NICOR INC 12/31/2006 FORM 10K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X ]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
	EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
	SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-7297

NICOR INC.

(Exact name of registrant as specified in its charter)

Illinois		36-2855175
(State of Incorporation)		(I.R.S. Employer
		Identification Number)
1844 Ferry Road
Naperville, Illinois 60563-9600		(630) 305-9500
(Address of principal executive offices)		(Registrant’s telephone number)

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

Title of each class		Name of each exchange on which registered
Common Stock, par value $2.50 per share		New York Stock Exchange
		Chicago Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

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

Large accelerated filer [X]

Accelerated filer [ ]

Non-accelerated filer [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]

The aggregate market value of common stock (based on the June 30, 2006 closing price of $41.50) held by non-affiliates of the registrant was approximately $1.8 billion. As of February 16, 2007, there were 44,911,933 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the company’s 2007 Annual Meeting Definitive Proxy Statement, to be filed on or about March 14, 2007, are incorporated by reference into Part III.

Nicor Inc.

Table of Contents

	Item No.	Description	Page No.

		Glossary	ii

		Part I
	1.	Business	1
	1A.	Risk Factors	6
	1B.	Unresolved Staff Comments	10
	2.	Properties	10
	3.	Legal Proceedings	10
	4.	Submission of Matters to a Vote of Security Holders	10
		Executive Officers of the Registrant	11

		Part II
	5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	12
	6.	Selected Financial Data	14
	7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	7A.	Quantitative and Qualitative Disclosures about Market Risk	34
	8.	Financial Statements and Supplementary Data	36
	9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	71
	9A.	Controls and Procedures	71
	9B.	Other Information	72

		Part III
	10.	Directors and Executive Officers of the Registrant	73
	11.	Executive Compensation	73
	12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	73
	13.	Certain Relationships and Related Transactions	74
	14.	Principal Accountant Fees and Services	74

		Part IV
	15.	Exhibits and Financial Statement Schedules	75
		Signatures	77
		Exhibit Index	78

Table of Contents

Nicor Inc.

Glossary

ARO. Asset retirement obligation.

Chicago Hub. A venture of Nicor Gas, which provides natural gas storage and transmission-related services to marketers and other gas distribution companies.

Degree day. The extent to which the daily average temperature falls below 65 degrees Fahrenheit.

Normal weather for Nicor Gas’ service territory, for purposes of this report, is considered to be 5,830 degree days per year for 2006 and 2005, and 6,000 degree days per year for 2004.

EN Engineering. EN Engineering, L.L.C., a 50-percent-owned joint venture that provides engineering and consulting services.

FASB. Financial Accounting Standards Board.

FERC. Federal Energy Regulatory Commission, the agency that regulates the interstate transportation of

natural gas, oil and electricity.

FSP. FASB Staff Position.

Horizon Pipeline. Horizon Pipeline Company, L.L.C., a 50-percent-owned joint venture that operates an interstate regulated natural gas pipeline of approximately 70 miles, stretching from Joliet, Illinois to near the Wisconsin/Illinois border.

ICC. Illinois Commerce Commission, the agency that establishes the rules and regulations governing

utility rates and services in Illinois.

IRS. Internal Revenue Service.

Jobs Act. American Jobs Creation Act of 2004.

LIBOR. London Inter-bank Offered Rate.

LIFO. Last in, first out.

Mcf, MMcf, Bcf. Thousand cubic feet, million cubic feet, billion cubic feet.

MMBtus. Million British thermal units.

Nicor Advanced Energy. Prairie Point Energy, L.L.C. (doing business as Nicor Advanced Energy), a wholly owned business that provides natural gas and related services on an unregulated basis to residential and small commercial customers.

Nicor Enerchange. Nicor Enerchange, L.L.C., a wholly owned business that engages in wholesale marketing of natural gas supply services primarily in the Midwest, administers the Chicago Hub for Nicor Gas, and manages Nicor Solutions’ and Nicor Advanced Energy’s product risks, including the purchase of natural gas supplies.

Nicor Gas. Northern Illinois Gas Company (doing business as Nicor Gas Company) is a wholly owned public utility business and one of the nation’s largest distributors of natural gas.

Table of Contents

Nicor. Nicor Inc., or the registrant.

Nicor Services. Nicor Energy Services Company, a wholly owned business that provides customer relationship management services to businesses and product warranty contracts, heating, ventilation and air conditioning repair, maintenance and installation services and equipment to retail markets, including residential and small commercial customers.

Nicor Solutions. Nicor Solutions, L.L.C., a wholly owned business that offers residential and small commercial customers energy-related products that provide for natural gas cost stability and management of their utility bill.

PBR. Performance-based rate, a regulatory plan which ended on January 1, 2003, that provided

economic incentives based on natural gas cost performance.

PGA. Nicor Gas’ Purchased Gas Adjustment.

SEC. The United States Securities and Exchange Commission.

SFAS. Statement of Financial Accounting Standard.

TEU. Twenty-foot equivalent unit, a measure of volume in containerized shipping equal to one 20-foot-

long container.

Triton. Triton Container Investments L.L.C., a cargo container leasing company in which Nicor Inc. has an investment.

