37,021 | ) | (3,776 | ) |
| Investment in Korshunov  Mining Plant                                                                   | ** ** |       | ** ** |                                       |       | **—** |   | — |   | (82,793 | ) |
| Investment in Yakutugol                                                                                 | ** ** |       | **2**      | **(j)**                                    |       | **(411,182** | **)** | — |   | — |   |
| Acquisition of Izhstal                                                                                  | ** ** |       | ** ** |                                       |       | **—** |   | (22,742 | ) | — |   |
| Acquisition of Port  Posiet                                                                             | ** ** |       | ** ** |                                       |       | **—** |   | (29,966 | ) | — |   |
| Acquisition of Kaslinsky  Architectural Casting Plant                                                   | ** ** |       | ** ** |                                       |       | **—** |   | (996 | ) | — |   |
| Investments in other  non-marketable securities                                                         | ** ** |       | ** ** |                                       |       | **(7,554** | **)** | (29,762 | ) | (28,525 | ) |
| Proceeds from disposal of  discontinued operations                                                      | ** ** |       | ** ** |                                       |       | **—** |   | — |   | 5,162 |   |
| Proceeds from disposal of  non-marketable equity securities                                             | ** ** |       | ** ** |                                       |       | **19,388** |   | 875,967 |   | 33,577 |   |
| Proceeds from disposals  of property, plant and equipment                                          | ** ** |       | ** ** |                                       |       | **2,628** |   | 3,647 |   | 3,813 |   |
| Purchases of mineral  licenses                                                                          | ** ** |       | ** ** | ** **                                 |       | **(93,033** | **)** | — |   | — |   |
| Purchases of property,  plant and equipment                                                             | ** ** |       | ** ** |                                       |       | **(427,521** | **)** | (303,411 | ) | (116,856 | ) |
| Net cash (used in)  provided by investing activities                                                    | ** ** |       | ** ** |                                       |       | **(994,707** | **)** | 455,716 |   | (210,317 | ) |
| ***Cash  Flows from Financing Activities***                                                             |       |       |       |                                       |       |   |   |   |   |   |   |
| Proceeds from short-term  borrowings                                                                    | ** ** |       | ** ** |                                       |       | **1,577,984** |   | 954,733 |   | 781,525 |   |
| Repayment of short-term  borrowings                                                                     | ** ** |       | ** ** |                                       |       | **(1,686,578** | **)** | (941,340 | ) | (747,815 | ) |
| Dividends paid                                                                                          | ** ** |       | ** ** |                                       |       | **(194,154** | **)** | (5,145 | ) | (26,282 | ) |
| Dividends received                                                                                      | ** ** |       | ** ** | ** **                                 |       | **2,000** | ** ** | — |   | — |   |
| Proceeds from issuance of  common stock                                                                 | ** ** |       | **18**     | ** **                                 |       | **—** |   | 220,873 |   | — |   |
| Proceeds from long-term  debt                                                                           | ** ** |       | ** ** |                                       |       | **14,815** |   | 75,241 |   | 112,736 |   |
| Repayment of long-term  debt                                                                            | ** ** |       | ** ** |                                       |       | **(20,180** | **)** | (52,093 | ) | (23,482 | ) |
| Loans and notes received  from related parties                                                          | ** ** |       | ** ** | ** **                                 |       | **—** | ** ** | — |   | 6,397 |   |
| Repayment of obligations  under finance lease                                                           | ** ** |       | ** ** |                                       |       | **(757** | **)** | — |   | — |   |
| Net cash (used in)  provided by financing activities                                                    | ** ** |       | ** ** |                                       |       | **(306,870** | **)** | 252,269 |   | 103,079 |   |
| Effect of exchange rate  changes on cash and cash equivalents                                           | ** ** |       | ** ** |                                       |       | **(30,284** | **)** | 1,360 |   | 991 |   |
| Net (decrease) increase  in cash and cash equivalents                                                   | ** ** |       | ** ** |                                       |       | **(712,986** | **)** | 1,005,482 |   | 13,611 |   |
| Cash and cash equivalents  at beginning of year                                                         | ** ** |       | ** ** |                                       |       | **1,024,761** |   | 19,279 |   | 5,668 |   |
| Cash and cash equivalents  at end of year                                                               | ** ** |       | ** ** | ** **                                 |       | **$** | **311,775** | ** ** | $ | 1,024,761 |   | $ | 19,279 |   |
| ***Supplementary  cash flow information:***                                                             |       |       |       |                                       |       |   |   |   |   |   |   |
| Interest paid, net of  amount capitalized                                                               | ** ** |       | ** ** | ** **                                 |       | **$** | **(43,354** | **)** | $ | (62,835 | ) | $ | (32,394 | ) |
| Income taxes paid                                                                                       | ** ** |       | ** ** | ** **                                 |       | **$** | **(171,774** | **)** | $ | (136,473 | ) | $ | (53,884 | ) |
| ***Non-cash  Activities:***                                                                             | ** ** |       | ** ** | ** **                                 |       | ** ** | ** ** |   |   |   |   |
| Net assets of  subsidiaries contributed by minority shareholders in exchange for shares  issued by SKCC | ** ** |       | **18**     | ** **                                 |       | **$** | **17,460** | ** ** | $ | 340 |   | $ | 4,428 |   |
| Acquisition of plant and  equipment in exchange for goods                                               | ** ** |       | ** ** | ** **                                 |       | **$** | **—** | ** ** | $ | 3,071 |   | $ | — |   |
| Acquisition of equipment  under finance lease                                                           | ** ** |       | **17**     | ** **                                 |       | **$** | **10,291** | ** ** | $ | — |   | $ | — |   |
| Assumption of debt in  business combination                                                             | ** ** |       | **2**      | **(b)**                                    |       | **$** | **—** | ** ** | $ | — |   | $ | 2,673 |   |
| Treasury shares issued to subsidiary                                                                    | ** ** |       | **18**     | ** **                                 |       | **$** | **—** | ** ** | $ | 9,723 |   | $ | — |   |

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

See accompanying notes to consolidated financial statements

F-6

----

**MECHEL OAO (formerly Mechel Steel Group OAO)Consolidated Statement of Changes inShareholders’ Equity**(in thousands of U.S. dollars, except share amounts)

| ** **                                                         | ** ** | ** **             | ** ** | ** **               | ** **  | ** **     | ** **      | ** **        | ** ** | ** **          | ** ** | **Accumulated other** | ** ** | **Retained earnings/** | ** **  | ** **  | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|--------------------------|-------------|----------------|-----------------|-------------------|------------|---------------------|------------|----------------------------|------------|-----------------------------|-------------|-------------|------------|
| ** **                                                         | ** ** | **Common shares** | ** ** | **Treasury shares** | ** **  | **Additional** | ** **      | **comprehensive** | ** ** | **(accumulated**    | ** ** | ** **                 | ** ** |
| ** **                                                         | ** ** | **Shares**             | ** ** | **Amount**               | ** **  | **Shares**     | ** **      | **Amount**        | ** ** | **paid-in-capital** | ** ** | **income**                 | ** ** | **deficit)**                | ** **  | **Total**   | ** ** |
| **Balances as of January 1, 2003**                                 | ** ** | **382,969,086**        | ** ** | **$**                    | **121,935** | ** **     | **(16,790,271** | **)**             |       | **$**               | **(5,346** | **)**                      |       |                        | **$**       | **86,031**  | ** ** |   |   | **$** | **—** |   |   |   | **$** | **75,431** |   |   | **$** | **278,051** |   |
| Net income                                                         |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | —     | ** **                  |        |        | —     |   |   |   | 143,508 |   |   | 143,508 |   |
| Dividends                                                          |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | —     | ** **                  |        |        | —     |   |   |   | (26,282 | ) |   | (26,282 | ) |
| Cumulative translation adjustment on opening balances  (Note 3(u)) |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | —     | ** **                  |        |        | 15,992     |   |   |   | — |   |   | 15,992 |   |
| Cumulative translation adjustment for 2003                         |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | —     | ** **                  |        |        | 30,929     |   |   |   | — |   |   | 30,929 |   |
| Stock-based compensation                                           |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | 2,200      | ** **                  |        |        | —     |   |   |   | — |   |   | 2,200 |   |
| Issuance of subsidiary stock                                       |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | 4,428      | ** **                  |        |        | —     |   |   |   | — |   |   | 4,428 |   |
| **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 18)                                          |       | 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 18)                                 |       | —                 |       | —                   |        | 2,297,815      |            |              | 732        | ** **          |       |                       | 668        | ** **                  |        |        | —     |   |   |   | — |   |   | 1,400 |   |
| Stock issued for acquisition of minority  interest (Note 18)       |       | —                 |       | —                   |        | 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 |   |
| Stock issued for acquisition of minority  interest (Note 18)       |       | —                 |       | —                   |        | —         |            |              | —     | ** **          |       |                       | 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** |   |

 

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, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(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 on March 19,2003, under the laws of the Russian Federation in connection with areorganization to serve as a holding company for various steel and mining companiesowned by two individual shareholders (the “Controlling Shareholders”). TheControlling Shareholders, directly or through their affiliates, either acquiredexisting companies or established new companies, at varying dates from 1995through March 19, 2003, which were contributed to Mechel after itsformation. Mechel and its subsidiaries****arecollectively****referred to herein asthe “Group”. Set forth below is a summary 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(*)**                                               | ** ** | **  2005  ** | ** ** | **  2004  ** | ** ** | **  2003  ** | ** ** |
| 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 | % |   |   | 75.0 | % |   |
| 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                                                 |       |   | 93.7 | % |   |   | 96.6 | % |   |   | 96.0 | % |   |
| Sibirginsk Open Pit Mine (SOPM)***                                                   |       |       | Russia        |                                                       |       | Coal  mining           |       | Jan  21, 1999                                                 |       |   | — |   |   |   | 90.4 | % |   |   | 86.3 | % |   |
| Krasnogorsk Open Pit Mine (KOPM)                                                |       |       | Russia        |                                                       |       | Coal  mining           |       | Jan  21, 1999                                                 |       |   | 88.9 | % |   |   | 87.4 | % |   |   | 77.7 | % |   |
| Tomusinsk Open Pit Mine (TOPM)                                                       |       |       | Russia        |                                                       |       | Coal  mining           |       | Jan  21, 1999                                                 |       |   | 74.4 | % |   |   | 74.4 | % |   |   | 74.2 | % |   |
| Olzherassk Open Pit Mine (OOPM)                                                      |       |       | Russia        |                                                       |       | Coal  mining           |       | Dec  28, 1999                                                 |       |   | 81.9 | % |   |   | 80.6 | % |   |   | 78.9 | % |   |
| Tomusinsk Group Processing Plant (TGPP)**                                            |       |       | Russia        |                                                       |       | Coal  processing       |       | Dec  31, 2000                                                 |       |   | — |   |   |   | — |   |   |   | 84.4 | % |   |
| Kuzbass Central Processing Plant (KCPP)***                                           |       |       | Russia        |                                                       |       | Coal  processing       |       | Dec  31, 2000                                                 |       |   | — |   |   |   | 95.0 | % |   |   | 88.4 | % |   |
| Lenin Mine (LM)                                                                      |       |       | Russia        |                                                       |       | Coal  mining           |       | Dec  29, 2001                                                 |       |   | 79.0 | % |   |   | 78.5 | % |   |   | 53.5 | % |   |
| Usinsk Mine (UM)                                                                     |       |       | Russia        |                                                       |       | Coal  mining           |       | Dec  29, 2001                                                 |       |   | 80.2 | % |   |   | 78.6 | % |   |   | 53.6 | % |   |
| Siberian Central Processing Plant (SCPP)***                                          |       |       | Russia        |                                                       |       | Coal  processing       |       | Dec  22, 2000                                                 |       |   | — |   |   |   | 90.8 | % |   |   | 89.6 | % |   |
|                                                                                      |            |            |               |                                                            |            |                        |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F-8

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **             | ** ** | **Interest in voting stock held by** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------|------------|------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | **Date control**  | ** ** | **the Group at December 31,**             | ** ** |
| **Name of subsidiary**           | ** ** | ** ** | ** ** | **Registered in**     | ** ** | **Core business** | ** ** | **acquired(*)**                                               | ** ** | **  2005  ** | ** ** | **  2004  ** | ** ** | **  2003  ** | ** ** |
| Chelyabinsk  Metallurgical Plant (CMP)     |       | Russia     |       | Steel  products            |       | Dec  27, 2001          |       |                                                          | 93.7       | % |   |   | 86.9 | % |   |   | 82.6 | % |   |
| Southern Urals  Nickel Plant (SUNP)        |       | Russia     |       | Nickel                     |       | Dec  27, 2001          |       |                                                          | 79.9       | % |   |   | 79.3 | % |   |   | 79.3 | % |   |
| Vyartsilya Metal  Products Plant (VMPP)    |       | Russia     |       | Steel  products            |       | May 24,  2002     |       |                                                          | 93.3       | % |   |   | 93.4 | % |   |   | 93.4 | % |   |
| Beloretsk  Metallurgical Plant (BMP)       |       | Russia     |       | Steel  products            |       | June 14,  2002    |       |                                                          | 90.3       | % |   |   | 90.2 | % |   |   | 80.5 | % |   |
| Mechel Targoviste  SA(2)                   |       | Romania    |       | Steel  products            |       | Aug  28, 2002          |       |                                                          | 83.7       | % |   |   | 81.0 | % |   |   | 81.0 | % |   |
| Mechel Zeljezara  (MZ)                     |       | Croatia    |       | Steel  products            |       | March 17,  2003   |       |                                                          | 100.0      | % |   |   | 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          |       |                                                          | 85.5       | % |   |   | 75.0 | % |   |   | 70.3 | % |   |
| Mechel Campia  Turzii SA(3)                |       | Romania    |       | Steel  products            |       | June 20,  2003    |       |                                                          | 84.9       | % |   |   | 81.0 | % |   |   | 79.8 | % |   |
| 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 | % |   |   | 100.0 | % |   |
| Mechel Energo                              |       | Russia     |       | Energy trading             |       | Feb 3, 2004            |       |                                                          | 100.0      | % |   |   | 100.0 | % |   |   | — |   |   |
| Port Posiet                                |       | Russia     |       | Transportation             |       | Feb  11, 2004          |       |                                                          | 80.0       | % |   |   | 80.0 | % |   |   | — |   |   |
| Izhstal                                    |       | Russia     |       | Steel  products            |       | May 14,  2004     |       |                                                          | 87.7       | % |   |   | 62.3 | % |   |   | — |   |   |
| Port Kambarka                              |       | Russia     |       | Transportation             |       | April 27,  2005   |       |                                                          | 90.4       | % |   |   | — |   |   |   | — |   |   |
| Kaslinsky Architectural  Art Casting Plant |       | Russia     |       | Steel products             |       | April 14, 2004    |       |                                                          | 100.0      | % |   |   | 100.0 | % |   |   | — |   |   |
|                                            |            |            |            |                            |            |                        |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

*       Datewhen a control interest was acquired by either the Group or ControllingShareholders.

**    Mergedwith SKCC on October 15, 2004 

***  Mergedwith SKCC in October - December 2005

(1)   Formerly—MechelTrading AG (MT). Renamed on December 20, 2005

(2)   Formerly—Combinatulde Oteluri Speciale Targoviste S.A. (COST)

(3)   Formerly—Industria Sarmei (IS)

F-9

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(b)   Controlling shareholders and reorganization**

Since 1995, theControlling Shareholders have acted in concert pursuant to a written Ownership,Control and Voting 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 ControllingShareholders to Mechel in exchange for all the outstanding capital stock ofMechel, forming a new holding company via an exchange of shares.

As a result of thisrestructuring, the Controlling Shareholders maintained their original equalownership in the subsidiaries through Mechel and Mechel became a direct holderof the stock of the subsidiaries.

Shareholders in each ofMechel’s subsidiaries before the restructuring who were not ControllingShareholders did not contribute any shares in these subsidiaries to Mechel inexchange for its shares and were considered as outside the control group andthese shareholders retained a minority interest in the subsidiaries. Thus, tothe extent minority interests existed in the entities under common controlprior to March 19, 2003, such minority interests did not change as aresult of the formation of Mechel and the reorganization of the Group.

**(c)    Basis of 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. Theconsolidated financial statements have been prepared on the basis that Mechelexisted for all periods presented since its inception, and was the majorityshareholder of the contributed subsidiaries in all such periods, unless asubsidiary was acquired by the Controlling Shareholders during the periodspresented, in which case the consolidated financial statements reflect theresults of operation of the acquired subsidiaries from the date control was acquired.

**(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.

F-10

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**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, 2003 and December 31,2005.

**(a)   Ural Stamping Plant (USP)**

On April 24,2003, the Group acquired 93.8% of the common shares of USP for $11,325 in cash.USP is located in the southern Urals and is Russia’s largest producer ofstampings from specialty steel and heatproof and titanium alloys. Theacquisition of USP was accounted for using the purchase method of accounting.The results of operations of USP were included in the consolidated financialstatements from the date of acquisition, April 24, 2003. The followingtable summarizes the fair values of net assets acquired at the date ofacquisition of control.

| ** **                           | ** ** | **April 24, 2003** | ** ** |
|--------------------------------------|------------|------------------------------|------------|
| Cash and cash  equivalents           |       |                         | 59         |   |   |
| Other current  assets                |       |                         | 9,832      |   |   |
| Other non-current  assets            |       |                         | 5          |   |   |
| Property, plant  and equipment       |       |                         | 12,497     |   |   |
| Current  liabilities                 |       |                         | (8,841     | ) |   |
| Deferred income  taxes               |       |                         | (181       | ) |   |
| Fair value of net assets acquired    |       |                         | 13,371     |   |   |
| Minority’s share  in net assets |       |                         | (2,046     | ) |   |
| **Total  investment**                | ** ** | ** **                   | **11,325** |   |   |

 

**(b)   Mechel Campia Turzii S.A.**

On June 20, 2003, the Group acquired 73.4% of thecommon shares of Mechel Campia Turzii S.A. for $2,849 in cash. Mechel CampiaTurzii is a Romanian steel mill that produces long steel products, includingcarbon and alloyed wire rod, rebar, hardware and carbon and low-alloy billets.The Group also committed to the Romanian government to invest $19,040 tomodernize the plant and upgrade its capacity, to spend $3,619 to improve theenvironment and to maintain its workforce level for five years. The environmentobligation taken by the Group was discounted using 17% rate and included in thecost of investment in the amount of $2,673, together with cash considerationpaid.

