Financial risks

Liquidity risk

As a result of borrowings undertaken for the acquisition of TMK IPSCO in 2008, as well as a result of continued large-scale capital expenditure program, our leverage remains significant. As of December 31, 2012, our total debt amounted to $3,885 million as compared to $3,787 million at the end of 2011. The increase of our total debt in 2012 was primarily attributable to the acquisition of Gulf International Pipe Industry LLC and inclusion of its debt in our balance sheet, and the appreciation of the rouble against the U.S. dollar. As a result our leverage increased and Net- Debt-to-EBITDA ratio increased to 3.5 as of December 31, 2012.

In 2012, we continued to concentrate on improving our liquidity profile and optimising financial performance. We negotiated extensions of credit terms and lower interest rates in order to improve our financial position and overall debt maturity profile. Nevertheless due to inclusion of our 2015 convertibles to shortterm debt owing to the put option, which could be exercised in February 2013, the share of short-term debt in the total credit portfolio increased to 27% as of December 31, 2012 as compared to 16% at the end of 2011. Anyway as of the date of 2012 IFRS statement disclosure no Bonds were redeemed and full issue was left outstanding.

Improving liquidity profile remains one of our priorities, and we continue to carry out measures to maintain sufficient liquidity and improve loan portfolio structure. Nevertheless, there can be no assurance that our efforts to improve liquidity profile and reduce leverage will prove successful. The negative market reaction on deteriorating global financial situation may have an adverse impact on our ability to borrow in banks or capital markets, and may put pressure on our liquidity, increase borrowing costs, temporary reduce the availability of credit lines and lead to unavailability of financing on acceptable terms.

Compliance with covenants

Certain of our loan agreements and public debt securities currently include financial covenants. For example, some covenants are set in relation to leverage, total indebtedness and tangible net worth, and impose financial ratios that must be maintained. Other covenants impose restrictions in respect of certain transactions, including restrictions in respect of indebtedness. A breach of a financial or other covenant in existing debt facilities, if not resolved by means such as obtaining a waiver from the relevant lender, could trigger a default under our obligations.

In 2012, we complied with the terms of our debt instruments and plan to be in compliance over next fiscal year.

Nevertheless, in case financial markets or economic environment deteriorate in the future, we may not comply with relevant covenants. Though, historically, we have successfully secured from the relevant lenders all necessary waivers or standstill letters to address possible breaches of financial covenants, we may not be able to secure such necessary waivers or standstill letters during future reporting periods if not in compliance with financial covenants. We do not expect the occurrence of such events in the foreseeable future.

Interest rate risk

Interest expenses are the prevailing part of our finance costs. In 2012, our finance costs decreased 2% or $6 million and amounted to $297 million as compared to $303 million in 2011. Our weighted average nominal interest rate as of December 31, 2012 increased by 7 basis points as compared to December 31, 2011. Although we currently benefit from relatively low interest rates, there can be no assurance that rates will stay low in the future. The cost of funding for Russian and international banks may increase in the future, which can increase our interest expense and adversely affect our financial position.

loans taken out at floating interest rates. As of December 31, 2012, loans with floating interest rates represented $667 million or 17% of our total credit portfolio. The underlying rates in current loans with floating interest rates are LIBOR and EURIBOR. In 2012, floating interest rates remained close to their historical lows, which kept our interest expense on the relevant loans low. Taking into account low levels of interest rates, we considered to hedge a part of interest rate risks at the beginning of 2012 and thus reducing the share of variable-rate debt to 11% as of the end 2012. Nevertheless, several loans with floating interest rates still exist in our credit portfolio and, should floating interest rates increase in the future, interest expenses on relevant loans will increase.

Currency risk

Our products are typically priced in roubles for Russian sales and in U.S. dollars and euros for CIS, U.S. and other international sales. Our direct costs, including raw materials, labour and transportation costs are largely incurred in roubles and U.S. dollars. Other costs, such as interest expense, are currently incurred largely in U.S. dollars and roubles, and capital expenditures are incurred principally in roubles, euros and U.S. dollars.

We hedge our net investment in operations located in the Unites States against foreign currency risks using U.S. dollar denominated liabilities. Gains or losses on the hedging instruments relating to the effective portion of the hedge are recognised as other comprehensive income while any gains or losses relating to the ineffective portion are recognised in the income statement. In 2012, we incurred foreign exchange gains from spot rate changes in the total amount of $83 million, including $23 million recognised in the income statement and $60 million recognised in the statement of other comprehensive income. Gains in the statement of other comprehensive income from foreign exchange difference relating to hedged financial instruments arose from the revaluation of U.S. dollar denominated loans attracted by Russian companies of the Group.

The rouble remains volatile. Our debt is currently largely denominated in U.S. dollars, and the possible devaluation of the rouble against the dollar in the future could result in foreign exchange losses. The share of U.S. dollar denominated loans in the loan portfolio in 2012 remained flat and equaled to 48% as of December 31, 2012. If the U.S. dollar appreciates against the rouble in the future, this could adversely affect our net profit as coherent losses will be reflected in our consolidated income statements.

Inflation risk

A significant amount of our production activities are located in Russia, and a majority of direct costs are incurred in Russian roubles. We tend to experience inflation-driven increases in certain costs, such as raw material costs, transportation costs, energy costs and salaries that are linked to the general price level in Russia. In 2012, inflation in Russia reached 6.6% as compared to 6.1% in 2011. In spite of the intention of the Russian government to reduce rates of inflation in the coming years, inflation may increase in the future. We may not be able to increase the prices sufficiently in order to preserve existing operating margins. Inflation rates in the United States, with respect to TMK IPSCO operations, are historically much lower than in Russia. In 2012, inflation in the United States decreased to 1.7% in comparison to 3.0% in 2011. High rates of inflation, especially in Russia, could increase our costs, decrease our operating margins and materially adversely affect our business and financial position.

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