Tropical Shipping. A wholly owned business and a carrier of containerized freight in the Bahamas and the Caribbean region.

iii

Table of Contents

PART I

Item 1. Business

Nicor, an Illinois corporation formed in 1976, is a holding company. Gas distribution is Nicor’s primary business. Nicor’s subsidiaries include Nicor Gas, one of the nation’s largest distributors of natural gas, and Tropical Shipping, a leading transporter of containerized freight in the Bahamas and the Caribbean region. Nicor also owns several energy-related ventures, including Nicor Services, Nicor Solutions and Nicor Advanced Energy, which provide energy-related products and services to retail markets, and Nicor Enerchange, a wholesale natural gas marketing company. As a consolidated group, Nicor had approximately 3,900 employees at year-end 2006.

Summary financial information for Nicor’s major business segments is included in Item 8 - Notes to the Consolidated Financial Statements - Note 15 - Business Segment and Geographic Information. The following sections describe Nicor’s larger businesses. Certain terms used herein are defined in the glossary on pages ii and iii.

GAS DISTRIBUTION

General

Nicor Gas, a regulated natural gas distribution utility, serves nearly 2.2 million customers in a service territory that encompasses most of the northern third of Illinois, excluding the city of Chicago. The company’s service territory is diverse and its customer base has grown steadily over the years, providing the company with a well-balanced mix of residential, commercial and industrial customers. Residential customers typically account for 45 to 50 percent of natural gas deliveries, while commercial and industrial customers each typically account for 25 to 30 percent. See Gas Distribution Statistics on page 23 for operating revenues, deliveries and number of customers by customer classification. Nicor Gas had approximately 2,100 employees at year-end 2006.

Nicor Gas maintains franchise agreements with most of the communities it serves, allowing it to construct, operate and maintain distribution facilities in those communities. Franchise agreement terms range up to 50 years. Currently, about 20 percent of the agreements will expire within five years.

Customers have the option of purchasing their own gas supplies, with delivery of the gas by Nicor Gas. The larger of these transportation customers also have options that include the use of Nicor Gas’ storage system and the ability to choose varying supply backup levels. The choice of transportation service as compared to gas sales service results in less revenue for Nicor Gas but has no direct impact on net operating results. Nicor Gas continues to deliver the natural gas, maintain its distribution system and respond to emergencies.

Nicor Gas also operates the Chicago Hub, which provides natural gas storage and transmission-related services to marketers and other gas distribution companies. The Chicago area is a major market hub for natural gas, and demand exists for storage and transmission-related services by marketers, other gas distribution companies and electric power-generation facilities. Nicor Gas’ Chicago Hub addresses that demand. Effective in the fourth quarter of 2005, the rate order received by Nicor Gas provides that Chicago Hub revenues be passed directly through to customers as a credit to Nicor Gas’ PGA rider.

Sources of Natural Gas Supply

Nicor Gas purchases natural gas supplies in the open market by contracting with producers and marketers. It also purchases transportation and storage services from the interstate pipelines that are regulated by the FERC. When firm pipeline services are temporarily not needed, Nicor Gas may release the services in

Table of Contents

the secondary market under FERC-mandated capacity release provisions, with proceeds reducing the cost of gas charged to customers.

Peak-use requirements are met through utilization of company-owned storage facilities, pipeline transportation capacity, purchased storage services and other supply sources, arranged by either Nicor Gas or its transportation customers. Nicor Gas has been able to obtain sufficient supplies of natural gas to meet customer requirements. The company believes natural gas supply and pipeline capacity will be sufficiently available to meet market demands in the foreseeable future.

Natural gas supply. Nicor Gas maintains a diversified portfolio of natural gas supply contracts. Supply purchases are diversified by supplier, producing region, quantity, credit limits and available transportation. Gas supply pricing is generally tied to published price indices so as to approximate current market prices. These supply contracts also may require the payment of fixed demand charges to ensure the availability of supplies on any given day.

The company also purchases gas supplies on the spot market to fulfill its supply requirements or to take advantage of favorable short-term pricing. Spot gas purchases accounted for about 40 percent of the company’s total gas purchases in the last three years. The majority of such spot purchases are made during the summer months and are directed toward satisfying storage injection requirements.

As part of its purchasing practices, Nicor Gas maintains a price risk hedging strategy to reduce the risk of short-term price volatility. A disciplined approach is used to systematically forward hedge a predetermined portion of forecasted monthly volumes.

As noted previously, transportation customers purchase their own gas supplies. About one-half of the gas that the company delivers is purchased by transportation customers directly from producers and marketers.

Pipeline transportation. Nicor Gas is directly connected to eight interstate pipelines, providing access to most of the major natural gas producing regions in North America. The company’s primary long-term transportation contracts are as follows (daily availability in MMBtus):

	Availability	Contract Expiration
Natural Gas Pipeline Company (NGPL)	968,000	Various dates through March 2012
Horizon Pipeline	300,000	May 2012
Tennessee Gas Pipeline Company (TGPC)	253,000	October 2009
Midwestern Gas Transmission Company	297,000	Various dates through October 2009
Northern Natural Gas Company	206,000	October 2008
ANR Pipeline	100,000	Various dates through March 2010
Texas Gas	47,000	March 2009

The company has rights of first refusal for contract extensions except for the TGPC contract. In addition to the above contracts, Nicor Gas enters into short-term winter only transportation contracts and contracts that enhance Nicor Gas’ operational flexibility. The availability numbers shown above represent maximums during the winter heating season. In some cases, the contract levels are lower during the summer period.