Inaccordance with the purchase agreement, Mechel Campia Turzii was obligated toconvert its debts to utility companies into shares. As a result of thisconversion, on July 2, 2003, 6,356,364 new shares were issued to certainRomanian utility companies. Immediately after this conversion, the Group’sinterest was diluted to 54.8% of the common shares of Mechel Campia Turzii. On August 1,2003, the Group purchased all of these new shares from the Romanian StatePrivatization Agency for a total consideration of $1,298. Upon completion ofthis transaction, the Group’s interest increased to 79.8%. The acquisition ofMechel Campia Turzii was accounted for using the purchase method of accounting.The results of operations of Mechel Campia Turzii are included in theconsolidated financial statements from the date of 

F-11

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

acquisition, June 20, 2003. The following tablesummarizes the fair values of net assets acquired at the date of acquisition ofcontrol.

| ** **                           | ** ** | **June 20, 2003** | ** ** |
|--------------------------------------|------------|-----------------------------|------------|
| Cash and cash  equivalents           |       |                        | 446        |   |   |
| Other current  assets                |       |                        | 26,949     |   |   |
| Property, plant  and equipment       |       |                        | 23,910     |   |   |
| Current  liabilities                 |       |                        | (18,596    | ) |   |
| Deferred income  taxes               |       |                        | 1,287      |   |   |
| Fair value of net assets acquired    |       |                        | 33,996     |   |   |
| Minority’s share  in net assets |       |                        | (21,436    | ) |   |
| Extraordinary  gain                  |       |                        | (5,740     | ) |   |
| **Total  investment**                | ** ** | ** **                  | **6,820**  |   |   |

 

**(c)    Korshunov Mining Plant (KMP)**

On December 25, 2002, the Group acquired 62.5% ofthe common shares of KMP, an iron ore mining operation located in easternSiberia, for the total consideration of $34,498 in cash. The shares, however,lacked any voting rights as KMP was in bankruptcy proceedings; accordingly, theinvestment in KMP was carried at cost. Until the ratification on September 29,2003, by a court of a Settlement Agreement with the KMP’s creditors (the Groupwas the second largest creditor after the government, which was owed in arrearsfor taxes and social charges, including various penalties and interest), andremoval of the court-appointed administrator for KMP on October 16, 2003,the Group’s equity interest in KMP did not provide it the ability to exerciseeither control or significant influence over KMP. The control restrictions werecompletely removed and the Group obtained full control over KMP’s operations onOctober 16, 2003, upon which the acquisition of KMP was accounted forusing purchase method of accounting. The Group included the results ofoperations of KMP in its consolidated financial statements beginning October 16,2003, the date of acquisition of control.

F-12

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Despitethe lack of control over KMP during bankruptcy proceedings, the Group continuedto increase its stake in KMP’s equity and in February 2003 acquired anadditional 7.7% of the common shares for $1 in cash. Together with the cashpaid for the shares in KMP, the Group provided loans and other continuingsupport to KMP, which were aimed to pay the current liabilities and the tax andcommercial debt arrears of KMP pursuant to the Settlement Agreement. At thedate of acquisition of control, the cost of the Group’s investment in KMP’sequity, in total comprising 70.3% of its voting shares, and the amount of loansand advances provided to KMP amounted to a total investment of $132,302. TheGroup has used and continues to use the assets of KMP in the manner in whichthey were previously used. The following table summarizes the fair values ofnet assets acquired and liabilities assumed at the date of acquisition ofcontrol.

| ** **                        | ** ** | **October 16, 2003** | ** **  |
|-----------------------------------|------------|--------------------------------|-------------|
| Cash and cash  equivalents        |       |                           | 127         |   |   |
| Other current  assets             |       |                           | 17,914      |   |   |
| Property, plant  and equipment    |       |                           | 78,914      |   |   |
| Mineral licenses                  |       |                           | 76,746      |   |   |
| Long-lived assets                 |       |                           | 2,144       |   |   |
| Current  liabilities              |       |                           | (13,363     | ) |   |
| Long-term  liabilities            |       |                           | (2,144      | ) |   |
| Deferred income  taxes            |       |                           | (28,036     | ) |   |
| Fair value of net assets acquired |       |                           | 132,302     |   |   |
| **Total  investment**             | ** ** | ** **                     | **132,302** |   |   |

 

The acquisition of KMP was intended to support theGroup’s policy of making the technological cycle complete and independent ofother iron ore suppliers.

F-13

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(d)**          MechelNemunas

On October 15,2003, the Group acquired 75.1% of the common shares of Nemuno Holding, aLithuanian hardware manufacturer with two operating subsidiaries (collectively,“Mechel Nemunas”), for $4,031 in cash. In November and December 2003,the Group purchased the remaining 24.9% of the common shares of Nemuno Holding,and the remaining shares in its subsidiaries not already owned by NemunoHolding, for a total of $1,000 in cash. As a result, the Group increased itsinterest in Nemuno Holding, subsequently renamed Mechel Nemunas, and itssubsidiaries to 100%. The acquisition of Mechel Nemunas was accounted for usingthe purchase method of accounting. The results of operations of Mechel Nemunasare included in the consolidated financial statements from the date ofacquisition of control, October 15, 2003. The following table summarizesthe fair values of net assets acquired and liabilities assumed at the date ofacquisition of control.

| ** **                        | ** ** | **October 15, 2003** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|
| Cash and cash  equivalents        |       |                           | 79         |   |   |
| Other current  assets             |       |                           | 3,506      |   |   |
| Property, plant  and equipment    |       |                           | 2,206      |   |   |
| Current  liabilities              |       |                           | (2,950     | ) |   |
| Deferred income  taxes            |       |                           | 117        |   |   |
| Fair value of net assets acquired |       |                           | 2,958      |   |   |
| Goodwill                          |       |                           | 2,073      |   |   |
| **Total  investment**             | ** ** | ** **                     | **5,031**  |   |   |

 

**(e)**           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 theacquisition was the Group’s intention to selectively expand its internallogistics capabilities, currently centered on the Group’s railway freight andforwarding company. Through the acquisition of Port Posiet, located on the Seaof Japan, the Group tries to optimize its transportation expenses. The Groupintends to ship primarily its coking coal concentrate, as well as steelproducts, to Asia through this port. No sea ports were readily available on themarket, due to this fact and because most ports located in the Far East arecontrolled either by competitors or independent transportation companies, theGroup had to pay a premium in order to acquire Port Posiet. The premium paidresulted in positive goodwill, none of which will be deductible for income taxpurposes. The Port Posiet is included in the mining segment as the majority ofits activity relate to movement of coal and coking coal concentrate.

F-14

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(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 net assets acquired atthe 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** |   |   |

 

**(f)**             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.

**(g)**           Izhstal

In January-February 2004, the Group acquired a15.35% interest in Izhstal, a producer of semifinished 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. During May 2004,the Group acquired an additional 2.19% interest by buying shares on the openmarket for $1,694 in cash. Thus, by the end of May 2004, the Group hadaccumulated 61.61% of Izhstal voting stock and had paid a total of $25,137 incash.

F-15

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(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.

**(h)**          InvestCoal

On June 17, 2004, theGroup acquired 100% of Invest Coal for $3,275 in cash. Invest Coal ownslicenses for mineral reserves extension, mostly in the area surrounding one ofthe Group’s coal mines. The acquisition of Invest Coal facilitates theextraction of mineral reserves of that coal mine. The acquisition of InvestCoal was accounted for as an acquisition of an asset as it did not constitute abusiness. On December 29, 2005, Invest coal was merged with OlzherasskOpen Pit Mine.

**(i)**             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 an intangibleasset and is being amortized over five years.

**(j)**             Yakutugol

On January 24, 2005, the Group won the auctionwhere the Government of Republic Sakha (Yakutia) sold shares of Yakutugol, aleading coal producer in the northeast of Russia. The Group acquired 

F-16

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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 are not included inthe accompanying consolidated financial statements of the Group as the Groupaccounts for Yakutugol as its equity-method investment. The following tablesummarizes the fair values of net assets of Yakutugol at the date ofacquisition 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).

The Group’s share in theYakutugol’s net income for the year ended December 31, 2005 of $9,353includes the effect of depletion of mineral licenses. Yakutugol is included inthe mining segment.

F-17

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(k)**          Chelyabenergo

From April throughDecember 2004, the Group acquired 3.77% of Chelyabenergo. In February 2005,Chelyabenergo was re-organized into several 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.

As of December 1, 2005, the Group possessedbetween 4.5% and 10.1% share in Chelyabenergo Group entities.

In December 2005, theGroup sold vast majority of shares of Chelyabenergo OAO E&E, ChelyabinskGenerating Holding Company, Chelyabinsk Energy Holding Company and SouthernUrals Hydroelectric Station (4.9%, 5.15%, 4.75% and 4.75% of each company,respectively), for the total consideration of $12,512, realizing a gain of$2,500 on such disposal. As of December 31, 2005, the Group’s totalinvestment in Chelyabenergo Group entities was $4,792.

**(l)**             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 Coal Resources,which was included in the net assets of Mechel Coal Resources of $4,964 as ofthe date of sale. The total gain on disposal of Mechel Coal Resources amountedto $2,036.

**(m)**      MagnitogorskIron and Steel Works (MMK)

As of December 31,2003, the Group had an investment in MMK shares and participated in the MMKboard of directors. During the year ended December 31, 2004, the Groupincreased its investment in MMK through acquisition of 0.59% of non-votingpreferred shares and 0.36% of common shares for the total cash consideration of$20,960. As a result, the Group subsidiaries owned 17.25% of ordinary sharesand 12.57% of preferred shares as of December 20, 2004 having a carryingvalue of $69,353. On December 21, 2004, the Group sold most of its sharesin MMK to a third party for the total of $870,000, including $90,000 paid undera mutual release agreement, in which all potential claims between Mechel, onone hand, and 

F-18

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

MMK andits other shareholders, on the other, are waived. The total sales price wasreceived in cash. The gain realized on the sales of MMK shares in 2004 wasequal to $799,982, as 0.01% of ordinary shares with carrying value of $367 weretransferred from Mechel to the buyer on January 17, 2005. The related saleproceeds of $701 were recorded as deferred income as of December 31, 2004and the related gain of $334 was recognized in 2005.

**(n)**          Discontinuedoperations

On February 6, 2003, the Group entered into anagreement to acquire substantially all the assets of Zeljezara Sisak, a tubeproducer located in Croatia. As consideration, the Group paid $0.01 in cash.The Group committed to invest $8,600 to modernize Zeljezara Sisak’s plant andupgrade its capacity, as well as to maintain its workforce level for five yearsin return for receiving the business at no cost. The deal closed withregistration of a new company, Mechel Zeljezara d.o.o. on March 17, 2003,whereby the assets of Zeljezara Sisak were transferred to Mechel Zeljezara. Theacquisition of Mechel Zeljezara was accounted for using the purchase method ofaccounting.

On September 14, 2004, Mechel Trading, MechelZeljezara, and Zeljezara Sisak, concurrently concluded two agreements relatingto the operations acquired by Mechel Zeljezara from Zeljezara Sisak. Pursuantto the first agreement, Zeljezara Sisak, the seller, assigned its rights andobligations under the original asset purchase agreement to the CroatianPrivatization Fund. Pursuant to the second agreement, all parties terminatedthe original purchase agreement, subject to the following conditions: (1) transferby Mechel Zeljezara to the Croatian Privatization Fund of the assets acquiredby Mechel Zeljezara and the employees of the plant; (2) donation by MechelZeljezara of spare parts in the amount of $1,798 to the Croatian PrivatizationFund; (3) the redemption by the Croatian government of a bank guaranteegiven to it pursuant to the original purchase agreement in the amount of$4,316; and (4) waiver of any and all claims against Mechel Trading andMechel Zeljezara. The Group has started accounting for Mechel Zeljezara asdiscontinued operations from September 14, 2004. Mechel Zeljezara iscurrently in liquidation, which is expected to be concluded in 2006. Theresults of operations of Mechel Zeljezara are included in the consolidatedfinancial statements from the date of acquisition, March 17, 2003.

Consequently,as of December 31, 2005 and 2004, the Group’s investment in MechelZeljezara was presented in the consolidated balance sheets, as follows:

| ** **                                                  | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Condensed balance sheet select  data**                    |       |                        |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                   |       | ** **                  | **88**     |                        |       |   | 273 |   |   |
| Other current assets                                        |       | ** **                  | **—** |                        |       |   | 974 |   |   |
| Total current  assets                                       |       | ** **                  | **88**     |                        |       |   | 1,247 |   |   |
| Property, plant and equipment and other non-current  assets |       | ** **                  | **97**     |                        |       |   | 165 |   |   |
| Total non-current  assets                                   |       | ** **                  | **97**     |                        |       |   | 165 |   |   |
| Accounts payable and accrued liabilities                    | ** ** | ** **                  | **(109**   | **)**                       |       |   | (30 | ) |   |
| **Total current liabilities**                               | ** ** | ** **                  | **(109**   | **)**                       |       |   | (30 | ) |   |

 

F-19

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

On July 1, 2001 and October 20, 1999, theGroup acquired control of Belov Insurance Company and Uglemetbank, whichprovided insurance services (life and property) and banking services,respectively, mainly to SKCC and its subsidiaries. The results of operations ofBelov Insurance Company and Uglemetbank were included in the consolidatedfinancial statements from their respective dates of acquisition of control,July 1, 2001 and October 20, 1999.

In June 2002, management committed to a plan todiscontinue and sell substantially all of its shares in both Belov InsuranceCompany and Uglemetbank as they were considered non-core to the Group’soperations and had generated net losses since acquisition. InOctober 2003, the Group sold its investment in Belov Insurance Company for$641 in cash and in November and December 2003 reduced its interestin Uglemetbank to 19%, by selling its shares for $4,521 in cash. Thedivestiture of the equity stakes in Belov Insurance Company and Uglemetbankresulted in a loss on disposal of $1,175, net of tax.

Forthe three years ended December 31, 2005, the Group’s operations pertainingto Mechel Zeljezara, Belov Insurance Company and Uglemetbank were presented ona net basis, as follows:

| ** **                                     | ** ** | **For the years ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                     | ** ** | ** **                                                    | ** ** | **2004** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **                                                    | ** ** | **Mechel** | ** ** | **Mechel** | ** ** | ** ** | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **2005**                                                      | ** ** | **Zeljezara** | ** ** | **Zeljezara** | ** ** | ** ** | ** ** | ** ** | ** ** | **Belov** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Mechel**                                                    | ** ** | **Through** | ** ** | **Upon** | ** ** | ** ** | ** ** | **Mechel** | ** ** | **Insurance** | ** ** | **Uglemet** | ** ** | **Loss on** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **Zeljezara**                                                 | ** ** | **disposal date** | ** ** | **disposal** | ** ** | **Total** | ** ** | **Zeljezara** | ** ** | **Company** | ** ** | **bank** | ** ** | **disposal** | ** ** | **Total** | ** ** |
| Revenues and operating gains                   |       |                                                          | 12         |   |   |   | 26,531 |   |   |   | — |   |   | 26,531 |   |   | 22,037 |   |   |   | 2,549 |   |   |   | 1,234 |   |   |   | — |   |   | 25,820 |   |
| Operating income  (loss)                       |       |                                                          | (116       | ) |   |   | (13,083 | ) |   |   | (2,806 | ) |   | (15,889 | ) |   | (4,904 | ) |   |   | 546 |   |   |   | (1,251 | ) |   |   | — |   |   | (5,610 | ) |
| Income (loss) before taxes                     |       |                                                          | (1,157     | ) |   |   | (12,864 | ) |   |   | (2,347 | ) |   | (15,211 | ) |   | (3,368 | ) |   |   | 321 |   |   |   | (1,251 | ) |   |   | (948 | ) |   | (5,246 | ) |
| Income tax effects                             |       |                                                          | —     |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   |   | (185 | ) |   |   | (132 | ) |   |   | (227 | ) |   | (544 | ) |
| Loss from discontinued operations, net of  tax |       |                                                          | (1,157     | ) |   |   | (12,864 | ) |   |   | (2,347 | ) |   | (15,211 | ) |   | (3,368 | ) |   |   | 136 |   |   |   | (1,383 | ) |   |   | (1,175 | ) |   | (5,790 | ) |

 

Mechel Zeljezara belongedto the Steel segment and Belov Insurance Company along with Uglemetbankbelonged to the Mining segment.

F-20

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(o)**          Goodwill

| **Balance  at December 31, 2002**    | ** ** | **3,329**  | ** ** |
|-------------------------------------------|------------|------------|------------|
| Acquisition of Mechel Nemunas (Note 2(d)) |       | 2,073      |       |
| **Balance at December 31, 2003**     | ** ** | **5,402**  | ** ** |
| Acquisition of Port Posiet (Note 2(e))    |       | 26,534     |       |
| **MMS  shares exchange (Note 18)**        |       | 7,505      |       |
| **Balance at December 31, 2004**     | ** ** | **39,441** | ** ** |
| Translation difference                    |       | 139        |       |
| **Balance  at December 31, 2005**    | ** ** | **39,580** | ** ** |

 

Goodwill arising from the acquisition of MechelNemunas in 2003 and MMS minority interest in 2004 of $2,073 and $7,505,respectively, was allocated to the Steel segment. Goodwill arising from theacquisition of Port Posiet in 2004 of $26,534 was allocated to the Miningsegment.

In accordance with SFAS No. 141,and SFAS No. 142, “Goodwill and Other Intangible Assets”, the excess ofthe fair value of net assets acquired over the purchase price (after reducingthe value of non-current assets to zero) in the amounts of $271 and$5,740, which related to the acquisitions of minority interests in KrasnogorskOpen Pit Mine in October-December 2004 and Mechel Campia Turzii in June 2003,respectively, was recorded as extraordinary gain, net of tax, in theconsolidated income statements.

