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, TMK leverage remains significant. As at 31 December 2010, the Company’s total debt amounted to U.S.$3,872 million as compared to U.S.$3,752 million at the end of 2009. The increase of total debt in 2010 was primarily attributable to the fact that TMK had to significantly increase working capital to meet a recovery in market demand for pipe products and finance certain capital expenditure projects. Together with the improvement of operating performance in 2010, the Company’s leverage levels continued to decrease. TMK Net-Debt-to-EBITDA ratio reduced to 3.9 as at 31 December 2010, as compared to historical highs of 6.0 and 10.7 as of 30 June 2010 and 31 December 2009, respectively.

In 2010, TMK continued to concentrate on improving its liquidity profile and optimising financial performance. The Company negotiated extensions of credit terms and lower interest rates in order to improve overall debt maturity profile. The actions relating to the loan portfolio allowed TMK to further decrease its ratio of short-term debt relative to long-term debt, which stood at 18% as of 31 December 2010 as compared to 41% at the end of 2009.

Improving liquidity profile remains one of the Company’s priorities, and TMK continues to carry out measures to maintain sufficient liquidity and improve loan portfolio structure. Thus, in January 2011 TMK issued 7.75% U.S.$500 million Eurobonds due 2018. Nevertheless, there can be no assurance that the Company’s 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 TMK ability to borrow in the bank or capital markets, and may put pressure on the Company’s 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 the Company’s 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 TMK obligations.

In order to be in compliance with covenants the Company previously obtained necessary waivers of financial covenants from the relevant lenders and reset the level of the certain financial covenants for 2010. In January 2010 and 2011, TMK also undertook two consent solicitations in relation to loan participation notes due 2011 issued by TMK Capital S.A. to modify certain covenants under the notes and further enhance the Company’s flexibility to implement refinancing plan.

Nevertheless, in case financial markets deteriorate in the future, TMK may not comply with relevant covenants. Though, historically, TMK has successfully secured from the relevant lenders all necessary waivers or standstill letters to address possible breaches of financial covenants, the Company may not be able to secure such necessary waivers or standstill letters during future reporting periods if not in compliance with financial covenants. TMK does not expect the occurrence of such events in the near future.

Interest rate risk

Interest expenses are the prevailing part of the Company’s finance costs. In 2010, in spite of a certain increase of total debt, TMK finance costs decreased by 4% or U.S.$16 million and amounted to U.S.$431 million, as compared to U.S.$447 million in 2009. The decrease in nominal interest expense, net of transaction and issue costs, was more considerable and achieved primarily due to lower interest rates as a result of the Company’s negotiations to reduce interest rates on most of significant borrowings as part of the measures to improve the structure of our loan portfolio. As a result, TMK weighted average nominal interest rate as at 31 December 2010 decreased by 286 basis points as compared to 31 December 2009. Although TMK currently benefits from relatively low interest rates, there can be no assurance that rates will stay on their low levels in the future. The cost of funding for Russian and international banks may increase in the future, which can increase TMK interest expense and adversely affect the Company’s financial position.

Additionally, certain part of TMK loan portfolio is represented by loans taken out at floating interest rates. As of 31 December 2010, loans with floating interest rates represented U.S.$292 million or 8% of the total TMK credit portfolio. The underlying rates in current loans with floating interest rates are LIBOR and EURIBOR. In 2010, floating interest rates remained close to their historical lows, which kept the Company’s interest expense on the relevant loans low. Taking into account the insignificant share of floating rate loans, TMK considers relevant interest risk negligible and, at present, does not use derivative instruments to hedge such interest rate risks. Nevertheless, should floating interest rates increase in the future, the Company’s interest expenses on relevant loans will increase.

Currency risk

TMK products are typically priced in roubles for Russian sales and in US dollars and euros for CIS, US and other international sales. The Company’s direct costs, including raw materials, labour and transportation costs, are largely incurred in roubles, and, with the acquisition of TMK IPSCO, in 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.

TMK hedges its net investment in operations located in the Unites States against foreign currency risks using US 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 2010 TMK incurred gains from spot rate changes in the amount of U.S.$0.7 million, including gains in the amount of U.S.$9.5 million recognised in the income statement and losses in the amount of U.S.$8.8 million recognised in the statement of comprehensive income. Gains in the income statement were primarily attributable to the fact that in 2010 the euro exchange rate decreased and the income arose from euro denominated loans. Such gains were partially compensated by the losses from non-hedged part of U.S. denominated loans. Losses in the statement of comprehensive income from foreign exchange difference relating to hedged financial instruments arose from the revaluation of dollar denominated loans attracted by Russian companies of the Group.

Though the rouble has recovered somewhat from its lows, it remains volatile. TMK debt is currently largely denominated in U.S. dollars, and the possible devaluation of the ruble against the dollar in the future could result in foreign exchange losses. To mitigate this risk, during 2010 TMK refinanced certain existing U.S. denominated loans with a series of loans taken in roubles. As a result, the share of U.S. denominated loans in the loan portfolio as of 31 December 2010 was decreased to 51% as compared to 61% at the end of 2009.

Nevertheless, if U.S. dollar appreciates against rouble in the future, this could adversely affect the Company’s net profit.

Inflation risk

A significant amount of TMK production activities are located in Russia, and a majority of direct costs are incurred in Russian roubles. The Company tends 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 2010, inflation rate in Russia reached 8.8% and generally corresponded with 2009 rate. In spite of the intention of the Russian government to decrease inflation rates in the coming years, inflation may increase in the future. TMK may not be able to increase the prices that the Company receives from the sale of pipe products 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 2010, U.S. inflation reached 1.5%. Accordingly, high rates of inflation, especially in Russia, could increase TMK costs, decrease operating margins and materially adversely affect the Company’s business and financial position.

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