Storage. Nicor Gas owns and operates eight underground natural gas storage facilities. This storage system is one of the largest in the gas distribution industry. With about 150 Bcf of annual storage capacity, the system is designed to meet about 50 percent of the company’s estimated peak-day deliveries and approximately 30 percent of its normal winter deliveries. In addition to company-owned facilities, Nicor Gas has about 40 Bcf of purchased storage services under contracts with NGPL that expire in 2009, 2010 and 2012. This level of storage capability provides Nicor Gas with supply flexibility, improves the reliability of deliveries, and can mitigate the risk associated with seasonal price movements.

Table of Contents

Competition/Demand

Nicor Gas is the largest natural gas distributor in Illinois and, as a regulated monopoly, has the exclusive right to distribute natural gas in its service territory. Substantially all single-family homes in Nicor Gas’ service territory are heated with natural gas. In the commercial and industrial markets, the company’s natural gas services compete with other forms of energy, such as electricity, coal, propane and oil, based on such factors as price, service, reliability and environmental impact. In addition, the company has a rate that allows negotiation with potential bypass customers, and no such customer has bypassed the Nicor Gas system since the rate became effective in 1987. Nicor Gas also offers commercial and industrial customers alternatives in rates and service, increasing its ability to compete in these markets. Other significant factors that impact demand for natural gas include weather and economic conditions.

Natural gas deliveries are temperature-sensitive and seasonal since about one-half of all deliveries are used for space heating. Typically, about three-quarters of the deliveries and revenues occur from October through March. Fluctuations in weather have the potential to significantly impact year-to-year comparisons of operating income and cash flow. It is estimated that a 100 degree-day variation from normal (5,830 degree days annually) would impact Nicor Gas’ net income by approximately $1.6 million.

The effect of weather variations on Nicor Gas’ results is mitigated, in part, due to weather risks within the consolidated Nicor group that are expected to be partially offsetting with the utility-bill management products marketed by Nicor Solutions and Nicor Advanced Energy. The amount of this offset will vary depending upon the time of year, weather patterns, the number of customers for these products and the market price for natural gas. In 2006 and 2004, the offsetting impact related to utility-bill management products was about one-half and one-third, respectively, of the gas distribution weather effect. In 2005, weather was near normal.

Nicor Gas’ large residential customer base provides for a relatively stable level of natural gas deliveries during weak economic conditions. The company’s industrial and commercial customer base is well diversified, lessening the impact of industry-specific economic swings. However, management believes that declines since 2000 in natural gas deliveries to industrial customers may be permanent. In addition, during periods of high natural gas prices, deliveries of natural gas can be negatively affected by conservation and the use of alternative energy sources.

Regulation

Nicor Gas is regulated by the ICC, which establishes the rules and regulations governing utility rates and services in Illinois. Those rules or regulations that may significantly affect business performance include the following:

Base rates, which are set by the ICC, are designed to allow the company an opportunity to recover its costs and earn a fair return for investors. In the fourth quarter of 2005, the company received approval from the ICC for a base rate increase. For additional information about the rate order, see Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Rate proceeding.

The company’s ICC-approved tariffs provide that the cost of natural gas purchased for customers will be fully charged to customers without markup. Therefore, the company does not profit from the sale of natural gas. Rather, the company earns income from fixed monthly charges and from variable transportation charges for delivering natural gas to customer premises. Annually, the ICC initiates a review of the company’s natural gas purchasing practices for prudence, and may disallow the pass-through of costs considered imprudent.

Table of Contents

·	As with the cost of natural gas, the company has a tariff that provides for the pass-through of prudently incurred environmental costs related to former manufactured gas plant sites. This pass-through is also subject to annual ICC review.

The ICC also has other rules that impact the company’s operations. Changes in these rules can impact operating and capital costs.

A PBR plan for natural gas costs went into effect in 2000 and was terminated by the company effective January 1, 2003. Under the PBR plan, Nicor Gas’ total gas supply costs were compared to a market-sensitive benchmark. Savings and losses relative to the benchmark were determined annually and shared equally with sales customers. The results of the PBR plan are currently under ICC review. Additional information on the plan and the ICC review are presented in Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies - Performance-Based Rate Plan.

Gas distribution, transmission and storage system, and other properties

The gas distribution, transmission and storage system includes approximately 34,000 miles of steel, plastic and cast iron main; approximately 2.0 million steel, plastic/aluminum composite, plastic and copper services connecting the mains to customers’ premises; and eight underground storage fields. Other properties include buildings, land, motor vehicles, meters, regulators, compressors, construction equipment, tools, communication and computer equipment, software and office equipment.

Most of the company’s distribution and transmission property, and underground storage fields are located on property owned by others and used by the company through easements, permits or licenses. The company owns most of the buildings housing its administrative offices and the land on which they sit.