F-21

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(p)**          Minorityinterest

Thefollowing table summarizes changes in minority interest for the three yearsended December 31, 2005:

| **Balance  at December 31, 2002**                                         | ** ** | **180,892** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------|------------|
| New acquisitions                                                               |       | 23,481      |       |
| Purchase of the  minority interest in existing subsidiaries by the Group       |       | (16,050     | )          |
| Reduction on  disposal of discontinued operations                              |       | (607        | )          |
| Minority’s share  in subsidiaries’ loss from continuing operations   |       | (18,979     | )          |
| Translation  adjustment                                                        |       | 15,607      |       |
| **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** | ** ** |

 

Atvarious dates during 2005, 2004 and 2003, the Group purchased minority interestin the following subsidiaries:

| ** **                                            | ** ** | ** **      | ** ** | **Minority interest acquired** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|-----------------|------------|------------------------------------------|------------|------------|------------|
| **Year ended December 31, 2003:** | ** ** | ** **      | ** ** | **Date of acquisition**        | ** ** | **%**      | ** ** | **  amount  ** | ** ** | **Cash paid** | ** ** |
| Tomusinsk Group  Processing Plant                     |       | June 22    |       | 3.21                                     | %          |       | 103        |   |   |   | 46 |   |   |
| Siberian Central  Processing Plant                    |       | June 27    |       | 6.12                                     | %          |       | 2,921      |   |   |   | 204 |   |   |
| Beloretsk  Metallurgical Plant                        |       | November 5 |       | 29.38                                    | %          |       | 11,346     |   |   |   | 3,217 |   |   |
| Other  individually insignificant purchases           |       | July-September  |       | <2% each                              |       |       | 1,680      |   |   |   | 309 |   |   |
|                                                  |       |            | ** ** | ** **                               | ** ** | ** ** | **16,050** |   | ** ** | ** ** | **3,776** |   |   |
|                                                       |            |                 |            |                                          |            |            |            |  |  |  |  |  |  |  |  |

 

F-22

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                                            | ** ** | ** **         | ** ** | **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 18)                        |       | 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** |   |   |
|                                                       |            |                    |            |                                          |            |                                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                   | ** ** | ** **                        | ** ** | **Minority interest acquired** | ** ** | ** **                                                                    | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| **Year ended December 31,  2005:**      | ** ** | ** **                        | ** ** | **Date of acquisition**        | ** ** | **      %      ** | ** ** | **      amount      ** | ** ** | **Cash paid** | ** ** |
| Chelyabinsk  Metallurgical Plant (CMP)       |       | Different dates through  the year |       |                                     | 6.81       | %                                                                             |       |   | 43,882 |   |   |   | 52,927 |   |   |
| Izhstal                                      |       | January-September                 |       |                                     | 25.14      | %                                                                             |       |   | 30,784 |   |   |   | 15,999 |   |   |
| Korshunov Mining Plant  (KMP)                |       | Different dates through  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 |   |   |   | 2 |   |   |
| Mechel Targoviste SA                         |       | April-December                    |       |                                     | 2.62       | %                                                                             |       |   | 52 |   |   |   | — |   |   |
| Mechel Campia Turzii SA                      |       | June-December                     |       |                                     | 3.90       | %                                                                             |       |   | 278 |   |   |   | — |   |   |
|                                         |       |                              | ** ** |                                     |       |                                                                          | ** ** | ** ** | **82,241** |   | ** ** | ** ** | **73,936** |   |   |
|                                              |            |                                   |            |                                          |            |                                                                               |            |  |  |  |  |  |  |  |  |  |  |

 

F-23

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

As discussed in Note 18, the acquisition of theremaining 25% interest in Mechel Metal Supply was carried out through issuanceof treasury stock on October 1, 2004.

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 through 2005, the Group acquired25.14% of voting stock of Izhstal for consideration of $15,999 paid in cash. Thepurchase of a minority interest in Izhstal was accounted for using the purchasemethod of accounting. The excess of the fair value of the net assets acquiredover the purchase price has been allocated as a pro rata reduction of $19,400of the amounts assigned to non-current assets, except for deferred incometax asset. The purchase of minority share in Izhstal was recorded in theconsolidated financial statements for the year ended December 31, 2005.

In accordance with purchase agreement concluded onacquisition of Mechel Targoviste and Mechel Campia Turzii, the Group convertedlong-term debt of these two companies into shares. As a result of thisconversion, the Group’s share was increased by 2.62% and by 3.9% in MechelTargoviste and in Mechel Campia Turzii, respectively.

The Group has accountedfor the purchases of minority interest under the purchase method of accounting.

F-24

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(q)**          Proforma condensed consolidated income statement data (unaudited)

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 |   |

 

Thefollowing unaudited pro forma condensed consolidated income statementinformation for (i) 12 months ended December 31, 2004, giveseffect to the business combinations that occurred in 2004, as if they hadoccurred at the beginning of 2004 and (ii) 12 months ended December 31,2003, gives effect to the business combinations that occurred in 2004 and 2003,as if they had occurred at the beginning of 2003:

| ** **           | ** ** | **Year ended December 31,** | ** ** |
|----------------------|------------|--------------------------------------------|------------|
| ** **           | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Revenue, net         |       | 3,705,596                                  |       | 2,081,653 |   |
| Net income           |       | 1,345,999                                  |       | 135,978 |   |
| Net income per share |       | 3.60                                       |       | 0.37 |   |

 

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.

**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.

F-25

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

The accompanyingconsolidated financial statements differ from the financial statements issuedfor Russian statutory and other GAAP purposes in that they reflect certainadjustments, not recorded in the statutory books, which are appropriate topresent the financial position, results of operations and cash flows inaccordance with U.S. GAAP. The principal adjustments relate to:(1) purchase accounting; (2) recognition of interest expense andcertain operating expenses; (3) valuation and depreciation of property,plant and equipment and mineral licenses; (4) foreign currencytranslation; (5) deferred income taxes; (6) accounting for taxpenalties; (7) revenue recognition, and (8) valuation allowances forunrecoverable assets.

**b)     Basis of 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.Intercompany profits, transactions and balances have been eliminated inconsolidation.

**c)     Goodwill and 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 noncurrent 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.

**d)     Minority interest**

Minority interests in the net assets and net resultsof consolidated subsidiaries are shown under “Minority interest” in theaccompanying consolidated balance sheets and income statements. Minorityinterests in the net liabilities of acquired companies were recorded asadditional goodwill, and when subsequently acquired, reversed. Formajority-owned subsidiaries that incur losses, the Group’s recognizes 100% ofthe 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.

F-26

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**e)     Reporting and functional currencies**

The Group has determined its reporting currency to bethe U.S. dollar. The functional currencies for Russian and Romaniansubsidiaries of the Group are the ruble and the Romanian lei, respectively. Asthe economy of Romania was considered highly inflationary through September 30,2004, transactions and balances of respective domestic operations not alreadymeasured in U.S. dollars were re-measured as if the functional currency werethe U.S. dollar, in accordance with the relevant provisions of SFAS No. 52,“Foreign Currency Translation”. The objective of this re-measurement 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 have been translated using the exchange rate as of the balancesheet dates. Non-monetary assets and liabilities, including non-currentnon-monetary assets, liabilities and shareholders’ equity, are stated at theiractual 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 re-measurement of the localcurrencies to U.S. dollars are included in the consolidated incomestatement as “Foreign exchange gain (loss)”.

The U.S. dollar is the functional currency of theother 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 financialstatements from the functional currency into the reporting currency areincluded in determining other comprehensive income. Mechel’s Russiansubsidiaries translate rubles into U.S. dollars using the current rate methodas prescribed by SFAS No. 52 for all periods presented.

**f)      Management estimates**

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 assets and liabilities as of the dateof the financial statements, and the amounts of revenues and expensesrecognized during the reporting period. Actual results could differ from thoseestimates.

**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 

F-27

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

US GAAP.The portion of minority interest not related to property, plant and equipmentis determined based on the historical cost of assets and liabilities.

**h)     Mining assets and processing plant andequipment**

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 arewell-established. Probable reserves are defined as reserves for which quantityand grade and/or quality are computed from information similar to that used forproven reserves, but the sites for inspection, sampling, and measurement arefarther apart or are otherwise less adequately spaced. Accordingly, the degreeof assurance, although lower than that for proven reserves, is high enough toassume continuity between points of observation. No exploration costs werecapitalized during 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 that are expected to be mined during the estimatedlives of the mines or license term, whichever is shorter determined on a mineby mine basis as estimated with the assistance of independent 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 reevaluated 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.

F-28

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**i)      Other property, 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:

| ** **                                                     | ** ** | **Useful economic lives** | ** ** |
|----------------------------------------------------------------|------------|-------------------------------------|------------|
| **Category of asset**                                | ** ** | ** **                          | ** ** | **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)      Mineral licenses**

Mineral licenses includecapitalized costs incurred to develop mineral resources and the rights(licenses) to develop mineral reserves and resources acquired upon acquisitionof certain Group subsidiaries, net of accumulated amortization. Althoughimmaterial to date since acquisition of the subsidiaries holding licenses, theGroup capitalizes development costs incurred in relation to the development ofnew proven and probable reserves. The mineral licenses acquired in businesscombinations are recorded in accordance with the provisions of SFAS No. 141at their fair values at the date of acquisition, based on the appraised fairvalue. Fair value of the acquired mineral licenses is based on independentmining engineer appraisals for proven and probable reserves during the licenseterm. Mineral licenses are amortized using the units-of-production method overthe shorter of the license term or the estimated proven and probable reservedepletion period.

**k)     Intangible assets**

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 

F-29

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

evaluationassumes determination of fair value of intangible assets based on a valuationmodel that incorporates expected future cash flows and profitabilityprojections.

**l)      Long-lived assets impairment, includingdefinite-lived intangibles and goodwill**

The Group follows the requirements of SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets”, whichaddresses financial accounting and reporting for the impairment and disposal oflong-lived assets, and 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 or changesin circumstances indicate that the carrying amount of such assets may not befully 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 the estimatedfuture net undiscounted cash flows are less than the carrying amount of theasset 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 two-step approach. Under the first step, companies mustcompare the fair value of a “reporting unit” to its carrying value. A reportingunit is the level at which goodwill impairment is measured and it is defined asan operating segment or one level below it if certain conditions are met. Ifthe fair value of the reporting unit is less than its carrying value, goodwillis 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 

F-30

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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. The Group did not have any impairment loss as a resultof adopting SFAS No. 142 and perform the required impairment test.

The Group performed an impairment analysis ofproperty, plant and equipment and mineral reserves at Southern Urals NickelPlant (SUNP, Mining segment) and related goodwill originated from itsacquisition by the Group as several impairment indicators existed as of December 31,2004 and 2005, including operating losses and change in market environment. Asa result of this analysis, the Group concluded that no impairment loss existedas of those dates.

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.will be 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, 2005, the Group reviewedthe remaining property, plant and equipment of these Romanian subsidiaries forimpairment. As a result of such impairment analysis, the Group did not considerthe assets impaired.

**m)    Finance lease**

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, andreflected in the balance sheet in full amount less accumulated depreciation.The cost of the equipment is subject to an annual impairment review. Capitallease liabilities are divided into long-term and current portion based on theagreed payment schedule and discounted using the lessor’s implicit interestrate.

**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.

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.

F-31

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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)     Accounts receivable**

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. We apply specific ratesto overdue balances of Group subsidiaries depending on the history of cashcollections 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)     Cash and 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)     Retirement benefit obligations**

The Group’s Russiansubsidiaries are legally obligated to make defined contributions to the RussianPension Fund, managed by the Russian Federation Social Security (a definedcontribution plan financed on a pay-as-you-go basis). The Group’s contributionsto the Russian Pension Fund relating to defined contribution plans are chargedto income in the year to which they relate.

Contribution to theRussian Pension Fund together with other social contributions are includedwithin a unified social tax (“UST”), which is calculated by the application ofa regressive rate from 26% (applied to the part of the annual gross salarybelow 280 thousand rubles or approximately $10 translated at the exchange rateof the rubles to the U.S. dollar at December 31, 2005) to 2% (applied tothe part of the annual gross salary above 600 thousand rubles or approximately$21 translated at the exchange rate of the ruble to the U.S. dollar at December 31,2005) to the annual gross remuneration of each employee. UST is allocated tothree social funds (including the Russian Pension Fund), where the rate ofcontributions to the Russian Pension Fund varies from 14% to 5.5%,respectively, depending on the annual gross salary of each employee.Contributions to the Russian Pension Fund for the years ended December 31,2005, 2004 and 2003 were $47,893, $39,511 and $25,883, respectively.

F-32

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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 already earnedthrough their service in the current and prior periods. The discount rateapplied represents the yield at the year end on highly rated long-term bonds.

**r)     Revenue recognition**

Revenue is recognized onan accrual basis when earned and realizable, which generally occurs whenproducts are delivered to customers. In some instances, while title ofownership has been transferred, the revenue recognition criteria are not met asthe selling price is subject to adjustment based upon the market prices.Accordingly, in those instances, revenue and the related cost of goods sold arerecorded as deferred revenues and deferred cost of inventory in transit in theconsolidated balance sheets and are not recognized in the consolidated incomestatement until the price becomes fixed and determinable, which typicallyoccurs when the price is settled with the end-customer. In certain foreignjurisdictions (e.g. Switzerland), the Group generally retains title togoods sold to end-customers solely to ensure the collectibility of its accountsreceivable. In such instances, all other sales recognition criteria are met,which allows the Group to recognize sales revenue in conformity with underlyingsales contracts.

Sales are recognized netof applicable provisions for discounts and allowances and associated salestaxes (VAT) and export duties.

**s)     Advertising costs**

Advertising costs areexpensed as incurred. During the years ended December 31, 2005, 2004 and2003 advertising costs were insignificant.

**t)      Shipping and 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 $389,598, $326,393and $206,564 for the years ended December 31, 2005, 2004 and 2003,respectively.

F-33

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**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**u)     Income taxes**

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.

Prior to January 1, 2003, when Russia was deemedto be hyper-inflationary and as a result of remeasuring its financialstatements the Group did not recognize deferred tax liabilities or assets forthose differences relating to assets and liabilities of its Russiansubsidiaries that, under SFAS No. 52, are re-measured from the localcurrency into the functional currency using historical exchange rates and thatresult from changes in exchange rates or indexing for tax purposes. Thedeferred tax effect associated with the temporary differences that arose fromthe change in the functional currency of the Group’s Russian subsidiaries (fromU.S. dollar to ruble) and when Russia ceased to be considered hyper-inflationaryon January 1, 2003, was reflected as an adjustment to the cumulativetranslation adjustment component of accumulated other comprehensive income on January 1,2003.

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 orindexing for tax purposes until September 30, 2004, as Romanian economywas considered 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)     Comprehensive income**

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 additional pension liabilities not yet recognized as net periodic pensioncost. For the years ended December 31, 2005, 2004 and 2003, as a result ofthe change in functional currency as described in Note 3(e), in addition to thenet income, total comprehensive income included the effect of translation ofthe financial statements denominated in currencies other than the reportingcurrency, in accordance with SFAS No. 52, and adjustments ofavailable-for-sale securities.

F-34

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**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**w)     Stock-basedcompensation**

The Group follows theprovisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, forthe stock-based compensation arrangement with one of its executives. SFAS No. 123generally allows companies to either account for stock-based compensation underthe provisions of SFAS No. 123 or under the provisions of APB Opinion No. 25,“Accounting for Stock Issued to Employees”, and to make disclosures inaccordance with the provisions of SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure—an Amendment of SFAS No. 123”.Because the fair value accounting requires use of valuation models that werenot developed for use in valuing employee stock awards, the Group has electedto account for its stock-based compensation in accordance with the provisionsof APB Opinion No. 25 and related interpretations.

Accordingly, thecompensation cost was recognized based on the excess, if any, of the fairmarket value of the Group’s shares on the measurement date (July 1, 2003)over the amount an executive must pay to acquire the shares. The Grouprecognized compensation expense on a straight-line basis over the remainingvesting period of the award through April 15, 2004.

The Group does not presentpro forma disclosures of results of operations as if the fair value method hadbeen applied, as the result would be substantially the same when compared tothe intrinsic method applied in accordance with APB Opinion No. 25.

**x)     Segmentreporting**

According to SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information”, segmentreporting follows the internal organizational and reporting structure of theGroup. Corresponding to the main products and services the Group’s organizationcomprises two business segments:

Steel segment, comprisingproduction and sales of semi-finished steel products, carbon and specialty longproducts, carbon and stainless flat products, value-added downstream metalproducts, including forgings, 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 the Group’s financialinstruments, which include cash equivalents, marketable securities,non-marketable debt securities, cost method investments, accounts receivableand accounts payable approximates their fair value at December 31, 2005and 2004. For long-term borrowings, the difference between the fair value andcarrying value was not material. The Group, using available market informationand appropriate valuation methodologies, such as discounted cash flows, hasdetermined the estimated fair values of financial instruments. Since differententities are located and operate in different regions of Russia and elsewherewith different business and financial market characteristics, there are generallyvery limited or no comparable market values available to assess the fair valueof the Group’s debt 

F-35

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

andother financial instruments. The cost method investments are shares of Russiancompanies that are not publicly traded and their market value is not available.It is not practicable for the Group to estimate the fair value of theseinvestments for which a quoted market price is not available because it has notyet obtained or developed the valuation model necessary to make the estimate,and the cost of obtaining an independent valuation would be excessiveconsidering the materiality of the instruments to the Group. Therefore, suchinvestments are recorded at cost (see also Note 8).

**z)     Derivativeinstruments and hedging activities**

The Group recognizes all itsderivative instruments as either assets or liabilities at fair value inaccordance with SFAS No. 133, “Accounting for Derivative instruments andHedging Activities”, and related interpretations. The accounting for changes inthe fair value of a derivative instrument depends on whether it has beendesignated and qualifies as an accounting hedge and further, on the type ofhedging relationship. For the years ended December 31, 2005, 2004 and2003, the Group did not have any derivatives designated as hedging instruments.Therefore, the gain or loss on a derivative instruments held by the Group wasrecognized currently in income. The net loss of $418, $1,480 and $447 relatedto the change in the fair value of the derivative instruments was included inthe net foreign exchange gain (loss) in the accompanying consolidated incomestatements for the years ended December 31, 2005, 2004 and 2003,respectively. Foreign currency forward and options contracts outstanding as of December 31,2004 related to the purchase of $38,367 and 5,000 Euros for Euros and U.S.dollars, respectively (none as of December 31, 2005).

**aa)   Concentrationof credit and other risks**

Financial instruments,which potentially expose the Group to concentrations of credit risk, consistprimarily of cash and cash equivalents, short-term and long-term investments,trade accounts receivable and other receivables. Generally, the Group does notrequire any collateral to be pledged in connection with its investments in theabove financial instruments.

Thefollowing table presents the exchange rates for the functional and operatingcurrencies at various subsidiaries, other than the reporting currency:

| ** **       | ** ** | **At April 17,** | ** ** | **Year end rates*  at December 31,** | ** ** | **Average exchange rates* for the  years ended December 31,** | ** ** |
|------------------|------------|----------------------------|------------|----------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| **Currency**     | ** ** | ** **                 | ** ** | **2006**                                                 | ** ** | **2005**                                                                                         | ** ** | **2004** | ** ** | **2003** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Russian ruble    |       |                       | 27.70      |                                                     |       | 28.78                                                                                            |       | 27.75 |   | 29.45 |   | 28.29 |   | 28.82 |   | 30.69 |   |
| Swiss franc      |       |                       | 1.30       |                                                     |       | 1.31                                                                                             |       | 1.13 |   | 1.25 |   | 1.24 |   | 1.24 |   | 1.34 |   |
| Euro             |       |                       | 0.83       |                                                     |       | 0.84                                                                                             |       | 0.73 |   | 0.79 |   | 0.80 |   | 0.81 |   | 0.88 |   |
| Romanian lei**   |       |                       | 2.89       |                                                     |       | 3.11                                                                                             |       | 29,067 |   | 32,595 |   | 2.91 |   | 32,637 |   | 33,200 |   |
| Croatian kuna    |       |                       | 6.04       |                                                     |       | 6.23                                                                                             |       | 5.64 |   | 6.12 |   | 5.97 |   | 6.04 |   | 6.70 |   |
| Lithuania lit    |       |                       | 2.85       |                                                     |       | 2.91                                                                                             |       | 2.53 |   | 2.76 |   | 2.77 |   | 2.78 |   | 2.83 |   |
| Kazakhstan tenge |       |                       | 134.35     |                                                     |       | 133.66                                                                                           |       | 130.00 |   | 143.95 |   | 132.67 |   | 136.04 |   | 149.49 |   |
|                  |            |                            |            |                                                          |            |                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

*                    Exchange ratesshown in local currency units for one U.S. dollar

**             On July 1, 2005,Romanian lei was denominated in proportion 1/10,000

F-36

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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.