Substantially all gas distribution properties are subject to the lien of the indenture securing Nicor Gas’ First Mortgage Bonds.

Additional information about Nicor Gas’ business is presented in Item 1A - Risk Factors, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Notes to the Consolidated Financial Statements.

SHIPPING

Tropical Shipping is one of the largest containerized cargo carriers in the Bahamas and the Caribbean, a region characterized by modest market growth and intense competition. The company is a major carrier of exports from the east coast of the United States and Canada to these regions. The company’s shipments consist primarily of southbound cargo such as building materials, food and other necessities for developers, manufacturers and residents in the Caribbean and the Bahamas, as well as tourist-related shipments intended for use in hotels and resorts, and on cruise ships. The balance of Tropical Shipping’s cargo consists primarily of northbound shipments of apparel and agricultural products, and inter-island shipments. Other related services such as inland transportation and cargo insurance are also provided by Tropical Shipping or other Nicor subsidiaries.

At December 31, 2006, Tropical Shipping’s operating fleet consisted of 10 owned vessels and 8 chartered vessels with a container capacity totaling approximately 5,800 TEUs. In addition to the vessels, the company owns and/or leases containers, container-handling equipment, chassis and other equipment. Real property, more than half of which is leased, includes office buildings, cargo handling facilities and warehouses located in the United States, Canada and some of the ports served.

Additional information about Tropical Shipping’s business is presented in Item 1A - Risk Factors, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Notes to the Consolidated Financial Statements.

Table of Contents

OTHER ENERGY VENTURES

Nicor owns several energy-related ventures, including three companies marketing energy-related products and services, and a wholesale natural gas marketing company. Nicor also has equity interests in joint ventures including a FERC-regulated natural gas pipeline.

Nicor Services, Nicor Solutions and Nicor Advanced Energy are businesses that provide energy-related products and services to retail markets, including residential and small commercial customers. Nicor Services operates primarily in northern Illinois and provides warranty and maintenance contracts, as well as repair and installation services of heating, air conditioning and indoor air-quality equipment, and customer and prospect management services. Nicor Solutions offers its residential and small commercial customers in the Nicor Gas service territory energy-related products that provide for natural gas price stability and management of their utility bill. These products mitigate and/or eliminate the risks to customers of colder than normal weather and/or changes in natural gas prices. Nicor Advanced Energy is certified by the ICC as an Alternate Gas Supplier, authorizing it to be a non-utility marketer of natural gas for residential and small commercial customers. Nicor Advanced Energy presently operates in northern Illinois, offering customers an alternative to the utility as its natural gas supplier.

Nicor Enerchange is a business that engages in wholesale marketing of natural gas supply services primarily in the Midwest, administers the Chicago Hub for Nicor Gas, and manages Nicor Solutions’ and Nicor Advanced Energy’s product risks, including the purchase of natural gas supplies.

Horizon Pipeline, a 50-percent-owned joint venture with NGPL, operates a natural gas pipeline of approximately 70 miles, stretching from Joliet, Illinois to near the Wisconsin/Illinois border. Nicor Gas has contracted for approximately 80 percent of Horizon Pipeline’s capacity under a 10-year agreement at rates that have been accepted by FERC.

EN Engineering, a 50-percent-owned joint venture between Nicor and A. Epstein & Sons International, is an engineering and consulting firm that specializes in the design, installation and maintenance of natural gas, petroleum and liquid pipeline facilities.

Additional information about Nicor’s other energy ventures is presented in Item 1A - Risk Factors, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8 - Notes to the Consolidated Financial Statements.

CORPORATE

Nicor has various equity investments, the largest of which is Triton Container Investments L.L.C., a cargo container leasing business.

AVAILABLE INFORMATION

Nicor files various reports with the SEC. These reports include the annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13 (a) of the Securities Exchange Act of 1934. Nicor makes all of these reports available without charge to the public on the investor relations section of the company’s Internet site at www.nicor.com as soon as reasonably practicable after Nicor files them with, or furnishes them to, the SEC.

Table of Contents

Item 1A. Risk Factors

The following factors are the most significant factors that can impact year-to-year comparisons and may affect the future performance of the company’s businesses. New risks may emerge and management cannot predict those risks or estimate the extent to which they may affect the company’s financial performance.

Regulation of Nicor Gas, including changes in the regulatory environment in general, may adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas is regulated by the ICC, which has general regulatory power over practically all phases of the public utility business in Illinois, including rates and charges, issuance of securities, services and facilities, system of accounts, investments, safety standards and transactions with affiliated interests and other matters.

Nicor Gas is permitted by the ICC’s PGA regulation to adjust the charge to its sales customers on a monthly basis to recover the company’s prudently incurred actual costs to acquire the natural gas it delivers to them. The company’s gas costs are subject to subsequent prudence reviews by the ICC for which the company makes annual filings. The annual prudence reviews for calendar years 1999-2006 are open for review and any disallowance of costs in those proceedings could adversely affect Nicor Gas’ results of operations, cash flows and financial condition. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion of annual prudence reviews.