**bb)   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.

**cc)   Recently issued accounting pronouncements**

***Inventory costs***

In December 2004, theFASB issued SFAS No. 151, “Inventory costs” (“SFAS No. 151”), whichamends ARB 43, Chapter 4, to clarify that abnormal amounts of idle facilityexpenses, freight, handling costs and wasted materials (spoilage) should berecognized as current period expenses. In addition, SFAS No. 151requires that allocation of fixed production overhead to the costs ofconversion 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. The Group will applythe provisions of the Statement prospectively to inventory costs incurred on orafter January 1, 2006. The adoption of this standard is not expected tohave a material impact on the Group’s financial position and results ofoperations.

***Share-based payment***

In December 2004, theFASB issued revised SFAS No. 123R, “Share-based payment” (“SFAS No. 123R”).SFAS No. 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 employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award (with limited exceptions). SFAS No. 123Ris effective as of the beginning of the annual reporting period that beginsafter June 15, 2005. The Group adopted the provisions of SFAS No. 123Ron January 1, 2006. The adoption of this standard is not expected to havea material impact on the Group’s financial position and results of operations.

***Exchanges of Non-monetary Assets***

In December 2004, theFASB issued SFAS No. 153, “Exchanges of Non-monetary Assets—an Amendmentof APB Opinion No. 29” (“SFAS No. 153”). SFAS No. 153 amendsOpinion 29 to eliminate 

F-37

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

theexception for non-monetary exchanges of similar productive assets and replacesit with a general exception for exchanges of non-monetary assets that do nothave commercial substance. The Statement specifies that a non-monetary exchangehas commercial substance if the future cash flows of the entity are expected tochange. The adoption of SFAS No. 153 by the Group in 2005 did not have amaterial impact on its financial position and results of operations.

***Accounting for Conditional Assets RetirementObligations***

In March 2005, theFASB issued Interpretation No. 47, “Accounting for Conditional AssetsRetirement Obligations” (“FIN 47”), that requires an entity to recognize aliability for a conditional asset retirement obligation when incurred if theliability can be reasonably estimated. FIN 47 clarifies that the termConditional Asset Retirement Obligation refers to a legal obligation to performan asset retirement 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 after December 15,2005. The adoption of FIN 47 in 2006 is not expected to have a material impacton the Group’s financial position and results of operations.

***Accounting for Stripping Costs Incurred duringProduction in the Mining Industry***

On March 17, 2005,the EITF issued Issue No. 04-6, “Accounting for Stripping CostsIncurred during Production 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 the inventoryproduced during the period that the stripping costs are incurred. EITF 04-6is effective for the first reporting period in fiscal years beginning after December 15,2005. The adoption of EITF 04-6 in 2006 is not expected to have amaterial impact on the Group’s financial position and results of operations.

***Accounting for Preexisting Relationships between theParties to a Business Combination***

In October 2004, theFASB ratified the consensus reached by the EITF on Issue 04-1 “Accountingfor Preexisting 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 the Group’s financial position and results ofoperations.

***Mining Assets: Impairment and Business Combinations***

In March 2004, theEITF reached consensus on Issue No. 04-3, “Mining Assets: Impairmentand Business Combinations” (“EITF 04-3”). EITF 04-3 relates toestimating cash flows used to value mining assets or assess those assets forimpairment. The Group currently assesses impairment on the projected mine lifeof each project or license period, whichever is shorter, utilizing existingtechnology. The adoption of EITF 04-3 in 2005 is not expected to have a materialimpact on the Group’s financial position and results of operations.

F-38

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

***Accounting for the Impairment or Disposal ofLong-Lived Assets***

In November 2004, theEITF reached a final consensus on Issue No. 03-13, “Applying theConditions in Paragraph 42 of FASB Statement No. 144, Accounting for theImpairment or Disposal of Long-Lived Assets, in Determining Whether to ReportDiscontinued Operations” (“EITF 03-13”). EITF 03-13 addresses theevaluation of whether the operations and cash flows of a disposed componenthave been or will be eliminated from the ongoing operations of the entity andwhether the selling entity will have significant continuing involvement in theoperations of the disposed entity. The consensus should be applied to acomponent that is either disposed of or classified as held for sale in periodsbeginning after December 15, 2004. The adoption of EITF 03-13 in2005 did not have a material impact on the Group’s financial position andresults of operations.

***Accounting and reporting of a change in accountingprinciple***

In May 2005, the FASBissued SFAS No. 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”),which changes the requirements for the accounting and reporting of a change inaccounting principle. SFAS No. 154 eliminates the requirement to includethe cumulative effect of changes in accounting principle in the incomestatement and instead requires that changes in accounting principle beretroactively applied. SFAS No. 154 is effective for accountingchanges and correction of errors made on or after January 1, 2006,with early adoption permitted. The Group will begin applying the provisions ofthis statement in 2006. The adoption of SFAS No. 154 is not expected to havea material impact on the Group’s financial position and results of operations.

***Accounting for purchases and sales of inventory withthe 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”). EITF 04-13relates to defining the circumstances under which two or more inventorypurchase and sales transactions with the same counterparty should be viewed asa single exchange transaction; and defining whether there are circumstancesunder which nonmonetary exchanges of inventory within the same line of businessshould be recognized at fair value. EITF 04-13 is effective prospectivelyfor new arrangements entered into, and modifications or renewals of existingarrangements, beginning in the first interim or annual reporting periodbeginning after March 15, 2006. The Group will begin applying theprovisions of this statement in 2006. The adoption of EITF 04-13 is notexpected to have a material impact on the Group’s financial position andresults of operations.

***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 

F-39

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

measuredat fair value. SFAS No. 156 is effective as of beginning of the firstfiscal year that begins after September 15, 2006. The Group will beginapplying the provisions of this statement in 2007. The adoption of SFAS No. 156is not expected to have a material impact on the Group’s financial position andresults of operation.

**4.      CASH AND CASH EQUIVALENTS**

Cashand cash equivalents are comprised of:

| ** **                           | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|--------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Russian ruble  bank deposits         |       |                            | 30,611      |                            |       |   | 33,784 |   |   |
| USD bank deposits                    |       |                            | 106,639     |                            |       |   | 962,960 |   |   |
| EURO bank deposits                   |       |                            | 164,784     |                            |       |   | 20,235 |   |   |
| Other                                |       |                            | 9,741       |                            |       |   | 7,782 |   |   |
| **Total  cash and cash equivalents** | ** ** | ** **                      | **311,775** |                            | ** ** | ** ** | **1,024,761** |   |   |

 

**5.      ACCOUNTS RECEIVABLE, NET**

Accountsreceivable, net are comprised of:

| ** **                           | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|--------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Domestic  customers                  |       |                            | 48,385      |                            |       |   | 41,553 |   |   |
| Foreign customers                    |       |                            | 109,773     |                            |       |   | 114,894 |   |   |
| Total accounts receivable            |       |                            | 158,158     |                            |       |   | 156,447 |   |   |
| Less allowance for doubtful accounts |       |                            | (17,509     | )                               |       |   | (20,850 | ) |   |
| **Total  accounts receivable, net**  | ** ** | ** **                      | **140,649** |                            | ** ** | ** ** | **135,597** |   |   |

 

Thefollowing summarizes the changes in the allowance for doubtful accounts for theyears ended December 31:

| ** **                                                                           | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **Balance  at beginning of year**                                                    |       | (20,850     | )          | (22,276     | )          | (21,942     | )          |
| Provision for doubtful accounts receivable                                           |       | (3,569      | )          | 7,859       |       | (9,056      | )          |
| Accounts receivable written off /(Recovery of  accounts previously written off), net |       | 6,983       |       | (5,900      | )          | 14,471      |       |
| Provision for doubtful accounts of acquired entities                                 |       | (73         | )          | (533        | )          | (5,749      | )          |
| **Balance  at the end of year**                                                      | ** ** | **(17,509** | **)**      | **(20,850** | **)**      | **(22,276** | **)**      |

 

F-40

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**6.      INVENTORIES**

Inventoriesare comprised of:

| ** **                        | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|-----------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Finished goods                    |       |                            | 174,173     |                            |       |   | 230,876 |   |   |
| Raw materials and purchased parts |       |                            | 235,782     |                            |       |   | 243,535 |   |   |
| Work-in-process                   |       |                            | 86,703      |                            |       |   | 94,134 |   |   |
| **Total  inventories**            | ** ** | ** **                      | **496,658** |                            | ** ** | ** ** | **568,545** |   |   |

 

**7.      PREPAYMENTS AND OTHER CURRENT ASSETS**

Prepaymentsand other current assets are comprised of:

| ** **                             | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| VAT and other  taxes recoverable       |       |                            | 277,832     |                            |       |   | 234,650 |   |   |
| Prepayments and advances for materials |       |                            | 34,734      |                            |       |   | 66,448 |   |   |
| Other current assets                   |       |                            | 34,415      |                            |       |   | 47,992 |   |   |
| **Total  other current assets**        | ** ** | ** **                      | **346,981** |                            | ** ** | ** ** | **349,090** |   |   |

 

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 balance sheetson a gross basis, i.e. as other current assets and taxes and social chargespayable.

**8.      LONG-TERM INVESTMENTS**

Long-terminvestments are comprised of:

| ** **                               | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Equity method  investments               |       |                            | 408,377     |                            |       |   | 7,353 |   |   |
| Magnitogorsk Iron&Steel Works (MMK)  |       |                            | —      |                            |       |   | 367 |   |   |
| Other related parties                    |       |                            | 331         |                            |       |   | 1,550 |   |   |
| **Total investments in related parties** | ** ** | ** **                      | **408,709** |                            | ** ** | ** ** | **9,270** |   |   |
| Cost method investments                  |       |                            | 10,772      |                            |       |   | 14,259 |   |   |
| Other                                    |       |                            | 5,376       |                            |       |   | 52,404 |   |   |
| **Total other long-term investments**    | ** ** | ** **                      | **16,148**  |                            | ** ** | ** ** | **66,663** |   |   |
| **Total  long-term investments**         | ** ** | ** **                      | **424,856** |                            | ** ** | ** ** | **75,933** |   |   |

 

F-41

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

As of December 31,2004, included in other long-term investments were $32,408 and $16,278 ofadvances issued to state auction authorities related to the acquisition ofshares in Yakutugol and CMP, respectively. The Group prevailed in both auctionssubsequent to December 31, 2004.

**(a)   Equity method investments**

Equitymethod investments are comprised of:

| ** **                                        | ** ** | **Percent voting shares held at  December 31,** | ** ** | **Investment carrying value at  December 31,**                                       | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| **Investee**                                      | ** ** | ** **                                                               | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** |
| Yakutugol (Mining  segment)                       |       |                                                                     | 25         | %                                                                                                        |       |   | — |   |   |   | 399,522 |   |   |   | — |   |   |
| Mechel Energy AG (Conares Eagle) (Mining segment) |       |                                                                     | 50         | %                                                                                                        |       |   | 50 | % |   |   | 3,417 |   |   |   | 4,352 |   |   |
| TPTU (Mining segment)                             |       |                                                                     | 40         | %                                                                                                        |       |   | 29 | % |   |   | 2,654 |   |   |   | 1,724 |   |   |
| TRMZ (Mining segment)                             |       |                                                                     | 25         | %                                                                                                        |       |   | 25 | % |   |   | 1,444 |   |   |   | 1,277 |   |   |
| RIKT (Mining segment)                             |       |                                                                     | 36         | %                                                                                                        |       |   | — |   |   |   | 1,340 |   |   |   | — |   |   |
| **Total  equity method investments**              | ** ** |                                                                     |       |                                                                                                     |       |   |   |   | ** ** | ** ** | **408,377** |   | ** ** | ** ** | **7,353** |   |   |
|                                                   |            |                                                                          |            |                                                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(j)).

Conares Eagle Ltd was a joint venture with U.K.trading partners of the Group that facilitated the Group’s sales in Europe. In2003, Conares Eagle Ltd ceased its operations and transferred all its businessto Swiss-based company Mechel Energy AG (formerly named “Conares Eagle AG”), inwhich the Group also owns 50%. In September 2004, Conares Eagle Ltd wasofficially closed.

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 (Tomusinskiy Transportation Management Center)shares are owned by SKCC. The core business is provision of transportationservices both to the Group’s subsidiaries and to third parties.

RIKT (Russian-Italian Telephone Company) shares areowned by SKCC and its subsidiaries. The core business is provision ofcommunication services both to the Group’s subsidiaries and to third parties.

As of December 31, 2005, there were no equityinvestments other than those disclosed in the table above.

F-42

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Summarizedunaudited financial information on equity method investees as of December 31,2005 and 2004 and for the years then ended is as follows:

| **Income data**       | ** ** | ** **      | ** ** | **2005**        | ** ** | **2004** | ** ** |
|----------------------------|------------|-----------------|------------|-----------------|------------|----------|------------|
| ** **                 | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Revenues and  other income |       |            | 706,931    |            |       |     | 154,065    |   |   |
| Operating income (loss)    |       |            | 83,885     |            |       |     | 15,282     |   |   |
| Net income (loss)          |       |            | 42,368     |            |       |     | 11,382     |   |   |

 

| ** **                       | ** ** | **At December 31,** | ** ** | **At December 31,** | ** ** |
|----------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| **Balance sheet data** | ** ** | ** **                    | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| ** **                       | ** ** | **(unaudited)**               | ** ** | **(unaudited)**               | ** ** |
| Current assets                   |       |                          | 213,648    |                          |       |   | 26,604 |   |   |
| Non-current assets               |       |                          | 1,855,770  |                          |       |   | 11,889 |   |   |
| Current liabilities              |       |                          | 93,055     |                          |       |   | 13,955 |   |   |
| Non-current liabilities          |       |                          | 553,057    |                          |       |   | 766 |   |   |
|                                  |            |                               |            |                               |            |  |  |  |  |  |  |

 

The followingtable shows movements in the equity method investments:

| ** **                             | ** ** | **Capital investment** | ** **  | **Share in net  income/(loss) since  acquisition** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-----------------------------|-------------|-------------------------------------------------------------------|------------|-----------|------------|
| **January 1, 2003**               | ** ** |                        | **3,863**   | ** **                                                        |       |      | **162**    | ** ** |   | **4,025** | ** ** |
| Investments                            |       |                        | 598         |                                                              |       |      | —     | ** ** |   | 598 |   |
| Share in net income                    |       |                        | —      |                                                              |       |      | 1,221      | ** ** |   | 1,221 |   |
| Disposals through sales  and write off |       |                        | (490        | )                                                                 |       |      | —     | ** ** |   | (490 | ) |
| Reclassification upon  consolidation   |       |                        | (2,073      | )                                                                 |       |      | —     | ** ** |   | (2,073 | ) |
| **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** | ** ** |

 

Cash dividends receivedfrom equity investees amounted to $2,000 for the year ended December 31, 2005.

F-43

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(b)   Cost method 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 not evaluated for impairmentbecause the Group did not identify any events or changes in circumstances thatmay have a significant effect on the fair value of these investments.

Decrease of $3,487 in theamount of cost method investments held by the Group as of December 31,2005 is mainly due to the transactions with Chelyabenergo shares in 2005 (note2 (k)).

**9.      RELATED PARTIES**

Duringthe three years ended December 31, 2005, the Group had the followingtransactions and current balances in settlement with related parties:

| ** **           | ** ** | **2005**      | ** ** | ** ** | ** ** |
|----------------------|------------|---------------|------------|------------|------------|
| ** **           | ** ** | ** **    | ** ** | ** ** | ** ** | **Financing** | ** ** | **Balances at December 31, 2005** | ** ** |
| ** **           | ** ** | ** **    | ** ** | ** ** | ** ** | **provided** | ** ** | **Receivable** | ** ** | **Payable** | ** ** | **Total** | ** ** |
| ** **           | ** ** | **Purchases** | ** ** | **Sales**  | ** ** | **(received), net** | ** ** | **from** | ** ** | **to** | ** ** | **outstanding, net** | ** ** |
| Uglemet  Kooperatsia |       |          | 1,007      |       |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Mechel Energy AG     |       |          | —     |       |       | 59,257 |   |   | — |   |   |   | 990 |   |   |   | — |   |   |   | 990 |   |   |
| Methol               |       |          | 114        |       |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| 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 |   |   |
| Uglemet              |       |          | 543        |       |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Metal Holding        |       |          | —     |       |       | — |   |   | 287 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Collierville         |       |          | —     |       |       | — |   |   | 124 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Fiscon Trust         |       |          | 118        |       |       | — |   |   | — |   |   |   | 18 |   |   |   | (2 | ) |   |   | 16 |   |   |
| Siga Treuhand        |       |          | 848        |       |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Other                |       |          | 719        |       |       | 731 |   |   | — |   |   |   | 7 |   |   |   | (220 | ) |   |   | (213 | ) |   |
| **Total**            | ** ** | ** **    | **74,795** |       | ** ** | **65,431** | ** ** | ** ** | **411** |   | ** ** | ** ** | **4,473** |   | ** ** | ** ** | **(2,937** | **)** | ** ** | ** ** | **1,536** |   |   |

 

F-44

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(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 |   |   |
| Methol                        |       |          | —     |       |       | — |   |   | — |   |   |   | 2,658 |   |   |   | (354 | ) |   |   | 2,304 |   |   |
| Uglemet                       |       |          | 67         |       |       | 3 |   |   | — |   |   |   | 920 |   |   |   | (2 | ) |   |   | 918 |   |   |
| TPTU                          |       |          | 2,564      |       |       | 101 |   |   | — |   |   |   | 40 |   |   |   | (217 | ) |   |   | (177 | ) |   |
| TRMZ                          |       |          | 4,927      |       |       | 3,134 |   |   | — |   |   |   | 6 |   |   |   | (356 | ) |   |   | (350 | ) |   |
| ZAO Consultatsia  i Marketing |       |          | 592        |       |       | — |   |   | 1,280 |   |   |   | 721 |   |   |   | (7 | ) |   |   | 714 |   |   |
| Metal Holding                 |       |          | 480        |       |       | — |   |   | — |   |   |   | — |   |   |   | (1,354 | ) |   |   | (1,354 | ) |   |
| Collierville                  |       |          | 120        |       |       | — |   |   | — |   |   |   | — |   |   |   | (346 | ) |   |   | (346 | ) |   |
| Fiscon Trust                  |       |          | 104        |       |       | — |   |   | — |   |   |   | 16 |   |   |   | — |   |   |   | 16 |   |   |
| Siga Treuhand                 |       |          | 318        |       |       | — |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Other                         |       |          | 1,075      |       |       | 1,094 |   |   | — |   |   |   | 884 |   |   |   | (507 | ) |   |   | 377 |   |   |
| **Total**                     | ** ** | ** **    | **12,756** |       | ** ** | **68,806** | ** ** | ** ** | **1,280** |   | ** ** | ** ** | **16,474** |   | ** ** | ** ** | **(3,748** | **)** | ** ** | ** ** | **12,726** |   |   |

 

| ** **              | ** ** | **2003**      | ** **  | ** ** | ** ** |
|-------------------------|------------|---------------|-------------|------------|------------|
| ** **              | ** ** | ** **    | ** **  | ** ** | ** ** | **Financing** | ** ** | **Balances at December 31, 2003** | ** ** |
| ** **              | ** ** | ** **    | ** **  | ** ** | ** ** | **provided** | ** ** | **Receivable** | ** ** | **Payable** | ** ** | **Total** | ** ** |
| ** **              | ** ** | **Purchases** | ** **  | **Sales**  | ** ** | **(received), net** | ** ** | **from** | ** ** | **to** | ** ** | **outstanding, net** | ** ** |
| Conares Holding         |       |          | 1,541       |       |       | 166 |   |   | 26,282 |   |   |   | — |   |   | (3,713 | ) |   | (3,713 | ) |   |
| Uglemet  Kooperatsia    |       |          | —      |       |       | 177 |   |   | 4 |   |   |   | 12,677 |   |   | (207 | ) |   | 12,470 |   |   |
| Korshunov Mining  Plant |       |          | 45,661      |       |       | 5,720 |   |   | 23,128 |   |   |   | — |   |   | — |   |   | — |   |   |
| MMK                     |       |          | 154,041     |       |       | 162,809 |   |   | — |   |   |   | 6,075 |   |   | (7,877 | ) |   | (1,802 | ) |   |
| Mechel Energy AG        |       |          | —      |       |       | 37,210 |   |   | — |   |   |   | 4,074 |   |   | — |   |   | 4,074 |   |   |
| Methol                  |       |          | —      |       |       | — |   |   | 587 |   |   |   | 1,793 |   |   | (6 | ) |   | 1,787 |   |   |
| Uglemet                 |       |          | 54          |       |       | 2 |   |   | — |   |   |   | 5 |   |   | (47 | ) |   | (42 | ) |   |
| Other                   |       |          | 11,195      |       |       | 5,859 |   |   | (1,064 | ) |   |   | 3,906 |   |   | (2,037 | ) |   | 1,869 |   |   |
| **Total**               | ** ** | ** **    | **212,492** |       | ** ** | **211,943** | ** ** | ** ** | **48,937** |   | ** ** | ** ** | **28,530** |   | ** ** | **(13,887** | **)** | ** ** | **14,643** |   |   |

 

**(a)   Conares Holding**

During 2004 and 2005,there were no significant transactions between the Group and Conares Holding.The outstanding account receivable from Conares Holding as of December 31,2004, amounted to $1,199 and represents the difference between the amount of$3,713 payable to Conares Holding AG as of December 31, 2003 and actualpayments made in during 2004. The remaining amount of $1,199 was repaid in2005.

F-45

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(b)   Uglemet Kooperatsia**

Uglemet Kooperatsia, 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 significanttransactions between the Group and Uglemetkooperatsia.

As of December 31, 2004, the amount receivablefrom Uglemet Kooperatsia by the Group was $9,271, which represented the amountsdue under unsecured loans and the amount payable to the company is $605resulting from the advances received and accounts payable resulting fromtrading activities with the Group’s subsidiaries during 2003.

During 2005, loans duefrom Uglemet Kooperatsia were repaid. On July 8, 2005, Uglemet Kooperatsiawas liquidated.

**(c)    Magnitogorsk Iron 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 disposal of MMK shares is disclosed in Note 2(o).

The Group had significantpurchase and sales transactions with MMK during 2003. The Group sold coal andcoke to MMK, and purchased metal products for resale through its distributionchannels. During the year ended December 31, 2003, the Group sold coal andcoke to MMK in the amount of $126,279, with other sales of $36,530, andpurchased metal products for resale in the amount of $154,041. During the yearended December 31, 2004, the Group curtailed sales of coal and coke to andpurchases of metal from MMK. The purchases of metal from MMK amounted to$2,509. Sales and purchases to and from MMK were made on market terms.

**(d)   Mechel Energy AG**

Mechel Energy AG, formerlynamed Conares Eagle AG, in which the Group owns 50% of its ordinary shares,purchased coal from the Group during the years ended December 31, 2005 and2004 in the amount of $59,257 and $63,528, respectively. Sales to Mechel EnergyAG were made on market terms with average margin attributable to coal sales.

**(e)    Tomusinskiy Transportation Management Center(TPTU)**

The Group subsidiaries own40% of the ordinary shares in TPTU, which provides transportation services.During the years ended December 31, 2005 and 2004, the Group purchasedtransportation services in the amount of $2,313 and $2,564, respectively.

F-46

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**(f)    Tomusinskiy Auto 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, 2005 and 2004, the Group purchasedrepair services in the amount of $7,862 and $4,927, respectively.

**(g)    Uglemet and Methol**

Uglemet and Methol,companies wholly owned by the Controlling Shareholders, had no material transactionswith the Group during 2004 and 2005. On July 5, 2005, Uglemet wasliquidated.

**(h)   Metal Holding and Collierville**

Metal Holding andCollierville are companies in which relatives of directors of certain Groupsubsidiaries are beneficiaries. Accounts payable to Metal Holding andCollierville as of December 31, 2004, of $1,354 and $346, respectively,represent mostly payments for management services received. During 2004, theGroup purchased management services in the amounts of $480 and $120 from MetalHolding and Collierville, respectively. The charged amounts were paid by theGroup in 2005. Also, in 2005 the Group provided financing to Metal Holding andCollierville in the amount of $287 and $124, respectively.

**(i)    Fiscon Trust and Siga Treuhand**

In 2004, the Group enteredinto secondment agreements with Fiscon Trust and Siga Treuhand, which providedworkforce to certain subsidiaries of the Group.

**(j)    Yakutugol**

The Group owns 25% of theordinary shares in Yakutugol which provides the Group with coal. During theyear ended December 31, 2005, the Group’s purchases from Yakutugolamounted to $61,271. The Group’s sales of services and auxiliary materials toYakutugol amounted to $1,293. As of December 31, 2005, the Group hadaccounts payable to Yakutugol for goods supplied of $2,117 and dividendsreceivable of $3,437.

**(k)   Other related parties**

Financing provided toother related parties, primarily shareholders of the Group and investeecompanies, consisted of short-term maturity, unsecured and interest-freeinstruments.

F-47

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**10.   INTANGIBLE ASSETS, NET**

Identifiableintangible assets, net are comprised of:

| ** **                                      | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Intangible  assets with determinable lives:** |       |                            |       |                            |       |   |   |   |   |
| Energy license                                  |       |                            | 1,872      |                            |       |   | 2,264 |   |   |
| Software                                        |       |                            | 1,589      |                            |       |   | 1,824 |   |   |
| Intangible  pension asset                       |       |                            | 3,962      |                            |       |   | 1,932 |   |   |
| Other                                           |       |                            | 167        |                            |       |   | 359 |   |   |
| **Total  intangible assets**                    | ** ** | ** **                      | **7,590**  |                            | ** ** | ** ** | **6,379** |   |   |

 

**11.   PROPERTY, PLANT AND EQUIPMENT, NET**

Property,plant and equipment, net are comprised of:

| ** **                                    | ** ** | **December 31, 2005** | ** **    | **December 31, 2004** | ** ** |
|-----------------------------------------------|------------|---------------------------------|---------------|---------------------------------|------------|
| Land improvements                             |       |                            | 39,600        |                            |       |   | 35,326 |   |   |
| Buildings                                     |       |                            | 449,939       |                            |       |   | 319,644 |   |   |
| Transfer devices                              |       |                            | 52,786        |                            |       |   | 33,420 |   |   |
| Operating  machinery and equipment            |       |                            | 751,069       |                            |       |   | 697,159 |   |   |
| Transportation  equipment and vehicles        |       |                            | 126,532       |                            |       |   | 92,740 |   |   |
| Tools, furniture,  fixtures and other         |       |                            | 64,171        |                            |       |   | 47,802 |   |   |
|                                          |       |                            | 1,484,097     |                            |       |   | 1,226,091 |   |   |
| Less: accumulated  depreciation               |       |                            | (391,946      | )                               |       |   | (288,673 | ) |   |
| Operating  property, plant and equipment, net |       |                            | 1,092,151     |                            |       |   | 937,418 |   |   |
| Mining,  processing plant and equipment       |       |                            | 187,930       |                            |       |   | 142,710 |   |   |
| Less: accumulated  depletion                  |       |                            | (29,825       | )                               |       |   | (26,631 | ) |   |
| Mining, processing plant and equipment, net   |       |                            | 158,105       |                            |       |   | 116,079 |   |   |
| Construction-in-progress                      |       |                            | 258,728       |                            |       |   | 221,225 |   |   |
| **Property,  plant and equipment, net**       | ** ** | ** **                      | **1,508,984** |                            | ** ** | ** ** | **1,274,722** |   |   |

 

Included withinconstruction-in-progress are advances to suppliers of equipment of $26,839 and$37,644 as of December 31, 2005 and 2004, respectively. During the yearsended December 31, 2005, 2004 and 2003, the Group incurred interestexpenses of $58,192, $61,218 and $52,924, respectively, of which interestcapitalized in the cost of property, plant and equipment was $17,363, $9,809and $4,408, respectively.

F-48

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**12.   MINERAL LICENSES, NET**

Minerallicenses, net, are comprised of the following:

| ** **                        | ** ** | **December 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|-----------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Coal deposits                     |       |                            | 192,700     |                            |       |   | 92,181 |   |   |
| Iron ore deposits                 |       |                            | 78,120      |                            |       |   | 87,159 |   |   |
| Nickel deposits                   |       |                            | 29,574      |                            |       |   | 30,676 |   |   |
| Limestone deposits                |       |                            | 3,018       |                            |       |   | 3,126 |   |   |
| Mineral licenses before depletion |       |                            | 303,412     |                            |       |   | 213,142 |   |   |
| Accumulated  depletion            |       |                            | (61,406     | )                               |       |   | (46,659 | ) |   |
| **Mineral  licenses, net**        | ** ** | ** **                      | **242,006** |                            | ** ** | ** ** | **166,483** |   |   |

 

Most of existing mineral licenses were recorded uponacquisition of mining subsidiaries in preceding years. Fair values of minerallicenses pertaining to the appraised proven and probable mineral reserves atthe date of acquisition were determined based on independent appraisalsperformed by independent mining engineers, for each acquisition date. Thecarrying values of the mineral licenses were reduced proportionate to thedepletion of the respective mineral reserves at each deposit related to miningand production of reserves adjusted for the reserves re-measurement and purchaseaccounting effects. No residual value is assumed in the mineral licensevaluation.

In valuation of mineral licenses the Group used onlyquantities of proven and probable deposits that are expected to be producedwithin the term of the Group’s current licenses. The Group’s mining segmentproduction activities are located primarily within Russia; therefore, all ofthe information provided in this note pertains to this region.

The Group’s mineral reserves and deposits are situatedon the land belonging to government and regional authorities. In Russia, miningminerals require a subsoil license from the state authorities with respect toidentified mineral deposits. The Group obtains licenses from such authoritiesand pays certain taxes to explore and produce from these deposits. Theselicenses expire between 2005 and 2027, with the most significant licensesexpiring between 2012 and 2024, and management believes that they may beextended at the initiative of the Group without substantial cost. Managementintends to extend such licenses for deposits expected to remain productivesubsequent to their license expiry dates.

In November 2004, SKCC won the auction to developa coking coal mine in the Sibirginskaya Mine area in the Kuzbass region ofRussia for $2,487 paid in cash. The coal reserves of the Sibirginskaya Minelicense area are estimated at approximately 40 million tonnes, based onindependent reserve evaluation. Due to the fact that official registration ofthe right to develop a coking coal mine in the Sibirginskaya Mine area isgranted in December 2004, mineral licenses of $2,487 were recorded inconsolidated financial statements as of December 31, 2004.

In December 2004, SKCC won two auctions for theright to use subsoil plots for coking coal exploration and mining at theRaspadsky Open Pit Mine and Berezovsky-2 areas, with total reserves of55.5 million tonnes according to independent reserve evaluation. Theconsideration paid for the right to 

F-49

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

use subsoil plots forcoking coal exploration and mining at the Raspadsky Open Pit Mine andBerezovsky-2 areas amounted to $1,030 and $780, respectively.

In April 2005, SKCC won the auction forexploration and development of Erunakovskaya-1 and Erunakovskaya-3coal 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.

**13.   DEBT**

| ** **                                                                                          | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **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                                                                    |       | 26,404                          |       |                            | 7-25       |   |   | 93,876 |   |   | 3-25 |   |   |
| Bonds issue                                                                                         |       | 178,420                         |       |                            | 7-11.75    |   |   | 36,038 |   |   | 16.9 |   |   |
| Corporate lenders                                                                                   |       | 251                             |       |                            | 0-11       |   |   | 11,371 |   |   | 0 |   |   |
| Total                                                                                               |       | 205,075                         |       |                            |       |   |   | 141,285 |   |   |   |   |   |
| *U.S. dollar-denominated:*                                                                          |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions                                                                    |       | 163,247                         |       |                            | 4.3-8.9    |   |   | 189,332 |   |   | 3.6-11 |   |   |
| Corporate lenders                                                                                   |       | 1,032                           |       |                            | 7.25-10    |   |   | 11,420 |   |   | 7.3-8 |   |   |
| Total                                                                                               |       | 164,279                         |       |                            |       |   |   | 200,752 |   |   |   |   |   |
| *Euro-denominated:*                                                                                 |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions                                                                    |       | 13,978                          |       |                            | 4-10.3     |   |   | 1,561 |   |   | 4-5.5 |   |   |
| Corporate lenders                                                                                   |       | 1,413                           |       |                            | 24         |   |   | — |   |   |   |   |   |
| Total                                                                                               |       | 15,391                          |       |                            |       |   |   | 1,561 |   |   |   |   |   |
| *Romanian lei-denominated:*                                                                         |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions                                                                    |       | 4,558                           |       |                            | 5.5-8      |   |   | 4,790 |   |   | 20.5-24 |   |   |
| Total                                                                                               |       | 4,558                           |       |                            |       |   |   | 4,790 |   |   |   |   |   |
| *Swiss francs—denominated*                                                                     |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions                                                                    |       | 108                             |       |                            | 6          |   |   | — |   |   | — |   |   |
| Total                                                                                               |       | 108                             |       |                            |       |   |   | — |   |   |   |   |   |
| Total short-term borrowings                                                                         |       | 389,411                         |       |                            |       |   |   | 348,388 |   |   |   |   |   |
| Current portion  of long-term debt                                                                  |       | —                          |       |                            |       |   |   | 492 |   |   |   |   |   |
| **Total short-term borrowings and  current portion of long-term debt**                         | ** ** | **389,411**                     | ** ** |                            |       |   | ** ** | **348,880** | ** ** |   |   |   |   |
|                                                                                                     |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

Theweighted average interest rate of the ruble-denominated short-term borrowingsas of December 31, 2005 and 2004 was 10.29% and 11.88% p.a., respectively.The weighted average interest rate of the U.S. dollar-denominated short-termborrowings as of December 31, 2005 and 2004 was 6.34% and 

F-50

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

4.82% p.a., respectively. The weighted averageinterest rate of the euro-denominated short-term borrowings as of December 31,2005 and 2004 was 7.90% and 4.19% p.a., respectively. The weighted averageinterest rate of the Romanian lei-denominated short-term borrowings as of December 31,2005 and 2004 was 7.32% and 22.18% p.a., respectively. The weighted averageinterest rate of the Swiss frank-denominated short-term borrowings as of December 31,2005 was 6.00% p.a.

| ** **                       | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Long-term debt:**         | ** ** | ** **                      | ** ** | **Amount**                      | ** ** | **Rate p.a.,  %** | ** ** | **Amount** | ** ** | **Rate p.a.,  %** | ** ** |
| *Russian  ruble-denominated:*    |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions |       |                            | —     |                            |       |   |   |   |   | 50 |   | — |   |
| Bonds issue                      |       |                            | 2,353      |                            |       |   | 7 |   |   | 180,189 |   | 10.7-11.8 |   |
| Corporate lenders                |       |                            | —     |                            |       |   |   |   |   | 4,140 |   | 0 |   |
| Total                            |       |                            | 2,353      |                            |       |   |   |   |   | 184,379 |   |   |   |
| *U.S. dollar-denominated:*       |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Banks and financial institutions |       |                            | 6,507      |                            |       |   | 9.8 |   |   | — |   |   |   |
| Corporate lenders                |       |                            | 181        |                            |       |   | 0 |   |   | 265 |   | 10 |   |
| Total                            |       |                            | 6,688      |                            |       |   |   |   |   | 265 |   |   |   |
| *Romanian lei-denominated:*      |       |                            |       |                            |       |   |   |   |   |   |   |   |   |
| Corporate lenders                |       |                            | 36,574     |                            |       |   | 24-28 |   |   | 31,961 |   | 24 |   |
| Total long-term obligations      |       |                            | 45,615     |                            |       |   |   |   |   | 216,605 |   |   |   |
| Less: current  portion           |       |                            | —     |                            |       |   |   |   |   | (492 | ) |   |   |
| **Long-term portion**            | ** ** | ** **                      | **45,615** |                            |       |   |   |   | ** ** | **216,113** | ** ** | ** ** | ** ** |
|                                  |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |

 

Aggregatescheduled maturities of the debt outstanding at December 31, 2005, are asfollows:

| **Payable in:**    | ** ** | ** **  | ** ** | ** ** | ** ** |
|-------------------------|------------|-------------|------------|------------|------------|
| 2006 (current  portion) |       | 389,411     |       |
| 2007                    |       | 22,470      |       |
| 2008                    |       | 20,792      |       |
| 2009                    |       | —      |       |
| 2010 and  thereafter    |       | 2,353       |       |
| **Total**               | ** ** | **435,026** | ** ** |

 

The most significant debt provided by bank financingincluded credit line facilities from Gazprombank, Sberbank, UralSib, BNPParibas and Hypo Vereinsbank. The unused portion under all credit facilities asof December 31, 2005 and 2004 was $182,538 and $236,391, respectively. Asof December 31, 2005, the Group’s credit facilities provided aggregatedborrowing capacity of $617,564, of which $571,949 expires in 2006, $22,470 in2007, $23,145 in 2008 and thereafter.