Most of Nicor Gas’ other charges are changed only through a rate case proceeding with the ICC. The charges established in a rate case proceeding are based on an approved level of operating costs and investment in utility property and are designed to allow the company an opportunity to recover those costs and to earn a fair return on that investment. To the extent Nicor Gas’ actual costs to provide utility service are higher than the levels approved by the ICC, Nicor Gas’ results of operations, cash flows and financial condition could be adversely affected until such time as it files for and obtains ICC approval for new charges through a rate case proceeding.

Nicor Gas is also subject to rules and regulations pertaining to the integrity of its distribution system and environmental compliance. The company’s results of operations, cash flows and financial condition could be adversely affected by any additional laws or regulations that are enacted that require significant increases in the amount of expenditures for system integrity and environmental compliance.

A change in the ICC’s approved rate mechanisms for recovery of environmental remediation costs at former manufactured gas sites, or adverse decisions with respect to the prudence of costs actually incurred, could adversely affect the company’s results of operations, cash flows and financial condition.

Current environmental laws may require the cleanup of coal tar at certain former manufactured gas plant sites. To date, Nicor Gas has identified about 40 properties for which it may in part be responsible. As of December 31, 2006, the company had recorded a liability of $19.9 million associated with certain remediation efforts. Management believes that any such costs that are not recoverable from other entities or from insurance carriers are recoverable through rates for utility services under ICC-approved mechanisms for the recovery of prudently incurred costs. A change in these rate recovery mechanisms, however, or a decision by the ICC that some or all of these costs were not prudently incurred, could adversely affect the company’s results of operations, cash flows and financial condition. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion.

Table of Contents

An adverse decision in the proceedings concerning Nicor Gas’ PBR Plan could result in a refund obligation which could adversely affect the company’s results of operations, cash flows and financial condition.

In 2000, Nicor Gas instituted a PBR plan for natural gas costs. Under the PBR plan, Nicor Gas’ total gas supply costs were compared to a market-sensitive benchmark. Savings and losses relative to the benchmark were determined annually and shared equally with sales customers. The PBR plan was terminated effective January 1, 2003. There are allegations that Nicor Gas acted improperly in connection with the PBR plan, and the ICC and SEC are reviewing these allegations in pending proceedings. An adverse decision or decisions in these proceedings could result in a refund or other obligations which could adversely affect the company’s results of operations, cash flows and financial condition. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion of the PBR proceeding and related matters.

Nicor Gas relies on direct connections to eight interstate pipelines and extensive underground storage capacity. If these pipelines or storage facilities were unable to deliver natural gas for any reason it could impair Nicor Gas’ ability to meet its customers’ full requirements.

Nicor Gas meets its customers’ peak day, seasonal and annual gas requirements through deliveries of gas transported on interstate pipelines with which it or its gas suppliers have contracts and through withdrawals of gas from storage fields it owns or leases. Nicor Gas contracts with multiple pipelines for transportation services. If a pipeline were to fail to perform transportation or storage service, including as a result of war, acts or threats of terrorism or natural disaster, on a peak day or other day with high volume gas requirements, Nicor Gas’ ability to meet all its customers’ gas requirements may be impaired unless or until alternative arrangements for delivery of supply were put in place. Likewise, if a storage field owned by Nicor Gas, or a principal Nicor Gas-owned transmission or distribution pipeline used to deliver gas to the market, were to be out of service for any reason, including as a result of war, acts or threats of terrorism or natural disaster, this could impair Nicor Gas’ ability to meet its customers’ full requirements.

Fluctuations in weather have the potential to adversely affect the company’s results of operations, cash flows and financial condition.

When weather conditions are milder than normal, Nicor’s gas distribution segment has historically delivered less natural gas, and consequently may earn less income. Nicor Gas’ natural gas deliveries are temperature-sensitive and seasonal since about one-half of all deliveries are used for space heating. Typically, about three-quarters of the deliveries and revenues occur from October through March. Mild weather in the future could adversely affect the company’s results of operations, cash flows and financial condition.

Conversely, results from products sold by Nicor Solutions and Nicor Advanced Energy generally benefit from milder than normal weather. Nicor Solutions and Nicor Advanced Energy offer utility-bill management products that mitigate and/or eliminate the risks to customers of variations in weather. Benefits or costs related to these products resulting from variances from normal weather are recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries. To the extent weather is colder than normal in the future, the company’s results of operations, cash flows and financial condition could be adversely affected.

Natural gas commodity price changes may affect the operating costs and competitive positions of the company’s businesses which could adversely affect its results of operations, cash flows and financial condition.

Nicor’s energy-related businesses are sensitive to changes in natural gas prices. Natural gas prices historically have been volatile and may continue to be volatile in the future. The prices for natural gas are

Table of Contents

subject to a variety of factors that are beyond Nicor’s control. These factors include, but are not limited to, the level of consumer demand for, and the supply of, natural gas, processing, gathering and transportation availability, the level of imports of, and the price of foreign natural gas, the price and availability of alternative fuel sources, weather conditions, political conditions or hostilities in natural gas producing regions.