During 2005 and 2004, Gazprombank providedruble-denominated loans to various Group subsidiaries bearing interest at 7.5 -11% and 13% p.a. respectively, guaranteed by certain Group 

F-51

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

subsidiaries. Theoutstanding balances as of December 31, 2005 and 2004 were $17,719 and$28,830, respectively. During 2004, Gazprombank also provided U.S.dollar-denominated short-term loan of $34,335, bearing interest at 8.9% p.a.and secured by property, plant and equipment and inventory. The loan was fullyrepaid during 2005.

During 2005 and 2004, Sberbank provided a series ofruble-denominated short-term loans and credit facilities to various Groupsubsidiaries, at 8.5% - 11.2% and 11% p.a., respectively. As of December 31,2005 and 2004, the balances outstanding were $nil and $50,478, respectively.

During 2005 and 2004, UralSib provided a series ofruble-denominated loans and credit facilities to various Group subsidiaries, at7 - 11% and 11% p.a., respectively, secured by inventory, property andequipment. As of December 31, 2005 and 2004, the balances outstanding were$8,686 and $2,523, respectively.

During 2005 and 2004, UralSib also provided a seriesof U.S. dollar-denominated loans to various Group subsidiaries, bearinginterest at 8.7% and 8.7 - 9% p.a. respectively. As of December 31, 2005and 2004, the balances outstanding under U.S.dollar-denominated loans were $niland $7,000, respectively.

During the years ended December 31, 2005 and2004, Raiffeisenbank provided a series of U.S. dollar-denominated credit linesto various Group subsidiaries bearing interest at 4.5% - 5.5% and 4.45% p.a.,respectively, and secured with accounts receivable and inventory. As of December 31,2005 and 2004, the balances outstanding were $13,292 and $1,500, respectively.

During the years ended December 31, 2005 and2004, Raiffesenbank also provided Romanian lei-denominated loans, bearinginterest at 8% and 21% p.a., respectively. As of December 31, 2005 and2004, the balances outstanding were $3,379 and $2,752, respectively.

During the year ended December 31, 2005,Raiffesenbank also provided euro-denominated loans bearing interest at 5.4% -5.55% p.a. and secured by inventory. The balance outstanding as of December 31,2005 was $8,181.

During 2004, Alfa bank provided U.S.dollar-denominated credit line facilities to Group companies, bearing interestat 9.5 - 11%, secured by property, plant and equipment. The loans werefully repaid in 2004.

During 2005, Vneshtorgbank provided a series of U.S.dollar-denominated loans to various Group subsidiaries bearing interest at 8.5- 9.7% p.a. and secured by property, plant and equipment. The balanceoutstanding as of December 31, 2005 was $6,507.

During 2005 and 2004, the Group utilized U.S.dollar-denominated bank overdraft facilities and credit lines bearing interestat 4.28% - 6.3% and 3.58 - 4.12% p.a. in 2005 and 2004, respectively, at BNPParibas, secured by the Mechel Trading and Mechel Metal Supply cash accounts,accounts receivable and inventory. As of December 31, 2005 and 2004, thebalances outstanding were $125,970 and $147,659, respectively.

F-52

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

During 2005, HypoVereins bank provided a series ofU.S. dollar-denominated loans to certain Group subsidiaries, bearing interestat 6% p.a. and secured by accounts receivable and inventory. The balanceoutstanding as of December 31, 2005 was $11,506.

During 2004, the Group obtained a short-term U.S.dollar-denominated loan from Cargill, bearing interest at 7.25% p.a. As of December 31,2004, the balance outstanding was $10,000. During 2005, the loan was fullyrepaid.

During 2002, the Groupissued ruble-denominated non-interest bearing notes payable with the face valueof $9,837 maturing on December 31, 2003. As of December 31, 2004 and2003, the balances payable were $10,548 and $10,615, respectively. During 2005the creditor was liquidated, and corresponding balance of $10,169 was writtenoff to income and included in other income, net.

***Bonds***

On February 4, 2003, CMP issued 1,000,000ruble-denominated bonds in an aggregate principal amount of 1 billion rubles($31,395). The bonds were issued at 100% par value. Interest is payable everysix months in arrears. The interest rate for the first coupon period wasdetermined upon the issuance based on the bids of buyers and amounted to 16.85%p.a. The interest rate for the second, third, and fifth coupon periods is setby the Group and is made public 10 days before the respective coupon periodstarts. Bondholders are entitled to early redemption of the bonds at face valuebefore the second, third and fifth coupon periods. The interest rate for thefourth and sixth coupon periods are set as equal to the rate for theimmediately preceding coupon period. The Group repurchased 865,127 bonds in February 2005.The bonds were redeemed on February 4, 2006.

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 period 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. The balanceoutstanding at December 31, 2005 and 2004, was $104,230 and $108,113,respectively. The decrease in the balance outstanding in 2005 is due todepreciation of ruble against the U.S. dollar (see Note 3(aa)).

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 wasdetermined upon the issuance based on the bids of buyers and amounted to 10.69%p.a. The interest rate for the second and third coupon period is set by the Groupand is made public 10 days before the end of the third coupon period (May 2006).The interest rate for the fifth and sixth coupon periods is 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 

F-53

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

total commission and issuecosts amounted to $610. The balances outstanding at December 31, 2005 and2004 were $69,487 and $72,075, respectively. The decrease in the balanceoutstanding in 2005 is due to depreciation of ruble against the U.S. dollar(see Note 3(aa)).

The bond issue costs are amortized to interest expenseusing the straight-line method, which approximates the effective interest ratemethod.

Carrying value ofproperty, plant and equipment pledged under loan agreements amounted to $20,946and $114,623 as of December 31, 2005 and 2004, respectively. Carryingvalue of inventories pledged under loan agreements amounted to $87,820 and$176,848 as of December 31, 2005 and 2004, respectively. Accountsreceivable pledged as of December 31, 2005 and 2004 amounted to $61,869and $63,364, respectively.

**14.   TAXES AND 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, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------|-------------|---------------------------------|------------|
| Current period  taxes and social contributions                             |       |                            | 136,967     |                            |       |   | 136,662 |   |   |
| Restructured  prior period taxes and social charges, principal amount |       |                            | 14,391      |                            |       |   | 30,182 |   |   |
| Restructured  related fines and penalties                                  |       |                            | 27,223      |                            |       |   | 66,047 |   |   |
| **Total  taxes and social charges payable**                                | ** ** | ** **                      | **178,581** |                            | ** ** | ** ** | **232,891** |   |   |

 

Presentedon the balance sheets as:

| Taxes and social  charges payable                                     |   |   | 144,715     |   |   |   | 145,527     |   |   |
|-----------------------------------------------------------------------|--------|--------|-------------|--------|--------|--------|-------------|--------|--------|
| Restructured  taxes and social charges payable, net of current portio |   |   | 33,866      |   |   |   | 87,364      |   |   |
| **Total**                                                             |   |   | **178,581** |   |   |   | **232,891** |   |   |

 

F-54

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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, 2005, mature as follows:

| **Payable in:** | ** ** | ** ** | ** ** | **Restructured  related fines and  penalties** | ** ** | **Restructured prior  period taxes and  social charges,  principal amount** | ** ** | **Total** | ** ** |
|----------------------|------------|------------|------------|----------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|-----------|------------|
| 2006                 |       |       | 6,169      |                                                     |       |                                                                                                 | 1,579      |      |       | 7,748 |   |
| 2007                 |       |       | 18,391     |                                                     |       |                                                                                                 | 3,173      |      |       | 21,564 |   |
| 2008                 |       |       | 845        |                                                     |       |                                                                                                 | 6,129      |      |       | 6,974 |   |
| 2009                 |       |       | 836        |                                                     |       |                                                                                                 | 1,755      |      |       | 2,591 |   |
| 2010 and  thereafter |       |       | 982        |                                                     |       |                                                                                                 | 1,755      |      |       | 2,737 |   |
| **Total**            | ** ** | ** ** | **27,223** |                                                     | ** ** | ** **                                                                                           | **14,391** |      | ** ** | **41,614** | ** ** |

 

Included in current periodtaxes as of December 31, 2003 was the accrual for penalties and finesclaimed by the tax authorities for income tax liabilities in certainsubsidiaries for the preceding periods allegedly underestimated based onvarying interpretations of the tax legislation existing during 1999-2002and as a result of applying certain tax planning strategies in the amount of$25,717. In 2005 and 2004, the Group paid $8,220 and $35,154 of such prior yeartax claims, respectively.

**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 liabilitiesincluding fines and penalties, were overdue and payable with short maturitiesand were accrued by the Group. Upon conclusion of the restructuring agreements,overdue taxes and charges accrued became payable in equal quarterlyinstallments within six years; and related fines and penalties became payableonly if certain conditions were not met. Subject to timely payment of at least50% of all the restructured principal amounts of taxes and charges within twoyears on schedule, and the full and timely payment of current taxes beingaccrued, a 50%-portion of the restructured fines and penalties will beforgiven.

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 bearinterest.

F-55

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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 relatedfines and 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.

Total net amount of restructured liabilities relatedto the acquisition of Mechel Targoviste and Mechel Campia Turzii as of December 31,2005 consisted of $36,575, $5,787, $437 and $2,306 classified as long-termdebt, long-term restructured taxes and social charges payable, short-termrestructured taxes and social charges payable and short-term debt,respectively. The gross amount equaled to $76,956 with a related discount of$31,867, of which $31,171 and $696 related to Mechel Targoviste and MechelCampia Turzii, respectively. Long-term obligations of Mechel Targoviste of$70,035 are due to its material suppliers and energy providers, and wererestructured as long-term debt in connection with the Group’s acquisition ofMechel Targoviste. Restructured taxes and social charges payable of MechelTargoviste of $5,402 are payable to the local tax authorities over the period2006-2010 with the current portion of $437 due in 2006. The majority ofsuch liability could be forgiven in 2008 contingent upon Mechel Targovistefulfilling all conditions as set in the purchase agreement and makes good onall ongoing and restructured debts that are subject to repayment.

At theacquisition of Mechel Targoviste long-term debt to its material suppliers andenergy providers was restructured and is payable, on an undiscounted basis andif the terms of the restructuring are not met, in accordance with the followingschedule:

| **Payable in:** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|------------|------------|
| 2006                 |       | 8,661      |       |
| 2007                 |       | 27,954     |       |
| 2008                 |       | 33,420     |       |
| **Total**            | ** ** | **70,035** | ** ** |

 

F-56

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Basedon the restructuring agreements, overdue taxes, net of discount, are payable asfollows:

| ** **           | ** ** | ** ** | ** ** | **Mechel Campia**     | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|----------------------------|------------|------------|------------|
| **Payable in:** | ** ** | ** ** | ** ** | **Mechel Targoviste** | ** ** | **Turzii** | ** ** | **Total:** | ** ** |
| 2006                 |       |       | 437        |                       |       |       | —     |   |   | 437 |   |
| 2007                 |       |       | 1,413      |                       |       |       | —     |   |   | 1,413 |   |
| 2008                 |       |       | 3,552      |                       |       |       | 823        |   |   | 4,375 |   |
| **Total**            | ** ** | ** ** | **5,402**  |                       | ** ** | ** ** | **823**    |   | ** ** | **6,225** | ** ** |
|                      |            |            |            |                            |            |            |            |  |  |  |  |  |  |

 

The amount payable in 2008 of $3,552, including finesand penalties relating to Mechel Targoviste, can be forgiven if MechelTargoviste is in compliance with the current payments schedule for the firstfour years. The same applies to the last payment of Mechel Campia Turzii inamount of $823 payable in 2008.

In addition, as of December 31, 2005, MechelCampia Turzii had a possible (rather than probable) loss contingency, notreflected on the balance sheet, related to rescheduled tax related penaltiesand late payment interests amounting to $36,194, that were conditionallyforgiven in accordance with the Romanian Common Orders (the “Orders”). They maybecome payable in case of non-fulfillment by the Group of certain conditions inthe Orders. Management believes that the Group will be able to meet all futureconditions required to obtain full forgiveness.

Labor force of MechelTargoviste and Mechel Campia Turzii SA comprise 5.9% and 6.4%, respectively, oftotal labor force of the Group. 96% and 95% of these employees, respectively,are under protection of collective bargaining agreement, which, according toprivatization agreements, will expire not earlier than August 2007 and June 2008,respectively. The net assets (liabilities) of Mechel Targoviste and MechelCampia Turzii as of December 31, 2005 amounted to $(16,494) and $22,131,respectively.

**15.   ASSET RETIREMENT 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.

F-57

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Thefollowing table presents the movements in asset retirement obligations for theyears ended December 31, 2005 and 2004:

| **Asset retirement obligation**   | ** ** | ** ** | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------|------------|------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Balance  at beginning of year**           | ** ** |       | **74,977** | ** **                      |       |                            | **13,937** | ** ** |   |
| Liabilities  incurred in the current period |       |       | —     |                            |       |                            | 24,119     |   |   |
| Liabilities  settled in the current period  |       |       | (2,249     | )                               |       |                            | (2,860     | ) |   |
| Liabilities  disposed in the current period |       |       | (9,091     | )                               |       |                            | —     |   |   |
| Accretion expense                           |       |       | 3,248      |                            |       |                            | 2,081      |   |   |
| Revision in  estimated cash flow            |       |       | (4,501     | )                               |       |                            | 34,652     |   |   |
| Translation and  other                      |       |       | (3,332     | )                               |       |                            | 3,048      |   |   |
| **Balance  at end of year**                 | ** ** |       | **59,052** | ** **                      |       |                            | **74,977** | ** ** |   |

 

Liabilities incurred during the year ended December 31,2004 related primarily to the acquisition of Izhstal ($20,726). Liabilitiesdisposed during the year ended December 31, 2005 related primarily to thedisposal of a subsidiary at BMP ($7,801). Revision in estimated cash flowrepresented the effect of the changes resulting from the management revisionsto the timing and/or the amounts of the original estimates, and is recordedthrough an increase or decrease in the value of the underlying non-currentassets.

Upon adoption of SFAS No. 143,“Accounting for Asset Retirement Obligation”, on January 1, 2003, theGroup recorded $3,788 (net of taxes) as a charge to cumulative effective ofchanges in accounting principles. Application of this new accounting principleresulted in an increase in property, plant and equipment of $5,474 and an assetretirement obligation liability of $9,262. The application of SFAS No. 143reduced income from continuing operations by $2,587, net income by $6,375(after income taxes of $nil), or $0.02 per basic and diluted share, for theyear ended December 31, 2003.

**16.   PENSION AND 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 payment tothe Fund. The Fund is obligated to provide former employees with monthlynon-state pensions throughout their life period. As of December 31, 2005,the Group’s obligations under this Fund were unfunded.

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 “territorialtreaties”), which also provide for certain post retirement benefits above oldage pensions. Additionally the Group voluntarily provides financial 

F-58

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

support, of a definedbenefit nature, to its old age and disabled pensioners, who did not acquire anypension under the occupational pension program.

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, 2005, there were approximately71,300 active participants to the defined benefit pension plans and 20,000pensioners receiving monthly pensions or other regular financial support fromthe employer.

Actuarial valuation of pension and other postemployment and postretirement benefits was performed in March 2006, withthe measurement date of December 31, 2005. Members’ census data as of thatdate was collected for all relevant business units of the Group.

Pension costs determined are supported by anindependent qualified actuary, and are charged to profit and loss accountratably over employees’ working service with the Group.

Themovements in the projected benefit obligation (PBO) were as follows during theyears ended December 31:

| ** **                                                           | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|------------|------------|
| **Benefit obligation at beginning of year** |       | **46,981** |       | **37,164** |       |
| Service cost                                                         |       | 2,161      |       | 1,843      |       |
| Amortization of  prior service cost                                  |       | 350        |       | 344        |       |
| Interest cost                                                        |       | 5,191      |       | 4,419      |       |
| Obligation  incurred                                                 |       | 2,762      |       | 3,662      |       |
| Settlement of  obligation                                            |       | (3,787     | )          | (2,751     | )          |
| Actuarial (gain)  losses                                             |       | —     |       | —     |       |
| Translation  difference                                              |       | (1,959     | )          | 2,300      |       |
| **Benefit obligation at end of  year**                               |       | **51,699** |       | **46,981** |       |

 

Thefunded status of the plan was as follows as of December 31:

| ** **                            | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|---------------------------------------|------------|-------------|------------|-------------|------------|
| Projected benefit  obligation (PBO)   |       | (60,415     | )          | (50,705     | )          |
| Accumulated  benefit obligation (ABO) |       | (47,671     | )          | (40,290     | )          |
| Funded status                         |       | (60,415     | )          | (50,705     | )          |
| Unrecognized net  actuarial loss      |       | 7,609       |       | 931         |       |
| Unrecognized  prior service cost      |       | 5,069       |       | 4,725       |       |
| **Net amount recognised**             | ** ** | **(47,737** | **)**      | **(45,049** | **)**      |

 

F-59

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Amountsrecognized in the balance sheet were as follows as of December 31:

| ** **                              | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|-----------------------------------------|------------|-------------|------------|-------------|------------|
| Prepaid benefit  cost                   |       | —      |       | —      |       |
| Accrued benefit  cost                   |       | (51,699     | )          | (46,981     | )          |
| Intangible asset                        |       | 3,962       |       | 1,932       |       |
| Accumulated other  comprehensive income |       | —      |       | —      |       |
| **Net amount recognised**               |       | **(47,737** | **)**      | **(45,049** | **)**      |

 

Thecomponents of net periodic benefit cost were as follows for the year ended December 31:

| ** **                          | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------------------|------------|-----------|------------|-----------|------------|
| Service cost                        |       | 2,161     |       | 1,843     |       |
| Interest cost                       |       | 5,191     |       | 4,419     |       |
| Expected return  on assets          |       | —    |       | —    |       |
| Amortization of  prior service cost |       | 350       |       | 344       |       |
| Recognised  actuarial loss          |       | (159      | )          | —    |       |
| **Net periodic benefit cost**       |       | **7,543** | ** ** | **6,606** | ** ** |

 

Thekey actuarial assumptions used were as follows as of December 31:

| ** **                                                               | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Discount rate                                                            |       |       |       |       |       |
| Russian entities                                                         |       | 9.48       | %          | 10.55      | %          |
| Romanian entities                                                        |       | 6.71       | %          | 10.55      | %          |
| Expected return  on plan assets                                          |       | N/A        |       | N/A        |       |
| Rate of compensation  increase                            |       |       |       |       |       |
| Russian entities                                                         |       | 8,42       | %          | 8,42       | %          |
| Romanian entities                                                        |       | 5.67       | %          | 8,42       | %          |
| Rate of pension  entitlement increase (before benefit commencement) |       | 8.42       | %          | 8.42       | %          |
| Rate of monthly  financial support increase                              |       | 6.3        | %          | 6.3        | %          |
| Rate used for  calculation of purchased annuity  value*                  |       | below 5.00 | %          | below 5.00 | %          |

----

*                    Regularretirement pensions in payment are insured by Penfosib

F-60

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Thefollowing benefit payments, which reflect expected future service, asappropriate, are expected to be paid:

| ** **                                      | ** ** | **2006**  | ** ** | **2007**  | ** ** | **2008**  | ** ** | **2009**  | ** ** | **2010**  | ** ** | **2011-2015** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|---------------|------------|-----------|------------|
| Pensions  (including monthly financial support) |       | 4,030     |       | 2,745     |       | 2,988     |       | 3,301     |       | 3,405     |       |          | 21,854     |      |       | 38,323 |   |
| Other benefits                                  |       | 5,177     |       | 1,668     |       | 1,807     |       | 2,050     |       | 2,189     |       |          | 13,689     |      |       | 26,580 |   |
| **Total expected  benefits to be paid**         | ** ** | **9,207** | ** ** | **4,413** | ** ** | **4,795** | ** ** | **5,351** | ** ** | **5,594** | ** ** | ** **    | **35,543** |      | ** ** | **64,903** | ** ** |

 

The Group did notrecognize pension obligations before January 1, 2004. Due to continuingincrease in ongoing pension obligations and enrollment of employees of recentlyacquired subsidiaries in the Group’s sponsored pension plans, managementdecided to accrue for pension obligations starting from January 1, 2004.

**17.   FINANCE LEASE**

In 2005 Mechel-Trans OOO, 100% subsidiary of MTH,entered into a six-year agreement with a third party for the lease of transportequipment. The lease was classified as a finance (capital) lease in accordancewith SFAS No. 13. The lease contains a bargain purchase option and thetitle to the leased equipment transfers to the lessee at the end of the leaseterm.

As of December 31,2005, the net book value of the leased assets was as follows:

| ** **                                                                               | ** ** | **December 31, 2005** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| Transport  equipment and vehicles                                                        |       |                            | 10,291     |   |   |
| Less: accumulated  depreciation                                                          |       |                            | (133       | ) |   |
| **Net value of property, plant  and equipment, obtained under capital lease agreements** | ** ** | ** **                      | **10,158** |   |   |

 

Thecarrying amount and maturities of capital lease liabilities as of December 31,2005 were as follows:

| ** **                           | ** ** | **Total payable** | ** ** | **Interest** | ** ** | **Net payable** | ** ** |
|--------------------------------------|------------|------------------------|------------|--------------|------------|----------------------|------------|
| Payable in 2006                      |       |                   | 2,672      |         |       |                 | (1,785     | ) |   |   | 887 |   |   |
| Payable in 2007                      |       |                   | 2,672      |         |       |                 | (1,606     | ) |   |   | 1,065 |   |   |
| Payable in 2008                      |       |                   | 2,672      |         |       |                 | (1,397     | ) |   |   | 1,275 |   |   |
| Payable in 2009                      |       |                   | 2,672      |         |       |                 | (1,136     | ) |   |   | 1,536 |   |   |
| Payable in 2010                      |       |                   | 2,672      |         |       |                 | (827       | ) |   |   | 1,845 |   |   |
| Payable after  2010                  |       |                   | 3,976      |         |       |                 | (518       | ) |   |   | 3,458 |   |   |
| **Total  capital lease liabilities** | ** ** | ** **             | **17,334** |         | ** ** | ** **           | **(7,268** | **)** | ** ** | ** ** | **10,066** |   |   |

 

F-61

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

The discount rate used forthe calculation of the present value of minimum lease payments equals theimplicit rate for the lessor and varies from 19.7% to 19.9% on different groupsof equipment. Interest expense charged to the accompanying Group’s incomestatement in 2005 amounts to $300.

**18.   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 403,118,680 common shares were outstanding as ofDecember 31, 2005 and 2004. As disclosed in Note 1, in the context of thereorganization under common control and based on the presentation of the Groupas if it existed for all periods presented since its inception, the number ofshares authorized and issued and earnings per share were based on the sharesissued to Controlling Shareholders in connection with the formation of theGroup in 2003, and that number of shares (less treasury shares) has beentreated as outstanding for all periods presented except where capitalcontributions were made during 2002 and 2001 for which shares have beenallocated to those contributions as if issued at that time based upon thenumber of shares that were issued for the contribution to acquired companies inthe common control reorganization as determined in accordance with Russian law.

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 thereorganization described in Note 1, 16,790,271 common shares were issued toMechel Trading, a Group subsidiary, in exchange for shares contributed by theControlling Shareholders and held by Mechel Trading. Consistent with thepresentation of common shares as described above, these 16,790,271 shares valuedat their aggregate par value have been treated as held in treasury as of December 31,2003, and 13,152,065 shares as of December 31, 2004 and 2005.

F-62

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**Stock-basedcompensation**

During the year ended December 31,2003, the Group recorded an issuance of a stock-based compensation awardpursuant to an employment contract with one of its executives. The stock-basedcompensation award entitles the executive to receive 0.6% (2,297,815 shares) ofthe issued shares of the Group, out of the shares held in treasury. The fairvalue of the award was estimated at approximately $3,600. The vesting periodfor the award and the respective stock based compensation expense commenced on July 1,2003. The stock-based compensation recognized during the years ended December 31,2004 and 2003 was $1,400 and $2,200, respectively, and recorded as an operatingexpense. On April 15, 2004, the stock option was exercised through theissuance of treasury stock.

**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, which can bereduced or eliminated if paid to foreign owners under certain applicable doubletax treaties. Additional dividend tax could be imposed on the transfer ofundistributed earnings of subsidiaries to Mechel (generally, tax rate isassumed as 9%). Approximately $2,507,142, and $1,906,070 were available fordividends as of December 31, 2005 and 2004, respectively.

On June 24, 2004,Mechel declared a dividend of 149 million rubles (approximately $5,145), whichwas paid in September 2004. On June 29, 2005, Mechel declared adividend of 5,543 million rubles (approximately $194,154), which was paid inJuly-August 2005.

**Earnings anddividends per share**

Net incomeper common share for all periods presented was determined in accordance withSFAS No. 128, “Earnings per Share”, by dividing income available toshareholders by the weighted average number of shares outstanding during thethree years ended December 31, 2005:

| ** **                                                                  | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-----------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Net income  available to shareholders                                       |       | 381,180     |       | 1,342,706   |       | 143,508     |       |
| Total weighted average number of shares outstanding  during the period |       | 403,118,680 |       | 373,971,312 |       | 366,178,815 |       |
| **Earnings  per common share**                                              | ** ** | **0.95**    | ** ** | **3.59**    | ** ** | **0.39**    | ** ** |

 

F-63

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Totalweighted-average number of common shares outstanding during the period is asfollows:

| ** **                                                       | ** ** | **Shares**      | ** ** | **Fraction of** | ** ** | **Weighted-average**   | ** ** |
|------------------------------------------------------------------|------------|-----------------|------------|----------------------|------------|------------------------|------------|
| **Dates outstanding**                                       | ** ** | ** **      | ** ** | **outstanding**      | ** ** | **period (days)** | ** ** | **number of shares** | ** ** |
| **2003:**                                                        |       |            |       |                 |       |                   |       |   |   |   |   |
| Common shares:  January 1-December 31                  |       | 382,969,086     |       |                 | 365        |                   |       |   | 382,969,086 |   |   |
| Treasury shares:  January 1-December 31                |       | (16,790,271     | )          |                 | 365        |                   |       |   | (16,790,271 | ) |   |
| Total weighted average shares outstanding during the  period     |       | 366,178,815     |       |                 |       |                   |       |   | 366,178,815 |   |   |
| **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** |   |   |
|                                                                  |            |                 |            |                      |            |                        |            |  |  |  |  |  |  |

 

There were no dilutivesecurities issued as of December 31, 2005, 2004 and 2003.

**Stock issued tominority shareholders**

In an effort to consolidate outstanding minorityinterest in certain consolidated subsidiaries, in July 2003, the Groupexchanged 3.9% of their equity interest in SKCC for minority interest insubsidiaries of SKCC. The non-monetary exchange was accounted for using thepurchase method of accounting and accordingly, the fair value of the stockissued of $4,428, to acquire the minority interests was credited to additionalpaid in capital.

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 TGPP. On October 15, 2004, TGPPmerged with SKCC and ceased its existence as a legal entity. The non-monetaryexchange of SKCC shares for TGPP shares that were cancelled was accounted forusing the purchase method of accounting and, accordingly, the fair value of theSKCC stock issued of $340, was credited to additional paid-in capital.

F-64

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

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 1, 2004,Mechel Trading, a 100%-owned subsidiary by the Group, agreed to transfer1,072,313 and 268,078 of Mechel’s shares held by it in treasury to twoemployees of MMS, the Group’s Liechtenstein trading subsidiary, in return for20% and 5%, respectively, of the shares of this subsidiary owned by theseemployees. The transaction was accounted for as the purchase of a minorityinterest in exchange for the issuance of treasury stock. The cost of thepurchase was based upon the fair value of treasury shares issued. Thenon-monetary exchange of Mechel shares for MMS shares was accounted for usingthe purchase method of accounting and, accordingly, the fair value of theMechel stock issued of $8,956 was credited to additional paid-in capital, andthe excess of fair value of Mechel stock over MMS shares of $7,505 was debitedto goodwill.

**19.   INCOME TAXES**

Income(loss) before income tax, minority interests, discontinued operations,extraordinary gain and change in accounting principle attributable to differentjurisdictions was as follows:

| ** **              | ** ** | **Years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Russia                  |       | 505,995                                     |       | 526,536 |   | 177,240 |   |
| Switzerland             |       | 104,398                                     |       | 238,895 |   | 20,549 |   |
| British Virgin  Islands |       | (28,249                                     | )          | 787,829 |   | — |   |
| Romania                 |       | (55,560                                     | )          | (9,885 | ) | (21,077 | ) |
| Lithuania               |       | (1,255                                      | )          | 2,390 |   | (517 | ) |
| Kazakhstan              |       | 486                                         |       | (670 | ) | (69 | ) |
| Ukraine                 |       | 44                                          |       | — |   | — |   |
| **Total**               | ** ** | **525,859**                                 | ** ** | **1,545,095** | ** ** | **176,126** | ** ** |

 

F-65

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

| ** **                              | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| *Current  income tax expense*           |       |                                        |       |   |   |   |   |
| Russia                                  |       | 140,753                                     |       | 162,057 |   | 51,913 |   |
| Switzerland                             |       | 8,176                                       |       | 22,713 |   | 2,730 |   |
| Romania                                 |       | 239                                         |       | 2,223 |   | 15 |   |
| Lithuania                               |       | —                                      |       | — |   | 6 |   |
| Ukraine                                 |       | 10                                          |       | — |   | — |   |
|                                    |       | 149,178                                     |       | 186,993 |   | 54,664 |   |
| *Deferred income tax expense (benefit)* |       |                                        |       |   |   |   |   |
| Russia                                  |       | (10,136                                     | )          | (14,389 | ) | (8,026 | ) |
| Switzerland                             |       | (1,555                                      | )          | 3,183 |   | 3,944 |   |
| Romania                                 |       | (580                                        | )          | 70 |   | (2,794 | ) |
| Lithuania                               |       | 110                                         |       | (43 | ) | (28 | ) |
| Kazakhstan                              |       | (374                                        | )          | (38 | ) | (1 | ) |
|                                    |       | (12,535                                     | )          | (11,217 | ) | (6,905 | ) |
| **Total  income tax expense**           | ** ** | **136,643**                                 | ** ** | **175,776** | ** ** | **47,759** | ** ** |

 

Taxes represent the Group’s provision for profit tax.In the years 2003 through 2005 income tax was calculated at 24% of taxableprofit in Russia, at 10.5% in Switzerland, at 16% in Romania, at 15% inLithuania and at 30% in Kazakhstan. The Group’s subsidiaries incorporated in Liechtensteinand British Virgin Islands are exempt from profit tax.

F-66

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(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 31,2005) to the income before taxes, minority interest, extraordinary items andchange in accounting principle, to the income tax expense reported in thefinancial statements is as follows:

| ** **                                                                                | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Theoretical income tax  expense computed on income before taxes at Russian statutory rate |       | 126,206                                     |       | 370,823 |   | 42,470 |   |
| *Effects of other jurisdictions and permanent  differences:*                              |       |                                        |       |   |   |   |   |
| Property, plant and  equipment basis difference                                           |       | 707                                         |       | 1,481 |   | — |   |
| Non-deductible expenses  and non-taxable income, net                                      |       | 8,591                                       |       | 25,502 |   | 11,423 |   |
| Social expenditures                                                                       |       | 6,711                                       |       | 7,838 |   | 2,406 |   |
| Loss carry-forward used                                                                   |       | —                                      |       | (5,840 | ) | — |   |
| Change in valuation  allowance                                                            |       | 7,200                                       |       | (4,563 | ) | (3,375 | ) |
| Other permanent  differences                                                              |       | (520                                        | )          | 917 |   | (1,664 | ) |
| Different tax rates in  foreign jurisdictions                                             |       | (4,352                                      | )          | (233,929 | ) | (7,680 | ) |
| Fines and penalties  related to taxes                                                     |       | (7,900                                      | )          | (284 | ) | 4,179 |   |
| Change in tax rate and  tax legislation                                                   |       | —                                      |       | 13,829 |   | — |   |
| **Income tax expense, as reported**                                                       | ** ** | **136,643**                                 | ** ** | **175,776** | ** ** | **47,759** | ** ** |

 

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.

F-67

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Thedeferred tax balances were calculated by applying the currently enactedstatutory tax rate in each jurisdiction applicable to the period in which thetemporary differences between the carrying amounts and tax base (both inrespective local currencies) of assets and liabilities are expected to reverse.The amounts reported in the accompanying consolidated financial statementsconsisted of the following:

| ** **                                   | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred tax assets, current:                |       |                        |       |                        |       |   |   |   |   |
| Inventory and product  related reserves      |       |                        | 3,148      |                        |       |   | 4,432 |   |   |
| Bad debt allowance                           |       |                        | 3,155      |                        |       |   | 4,309 |   |   |
| Timing difference in  cost recognition       |       |                        | 3,010      |                        |       |   | — |   |   |
| Deferred revenue                             |       |                        | —     |                        |       |   | 301 |   |   |
| Accrued liabilities                          |       |                        | 1,442      |                        |       |   | 1,438 |   |   |
| Vacation provision                           |       |                        | 4,123      |                        |       |   | 2,168 |   |   |
| Other                                        |       |                        | 514        |                        |       |   | — |   |   |
| Total deferred tax  asset, current           |       |                        | 15,392     |                        |       |   | 12,648 |   |   |
| Deferred tax assets, non-current:            |       |                        |       |                        |       |   |   |   |   |
| Net operating loss carry-forward             |       |                        | 9,781      |                        |       |   | 7,227 |   |   |
| Asset retirement  obligation                 |       |                        | 4,612      |                        |       |   | 3,021 |   |   |
| Property, plant and  equipment               |       |                        | 7,970      |                        |       |   | 8,880 |   |   |
| Pension obligations                          |       |                        | 11,757     |                        |       |   | 7,606 |   |   |
| Other                                        |       |                        | 105        |                        |       |   | 1,223 |   |   |
| Total deferred tax  assets, non-current      |       |                        | 34,225     |                        |       |   | 27,597 |   |   |
| Valuation allowance for  deferred tax assets |       |                        | (11,130    | )                           |       |   | (5,013 | ) |   |
| **Total  deferred tax asset, net**           | ** ** | ** **                  | **38,487** |                        | ** ** | ** ** | **35,232** |   |   |
|                                              |            |                             |            |                             |            |  |  |  |  |  |

 

| ** **                                   | ** ** | **December 31,  2005** | ** **  | **December 31,  2004** | ** ** |
|----------------------------------------------|------------|-----------------------------|-------------|-----------------------------|------------|
| Deferred tax liabilities, current:           |       |                        |        |                        |       |   |   |   |   |
| Timing difference in  revenue recognition    |       |                        | 13,451      |                        |       |   | 14,243 |   |   |
| Timing difference in  cost recognition       |       |                        | 2,833       |                        |       |   | — |   |   |
| Inventories                                  |       |                        | 12,686      |                        |       |   | 15,000 |   |   |
| Bad debt provision                           |       |                        | 1,316       |                        |       |   | — |   |   |
| Other                                        |       |                        | 1,788       |                        |       |   | 1,812 |   |   |
| Total deferred tax  liabilities, current     |       |                        | 32,074      |                        |       |   | 31,055 |   |   |
| Deferred tax liabilities, non-current:       |       |                        |        |                        |       |   |   |   |   |
| Property, plant and  equipment               |       |                        | 75,556      |                        |       |   | 71,670 |   |   |
| Mineral licenses                             |       |                        | 32,044      |                        |       |   | 38,488 |   |   |
| Investments                                  |       |                        | 3,329       |                        |       |   | 1,433 |   |   |
| Timing difference in  cost recognition       |       |                        | 153         |                        |       |   | 5,006 |   |   |
| Other                                        |       |                        | 917         |                        |       |   | — |   |   |
| Total deferred tax liabilities,  non-current |       |                        | 111,999     |                        |       |   | 116,597 |   |   |
| **Total deferred tax liability**             |       |                        | **144,073** |                        | ** ** | ** ** | **147,652** |   |   |
|                                              |            |                             |             |                             |            |  |  |  |  |  |

 

F-68

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

 

A deferred tax liability of approximately $278,492 and$162,500 as of December 31, 2005 and 2004, respectively, has not beenrecognized for temporary differences related to the Group’s investment incertain foreign subsidiaries primarily as a result of unremitted earnings ofconsolidated subsidiaries, as it is the Group’s intention, generally, toreinvest such earnings permanently.

Similarly, a deferred tax liability of $89,553 and$48,057 as of December 31, 2005 and 2004, respectively, has not beenrecognized for temporary difference related to unremitted earnings ofconsolidated domestic subsidiaries as management believes the Group has boththe ability and intention to a tax-free reorganization or merger of majorsubsidiaries into Mechel. A deferred tax liability of $2,251 as of December 31,2005, was recognized for temporary difference related to unremitted earnings ofYakutugol.