Any changes in natural gas prices could affect the prices Nicor’s energy-related businesses charge, operating costs and the competitive position of products and services. In accordance with the ICC’s PGA regulations, Nicor Gas adjusts its gas cost charges to sales customers on a monthly basis to account for changes in the price of natural gas. However, changes in natural gas prices can also impact certain operating expenses such as bad debt expense, company use gas and storage-related gas expenses, financing costs and customer service expenses, and these changes can only be reflected in Nicor Gas’ charges to customers if approved by the ICC in a rate case. Increases in natural gas prices can also have an adverse effect on natural gas distribution margin because such increases can result in lower customer demand.

Nicor’s other energy businesses are also subject to natural gas commodity price risk, arising primarily from fixed-price purchase and sale agreements, natural gas inventories and utility-bill management arrangements. Derivative instruments such as futures, options, forwards and swaps may be used to hedge these risks.

Nicor is subject to margin requirements in connection with the use of derivative financial instruments and these requirements could escalate if prices move adversely.

Nicor’s use of derivative instruments could adversely affect the company’s results of operations.

Nicor uses derivative instruments, including futures, options, forwards and swaps, either traded on exchanges or executed over-the-counter with natural gas merchants as well as financial institutions, to hedge natural gas price risk. Fluctuating natural gas prices cause earnings and financing costs of Nicor to be impacted. The use of derivative instruments that are not perfectly matched to the exposure could adversely affect the company’s results of operations, cash flows and financial condition. Also, when Nicor’s derivative instruments and hedging transactions fail to qualify for hedge accounting under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, the company’s results of operations could be adversely affected.

Adverse decisions in lawsuits seeking a variety of damages allegedly caused by mercury spillage could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas has incurred, and expects to continue to incur, costs related to its historical use of mercury in various kinds of equipment. Nicor Gas is a defendant in several private lawsuits, all in the Circuit Court of Cook County, Illinois, seeking a variety of damages (including bodily injury, property and punitive damages) allegedly caused by mercury spillage resulting from the removal of mercury-containing regulators. Adverse decisions regarding these claims or other mercury-related claims, to the extent they require the company to make payments in excess of amounts provided for in its financial statements, could adversely affect the company’s results of operations, cash flows and financial condition.

Transporting and storing natural gas involve numerous risks that may result in accidents and other operating risks and costs that could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Gas’ gas distribution activities involve a variety of inherent hazards and operating risks, such as leaks, accidents and mechanical problems, which could cause substantial financial losses. In addition, these risks could result in loss of human life, significant damage to property, environmental pollution and

Table of Contents

impairment of Nicor’s operations, which in turn could lead to substantial losses. In accordance with customary industry practice, Nicor maintains insurance against some, but not all, of these risks and losses. The location of pipelines and storage facilities near populated areas, including residential areas, commercial business centers and industrial sites, could increase the level of damages resulting from these risks. The occurrence of any of these events if not fully covered by insurance could adversely affect Nicor’s results of operations, cash flows and financial condition.

An inability to access financial markets could affect the execution of Nicor’s business plan and could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor relies on access both to short-term money markets and longer-term capital markets as a significant source of liquidity for capital and operating requirements not satisfied by the cash flows from its operations. Management believes that Nicor and its subsidiaries will maintain sufficient access to these financial markets based upon current credit ratings. However, certain disruptions outside of Nicor’s control or events of default under its debt agreements may increase its cost of borrowing or restrict its ability to access one or more financial markets. Such disruptions could include an economic downturn, the bankruptcy of an unrelated energy company or downgrades to Nicor’s credit ratings. Restrictions on Nicor’s ability to access financial markets may affect its ability to execute its business plan as scheduled and could adversely affect the company’s results of operations, cash flows and financial condition.

Changes in the rules and regulations of certain regulatory agencies could adversely affect the results of operations, cash flows and financial condition of Tropical Shipping.

Tropical Shipping is subject to the International Ship and Port-facility Security Code and is also subject to the United States Maritime Transportation Security Act, both of which require extensive security assessments, plans and procedures. Tropical Shipping is also subject to the regulations of both the Federal Maritime Commission, and the Surface Transportation Board, other Federal Agencies as well as local laws, where applicable. Additional costs that could result from changes in the rules and regulations of these regulatory agencies would adversely affect the results of operations, cash flows and financial condition of Tropical Shipping.

Tropical Shipping’s business is dependent on general economic conditions and could be adversely affected by downturns in the economy.

Tropical Shipping’s business consists primarily of the shipment of building materials, food and other necessities for developers, manufacturers and residents in the Bahamas and the Caribbean region, as well as tourist-related shipments intended for use in hotels and resorts, and on cruise ships. As a result, Tropical Shipping’s results of operations, cash flows and financial condition can be significantly affected by general economic conditions in the United States, the Bahamas, Caribbean region and Canada.

The occurrence of hurricanes, storms and other natural disasters in Tropical Shipping’s area of operations could adversely affect its results of operations, cash flows and financial condition.

Tropical Shipping’s operations are affected by weather conditions in Florida, Canada, the Bahamas and Caribbean regions. During hurricane season in the summer and fall, Tropical Shipping may be subject to revenue loss, higher operating expenses, business interruptions, delays and ship, equipment and facilities damage which could adversely affect Tropical Shipping’s results of operations, cash flows and financial condition.