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 2002-2005,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, will be restricted to a maximum of50% of taxable income in 2006 and will have no restrictions effective January 1,2007. Tax loss carryforwards may be eroded by future devaluation of the ruble.As of December 31, 2005, for statutory income tax purposes, thesubsidiaries of the Group had tax losses available to carryforward ofapproximately $63,680 expiring as follows:

| December 31,  2006      |       | 1,042      |       |
|------------------------------|------------|------------|------------|
| December 31, 2007       |       | 3,862      |       |
| December 31, 2008       |       | 15,298     |       |
| December 31, 2009       |       | 3,704      |       |
| December 31, 2010       |       | 28,133     |       |
| Thereafter                   |       | 11,641     |       |
| **Total  loss carryforward** | ** ** | **63,680** | ** ** |

 

F-69

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**20.   TAXES OTHER THAN INCOME TAX**

Taxesother than income tax included in the consolidated income statements arecomprised of the following:

| ** **                             | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------------|------------|
| ** **                             | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Property and land tax                  |       | 51,280                                      |       | 42,476 |   | 24,458 |   |
| VAT                                    |       | 1,887                                       |       | 1,017 |   | 2,898 |   |
| Fines and penalties related to taxes   |       | 14,047                                      |       | 13,340 |   | 10,377 |   |
| Other taxes and penalties              |       | 23,469                                      |       | 12,452 |   | 6,983 |   |
| **Total  taxes other than income tax** |       | **90,683**                                  | ** ** | **69,285** | ** ** | **44,716** |   |

 

Property and land taxconsists mostly of payments for land tax, which amounted to $30,700, $28,880,and $14,666 for the years ended December 31, 2005, 2004 and 2003,respectively. This tax is levied on the land beneath the Group’s productionsubsidiaries that is occupied based on the right of perpetual use. According tonew land legislation, the right of perpetual use has to be re-registered beforeJanuary 1, 2008 through purchase of land or operating leases up to 49years, which will be decided by the Group during 2006.

**21.   GENERAL, ADMINISTRATIVE AND OTHER OPERATINGEXPENSES**

General,administrative and other operating expenses are comprised of the following:

| ** **                                                      | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Personnel and social  contributions                             |       | 109,735                                     |       | 88,189 |   | 62,861 |   |
| Social expenses                                                 |       | 38,269                                      |       | 27,751 |   | 13,247 |   |
| Fixed assets disposals                                          |       | 1,801                                       |       | 5,736 |   | 4,111 |   |
| Audit and consulting  services                                  |       | 20,234                                      |       | 12,432 |   | 10,022 |   |
| Depreciation                                                    |       | 9,434                                       |       | 7,621 |   | 7,890 |   |
| Rent                                                            |       | 5,341                                       |       | 13,729 |   | 5,567 |   |
| Banking charges and  services                                   |       | 3,907                                       |       | 3,678 |   | 2,102 |   |
| Other                                                           |       | 71,007                                      |       | 69,903 |   | 31,401 |   |
| **Total general, administrative and other  operating expenses** | ** ** | **259,728**                                 | ** ** | **229,039** | ** ** | **137,201** | ** ** |

 

F-70

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Rent representsoffice-related expenses and expenses for the operating lease of land, whichranges between 1 and 47 years. These land lease expenses amounted to $2,843, $2,184and $1,749 for the years ended December 31, 2005, 2004 and 2003,respectively. The amount of rental payments is determined by local authoritiesand cannot be reasonably estimated beyond a five-year horizon. The table belowpresents future land rental payments for the next five years undernon-cancelable operating lease agreements based on the current rental rates:

| **Year of payment**            | ** ** | ** ** | ** **  | **Operating  lease payments** | ** ** |
|------------------------------------------|------------|------------|-------------|------------------------------------|------------|
| 2006                                     |       |       | 2,599       |                               |       |
| 2007                                     |       |       | 2,815       |                               |       |
| 2008                                     |       |       | 3,091       |                               |       |
| 2009                                     |       |       | 3,400       |                               |       |
| 2010                                     |       |       | 3,740       |                               |       |
| Thereafter                               |       |       | 132,234     |                               |       |
| **Total  land operating lease payments** | ** ** | ** ** | **147,879** |                               |       |

 

**22.   OTHER INCOME, NET**

Otherincome is comprised of the following:

| ** **                                       | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Gain on sale of  MMK shares                      |       | —                                      |       | 799,982 |   | — |   |
| Gain on sale of other long-term investments      |       | 2,743                                       |       | 3,423 |   | 2,417 |   |
| Gain on forgiveness of fines and penalties       |       | 38,383                                      |       | 18,296 |   | 9,588 |   |
| Gain on accounts payable with expired legal term |       | 23,347                                      |       | 1,250 |   | 1,400 |   |
| Dividends received                               |       | —                                      |       | 2,407 |   | — |   |
| (Loss) gain on sale of promissory notes          |       | (3                                          | )          | (2,044 | ) | 2,657 |   |
| Other                                            |       | 1,450                                       |       | 13,503 |   | 10,271 |   |
| **Total  other income, net**                     | ** ** | **65,920**                                  | ** ** | **836,817** | ** ** | **26,333** | ** ** |

 

Gain on forgiveness of fines and penalties of $38,383includes forgiveness of specified portion of restructured fines and penaltiesof 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 (refer also tonote 14).

Gain on accounts payablewith expired legal term of $23,347 includes gain on the write-off of loans andpromissory notes payable of $19,982 that were written-off due to legalliquidation of the creditors or expiration of the statute of limitation.

F-71

----

**MECHEL OAO (formerly Mechel Steel Group OAO)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

**23.   SEGMENTAL INFORMATION**

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.

Segmentalinformation for 2005, 2004 and 2003 is as follows:

| ** **                                          | ** ** | **Mining** | ** ** | **Steel** | ** ** | **2005**  | ** ** | **Mining** | ** ** | **Steel** | ** ** | **2004**  | ** ** | **Mining** | ** ** | **Steel** | ** ** | **2003**  | ** ** |
|-----------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|------------|------------|-----------|------------|-----------|------------|------------|------------|-----------|------------|-----------|------------|
| Revenues from  external customers                   |       | 1,094,782  |       | 2,710,213 |       | 3,804,995 |       | 878,417    |       | 2,757,538 |       | 3,635,955 |       | 413,943    |       | 1,614,108 |       | 2,028,051 |       |
| Intersegment  revenues                              |       | 336,593    |       | 56,633    |       | 393,226   |       | 322,992    |       | 74,651    |       | 397,643   |       | 185,813    |       | 42,250    |       | 228,063   |       |
| Gross margin                                        |       | 715,636    |       | 620,225   |       | 1,335,861 |       | 644,158    |       | 766,709   |       | 1,410,867 |       | 179,020    |       | 426,044   |       | 605,064   |       |
| Gross margin*,%                                     |       | 50.0       | %          | 22.4      | %          | 35.1      | %          | 53.6       | %          | 27.1      | %          | 38.8      | %          | 29.9       | %          | 25.7      | %          | 29.9      | %          |
| Depreciation,  depletion and amortization           |       | 71,811     |       | 95,789    |       | 167,600   |       | 56,768     |       | 81,052    |       | 137,820   |       | 34,416     |       | 67,273    |       | 101,689   |       |
| Loss on write-off  of property, plant and equipment |       | —     |       | (12,667   | )          | (12,667   | )          | —     |       | —    |       | —    |       | —     |       | —    |       | —    |       |
| Operating income                                    |       | 401,252    |       | 114,475   |       | 515,727   |       | 384,053    |       | 366,754   |       | 750,807   |       | 63,451     |       | 134,230   |       | 197,681   |       |
| Income from equity  investees                       |       | 12,426     |       | —    |       | 12,426    |       | 4,621      |       | —    |       | 4,621     |       | 1,221      |       | —    |       | 1,221     |       |
| Interest income                                     |       | 6,884      |       | 3,165     |       | 10,049    |       | 881        |       | 1,494     |       | 2,375     |       | 117        |       | 2,157     |       | 2,274     |       |
| Interest expense                                    |       | 4,940      |       | 35,889    |       | 40,829    |       | 15,351     |       | 36,058    |       | 51,409    |       | 10,165     |       | 38,351    |       | 48,516    |       |
| Segment assets                                      |       | 1,667,017  |       | 1,933,066 |       | 3,600,083 |       | 1,682,871  |       | 1,995,398 |       | 3,678,269 |       | 646,046    |       | 1,188,463 |       | 1,834,509 |       |
| Invesments in  equity investees**                   |       | 408,377    |       | —    |       | 408,377   |       | 7,353      |       | —    |       | 7,353     |       | 3,281      |       | —    |       | 3,281     |       |
| Capital  expenditures                               |       | 260,056    |       | 260,498   |       | 520,555   |       | 81,177     |       | 222,234   |       | 303,411   |       | 66,639     |       | 50,216    |       | 116,855   |       |
| Income tax expense                                  |       | (75,223    | )          | (61,420   | )          | (136,643  | )          | (57,599    | )          | (118,177  | )          | (175,776  | )          | (21,573    | )          | (26,186   | )          | (47,759   | )          |
| Extraordinary gain                                  |       | —     |       | —    |       | —    |       | 271        |       | —    |       | 271       |       | —     |       | 5,740     |       | 5,740     |       |

----

*           Grossmargin percentage is calculated as a function of total revenues for thesegment, including both from external customers and intersegment.

**         Includedin 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.

| ** **             | ** ** | **2005**      | ** ** | **2004**      | ** ** | **2003**      | ** ** |
|------------------------|------------|---------------|------------|---------------|------------|---------------|------------|
| **Domestic:**          |       |          |       |          |       |          |       |
| Russia                 |       | 1,753,103     |       | 1,432,866     |       | 1,002,202     |       |
| Other                  |       | 328,229       |       | 244,210       |       | 121,881       |       |
| Total                  |       | 2,081,332     |       | 1,677,076     |       | 1,124,083     |       |
| **Export**             |       | 1,723,663     |       | 1,958,879     |       | 903,968       |       |
| **Total revenue, net** | ** ** | **3,804,995** | ** ** | **3,635,955** | ** ** | **2,028,051** | ** ** |

 

F-72

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(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:

| ** **    | ** ** | **2005**      | ** ** | **2004**      | ** ** | **2003**      | ** ** |
|---------------|------------|---------------|------------|---------------|------------|---------------|------------|
| Russia        |       | 1,753,103     |       | 1,432,866     |       | 1,002,202     |       |
| Europe        |       | 1,175,743     |       | 1,260,264     |       | 639,547       |       |
| Asia          |       | 342,450       |       | 551,153       |       | 292,911       |       |
| CIS           |       | 281,570       |       | 224,907       |       | 9,398         |       |
| Middle East   |       | 148,395       |       | 114,372       |       | 53,574        |       |
| USA           |       | 57,074        |       | 33,090        |       | 9,446         |       |
| Other Regions |       | 46,660        |       | 19,303        |       | 20,973        |       |
| **Total**     | ** ** | **3,804,995** | ** ** | **3,635,955** | ** ** | **2,028,051** | ** ** |

 

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, 2005 and 2004 was as follows:

| ** **                | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Switzerland/Liechtenstein |       | 2,457    |       | 14,504   |       |
| Lithuania                 |       | 2,059    |       | 2,431    |       |
| Romania                   |       | 81,593   |       | 96,075   |       |
| CIS                       |       | —   |       | 6,420    |       |

 

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, Inc. (predominantly Steelsegment products), which comprised 9.7%, 8.2% and 14% of the Group’s totalrevenue for 2005, 2004 and 2003, respectively.

**24.  ****COMMITMENTS AND 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 31,2005, total Group’s contract commitments amounted to $503,457, which consistedof the following: commitment to acquire property, plant and equipment $40,544,commitment to acquire raw materials $454 and commitment for delivery of goodsand services $462,459.

F-73

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

***Contingencies***

**(a)   Guarantees**

As of December 31,2005, the Group guaranteed the fulfillment of obligations to third partiesunder various debt agreements for the total amount of $448,440. The guaranteesgiven for loans received by various entities and employees of the Groupamounted to $447,369 and $1,071, respectively. Out of these, guarantees givenby the Group to third parties for its own subsidiaries amounted to $447,223. Incase the borrower fails to fulfill its obligations under the loan agreement theGroup repays the outstanding amount under the debt agreement with allinterests, fines and penalties due. Maximum potential amount of future paymentsunder the guarantees given as of December 31, 2005 amounted to $448,654,out of which $447,223 related to guarantees given by the Group for itsentities.

**(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, respectively, through 2008,into 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. Environmental obligations of Mechel Targoviste andMechel Campia Turzii as of December 31, 2005 amounted to $911 and $181,respectively.

In April 2006, the Groupbecame aware of unasserted claims related to the CMP potential non-compliancewith established pollution norms. While the Group was not provided with anyofficial information, management believes that this loss contingency ispossible, rather than probable. At present the risk can not be reliablyestimated, nevertheless, should the claims be issued, the amounts of fines andpenalties could be significant. This risk is not accrued in the financialstatements for the period ended December 31, 2005.

**(c)    EU ascension 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 

F-74

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

obligationsunder privatization contracts. Viability plans of Mechel Targoviste and MechelCampia Turzii include additional investments into technology development andecology improvement. After restructuring completion, key business performanceindicators of both companies are to be in line with effectiveness requirementsof the EU. Management has not determined impact thereof on the Group’s Romaniansubsidiaries as of April 17, 2006.

**(d)   Taxation**

The Group is subject to taxation to the largest extentin Russia, and secondarily in other jurisdictions. The Russian tax systemcontinues to evolve. Applicable taxes include value-added tax, corporate incometax (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 2004and 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 tothat year, 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.

In addition, during the course of liquidation MechelZeljezara became exposed to potential tax claims. These tax claims resultedfrom free of charge transfer of assets to the Croatian Privatization Fund. TheGroup estimates that possible claims will not exceed $10,900 and $14,000 withrespect to income tax and value added tax, respectively. These amounts have notbeen accrued as of December 31, 2005.

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. Possible liabilities, which were identified by management at thebalance sheet date as those that can be subject to different interpretations ofthe tax laws and regulations and are not accrued in the consolidated financialstatements could be up to approximately $37,800, including $8,594 of tax claimsrelated to mineral extraction tax that KMP is currently contesting in court.The court decision is to be announced after 

F-75

----

**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

April 25, 2006. Themanagement believes this tax contingency is possible rather than probable.Consequently, no accruals have been made in the financial statements as of December 31,2005 for this contingency.

As of December 31,2005, the Group does not believe that any other material matters exist relatingto the Group activities, including current pending or future governmentalclaims and demands, which would require adjustment to the accompanying financialstatements in order for those statements not to be materially misstated ormisleading.

**(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 14 and24, 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 andfinancial position will continue to be affected by Russian politicaldevelopments including the application of existing and future legislation andtax regulations. The likelihood of such occurrences and their effect on theGroup could have a significant impact on the Group’s ability to continueoperations.

**(f)    Transfer pricing**

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 betweenindependent parties, such as foreign trade transactions with significant (by morethan 20%) price fluctuations. The Russian transfer pricing rules arevaguely drafted, leaving wide scope for interpretation by Russian taxauthorities and courts. Due to the uncertainties in interpretation of transferpricing legislation, the tax authorities may challenge the Group’s price andpropose adjustments. If such price adjustments are upheld by the Russian courtsand implemented, the Group’s future financial results could be adverselyaffected. In addition, the Group could face significant losses associated withthe assessed of 

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

priortax underpaid 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 and cannot be reasonably estimated.

**(g)    Other commitments**

In the course ofacquisition of various subsidiaries in 2002 and 2003, the Group undertook anumber of commitments in respect of future capital expenditures connected withthe development 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 Targoviste and Mechel Campia Turzii for five years.Total obligations of Mechel Campia Turzii and Mechel Targoviste underprivatization contracts as of December 31, 2005 amounted to $3,657 and$8,506, respectively. Amounts related to environmental obligations aredisclosed separately in section (b) above.

**25.   SUBSEQUENT EVENTS**

**(a)   Development of Elga coal deposit**

On March 2, 2006,Mechel, in response to a request for proposal from Russian Railways OAO,submitted a non-binding proposal regarding Yakutugol and the development of theElga coal deposit in Yakutia. The non-binding proposal contemplates theformation of a new company, to be named Sakhaugol OAO. Mechel contemplatesseveral approaches to the formation of Sakhaugol, one of which could be throughthe contribution by Mechel of its 25%+1 share in Yakutugol and up to $300,000,in return for which Mechel would obtain 51% of Sakhaugol. As a result,Sakhaugol would own about 70% of Yakutugol and 68.9% of Elgaugol.

**(b)   Dividends**

On March 9, 2006,Mechel announced that it changed its dividend policy so that its shareholderswould receive dividends in the amount of 50% of US GAAP net income for theyear. The new dividend policy will be effective for 2005 dividenddistributions.

**(c)    Change in shareholders structure**

On February 10, 2006,Mechel’s core shareholders reached an agreement pursuant to which Mr. Zyuzin,Chairman of the Board, will purchase a 42.2% stake from Mechel’s CEO, VladimirIorich, over the course of the following twelve months. Regardless of thefinancing selected, Mr. Zyuzin will retain at least a 51% stake.

**(d)   Mechel Hardware OOO**

On March 21, 2006,the Group established a 100%-owned subsidiary, Mechel Hardware OOO. The newcompany will sell products manufactured by Mechel’s hardware plants. Thechanges are in line with 

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**MECHEL OAO (formerly Mechel Steel Group OAO) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**As of December 31, 2005 and 2004, and for each of the three years in the period ended**

**December 31, 2005**

**(All amounts are in thousands of U.S. dollars, unless stated otherwise)**

Mechel’soverall strategy to develop its mining segment and improve the efficiency ofits steel business. Mechel Hardware OOO will sell hardware produced atBeloretsk Metallurgical Plant, Vyartsilya Metal Products Plant, and MechelNemunas to the Russian and international markets.

**(e)    Bond issuance**

On March 30, 2006,Mechel announced its decision to place two issues, Series 02 and 03, ofinterest-bearing non-convertible bonds with a par value of 1,000 rubles, theamount of each issue to be 5 billion rubles ($180,098), at the Moscow InterbankCurrency Exchange (MICEX). The funds from the bond placement are planned to beutilized to refinance the debt under the previous bond issues and to financethe long-term investment programs of the Mechel’s subsidiaries. The offeringprice of the seven-year Series 02 bonds with a fixed coupon is fixed to be100% of the par value. The issue documents provide for a flexible offer of thebond redemption at par value. The bond coupons are to be paid semi-annually.The first coupon rate is to be determined on a competitive basis on the firstday of the bond placement and to be fixed for the entire period until eitherthe bond redemption or execution of the first option. Any subsequent couponrates are to be determined and noted to investors in compliance with theprocedures and dates established in the issue documents. The offering price ofthe five-year Series 03 bonds with a variable coupon is fixed to be 100%of the par value. The bond coupons are to be paid quarterly. The coupon rate ispegged to the MosPrime money-market rate. The credit spread is to be determinedon a competitive basis on the first date of the bond placement and to be fixedfor the entire period until redemption. The issue documents provide for put andcall options. Placement of the bonds shall be started not earlier than twoweeks following the announcement of the information on the bond issue stateregistration and the procedure of obtaining access to the information includedin the prospectus of the securities issue.

**(f)    Acquisition of minority interest in Port Posiet**

On December 28, 2005, the Group won the auctionto purchase 13.3% shares of Port Posiet from the Russian State Property Fundfor $1,065 in cash. The legal title to the shares was transferred to the Groupon February 8, 2006. The purchase of the minority interest will beaccounted under the purchase method of accounting in the consolidated financialstatements from the date of acquisition, February 8, 2006.

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