Nicor has credit risk that could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor extends credit to its counterparties. Despite what the company believes to be prudent credit policies and the maintenance of netting arrangements, the company is exposed to the risk that it may not

Table of Contents

be able to collect amounts owed to it. If the counterparty to such a transaction fails to perform and any collateral the company has secured is inadequate, it could experience financial losses.

The company is involved in legal or administrative proceedings before various courts and agencies that could adversely affect the company’s results of operations, cash flows and financial condition.

The company is involved in legal or administrative proceedings before various courts and agencies with respect to general claims, rates, taxes, environmental, gas cost prudence reviews and other matters. Adverse decisions regarding these matters, to the extent they require the company to make payments in excess of amounts provided for in its financial statements, could adversely affect the company’s results of operations, cash flows and financial condition. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion.

The risks described above should be carefully considered in addition to the other cautionary statements and risks described elsewhere, and the other information contained in this report and in Nicor’s other filings with the SEC, including its subsequent reports on Forms 10-Q and 8-K. The risks and uncertainties described above are not the only risks Nicor faces although they are the most significant risks. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7A - Quantitative and Qualitative Disclosures About Market Risk, and Item 8 - Notes to the Consolidated Financial Statements - Note 10 - Income and Other Taxes and Note 21 - Contingencies for further discussion of these and other risks Nicor faces.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

Information concerning Nicor and its major subsidiaries’ properties is included in Item 1 - Business, and is incorporated herein by reference. These properties are suitable, adequate and utilized in the company’s operations.

Item 3. Legal Proceedings

See Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies, which is incorporated herein by reference.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Table of Contents

Executive Officers of the Registrant

Name	Age	Current Position and Background

Russ M. Strobel	54	Chairman, Nicor and Nicor Gas (since 2005); Chief Executive Officer, Nicor (since 2005); Chief Executive Officer, Nicor Gas (since 2003); President, Nicor and Nicor Gas (since 2002); Executive Vice President, General Counsel and Secretary, Nicor and Nicor Gas (2002); Senior Vice President, General Counsel and Secretary, Nicor and Nicor Gas (2000-2002).

Richard L. Hawley	57	Executive Vice President and Chief Financial Officer, Nicor and Nicor Gas (since 2003); Vice President and Chief Financial Officer, Puget Energy, Inc., a holding company with its primary business being an electric and natural gas provider (2000-2002) and Puget Sound Energy, Inc., electric and natural gas provider (1998-2002).

Rocco J. D’Alessandro	48	Executive Vice President Operations, Nicor Gas (since December 2006); Senior Vice President Operations, Nicor Gas (2002-2006); Vice President Customer Service, Nicor Gas (1999-2002).

Claudia J. Colalillo	57	Senior Vice President Human Resources and Corporate Communications, Nicor and Nicor Gas (since 2002); Vice President Human Resources, Nicor and Nicor Gas (1998-2002).

Daniel R. Dodge	53	Senior Vice President Diversified Ventures and Corporate Planning, Nicor and Nicor Gas (since 2002); Vice President Business Development, Nicor and Nicor Gas (1998-2002).

Paul C. Gracey, Jr.	47	Senior Vice President, General Counsel and Secretary, Nicor and Nicor Gas (since March 2006); Vice President, General Counsel and Secretary, Nicor and Nicor Gas (2002-2006); Vice President and General Counsel, Midwest Generation, Chicago, independent power producer (2000-2002).

Gerald P. O’Connor	55	Vice President Finance and Treasurer, Nicor and Nicor Gas (since June 2006); Vice President Administration and Finance, Nicor and Nicor Gas (2004-2006); Temporary General Manager - Internal Audit, Nicor and Nicor Gas (2003-2004); Partner, Tatum Partners L.L.C., professional services (2003-2004); Vice President and Chief Financial Officer, Aux Sable Liquid Products L.L.P., natural gas processing (2000-2002).

Karen K. Pepping	42	Vice President and Controller, Nicor and Nicor Gas (since June 2006); Assistant Vice President and Controller, Nicor and Nicor Gas (2005-2006); Assistant Controller, Nicor and Nicor Gas (2003-2005); Assistant Corporate Controller, Wallace Computer Services, Inc., commercial printing (2002-2003); Director of Accounting, Tellabs, Inc., telecommunication equipment manufacturer (2000-2002).

Table of Contents

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Nicor common stock is listed on the New York and Chicago Stock Exchanges. At February 16, 2007, there were approximately 20,900 common stockholders of record and the closing stock price was $46.81.

	Stock price				Dividends
Quarter	High		Low		Declared

2006
First	$	43.12	$	39.25	$	.465
Second		42.29		38.72		.465
Third		44.40		41.01		.465
Fourth		49.92		42.38		.465

2005
First	$	38.33	$	35.50	$	.465
Second		41.87		35.76		.465
Third		42.59		39.10		.465
Fourth		42.97		37.42		.465

In 2001, Nicor announced a $50 million common stock repurchase program, under which Nicor may purchase its common stock as market conditions permit through open market transactions and to the extent cash flow is available after other cash needs and investment opportunities. There have been no repurchases under this program during 2006 or 2005. As of December 31, 2006, $21.5 million remained authorized for the repurchase of common stock.

Table of Contents

STOCK PERFORMANCE GRAPH

The following graph shows a five-year comparison of cumulative total returns for Nicor Common Stock, the S&P Utilities Index and the S&P 500 Index (both of which include Nicor Common Stock) as of December 31 of each of the years indicated, assuming $100 was invested on January 1, 2002, and all dividends were reinvested.

Comparison of Five-Year Cumulative Total Return

	2002		2003		2004		2005		2006

Nicor	$	86	$	91	$	104	$	116	$	144
S&P Utilities		70		88		110		128		155
S&P 500		78		100		111		117		135

Table of Contents

Nicor Inc.

Item 6. Selected Financial Data
(in millions, except per share data)

	Year ended December 31
	2006		2005		2004		2003			2002

Operating revenues	$	2,960.0	$	3,357.8	$	2,739.7	$	2,662.7		$	1,897.4

Operating income	$	202.5	$	201.7	$	137.7	$	189.4		$	226.5

Income before cumulative effect of
accounting change	$	128.3	$	136.3	$	75.1	$	109.8	*	$	128.0

Net income	$	128.3	$	136.3	$	75.1	$	105.3		$	128.0

Earnings per common share
Basic
Before cumulative effect of
accounting change	$	2.88	$	3.08	$	1.71	$	2.49		$	2.90
Basic earnings per share		2.88		3.08		1.71		2.39			2.90

Diluted
Before cumulative effect of
accounting change	$	2.87	$	3.07	$	1.70	$	2.48		$	2.88
Diluted earnings per share		2.87		3.07		1.70		2.38			2.88

Dividends declared per common share	$	1.86	$	1.86	$	1.86	$	1.86		$	1.84

Property, plant and equipment
Gross	$	4,479.7	$	4,351.3	$	4,143.6	$	3,999.5		$	3,872.8
Net		2,714.7		2,659.1		2,549.8		2,484.2			2,421.8

Total assets	$	4,090.1	$	4,391.2	$	3,975.2	$	3,797.2		$	3,524.4

Capitalization
Long-term debt, net of
unamortized discount	$	497.5	$	485.8	$	495.3	$	495.1		$	396.2
Mandatorily redeemable preferred stock		.6		.6		1.6		1.8			4.3
Common equity		872.6		811.3		749.1		754.6			728.4
	$	1,370.7	$	1,297.7	$	1,246.0	$	1,251.5		$	1,128.9


See Item 1A - Risk Factors and Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations for factors that can impact year-to-year comparisons and may affect the future performance of Nicor's
business.


* The change in accounting method relates to a rescission of Emerging Issues Task Force Consensus No. 98-10,
Accounting for Contracts Involved in Energy Trading and Risk Management Activities, which disallowed the
recording of inventory at fair value. Effective January 1, 2003, Nicor’s wholesale natural gas marketing business,
Nicor Enerchange, began applying accrual accounting rather than fair value accounting to gas in storage and
certain energy-related contracts, such as storage and transportation agreements. Effective with the change, Nicor
recorded a $4.5 million cumulative effect loss from the change in accounting principle, which was net of $3.0 million
in income tax benefits.

Table of Contents

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this financial review is to explain changes in operating results and financial condition from 2004 to 2006 and to discuss business trends that might affect Nicor. Certain terms used herein are defined in the glossary on pages ii and iii. The discussion is organized into six sections - Summary, Results of Operations, Financial Condition and Liquidity, Outlook, Contingencies and Critical Accounting Estimates.

SUMMARY

Nicor is a holding company. Gas distribution is Nicor’s primary business. Nicor’s subsidiaries include Nicor Gas, one of the nation’s largest distributors of natural gas, and Tropical Shipping, a leading transporter of containerized freight in the Bahamas and the Caribbean region. Nicor also owns several energy-related ventures, including Nicor Services, Nicor Solutions and Nicor Advanced Energy, which provide energy-related products and services to retail markets, and Nicor Enerchange, a wholesale natural gas marketing company. Nicor also has equity interests in energy-related businesses.

Net income and diluted earnings per common share are presented below (in millions, except per share data):

	2006		2005		2004

Net income	$	128.3	$	136.3	$	75.1

Diluted earnings per common share		2.87		3.07		1.70

Net income and diluted earnings per common share were lower in 2006 compared with 2005 due to a $10 million charge ($.22 per share and non-deductible for tax purposes) associated with the company’s outstanding SEC inquiry recorded in the second quarter of 2006, the absence of a 2005 pretax benefit of $29.9 million ($.41 per share) related to net insurance recoveries and earnings thereon related to the securities class action and shareholder derivative lawsuit settlements, and the absence of a $17 million tax benefit ($.38 per share) recognized in the fourth quarter of 2005 in connection with the Jobs Act, partially offset by a first quarter of 2006 pretax recovery of $3.8 million ($.05 per share) associated with Nicor Gas’ mercury inspection and repair program. Year over year comparisons (excluding the effects of the items noted above) reflect improved operating results across all business segments and the recognition of certain income tax benefits including those resulting from the reorganization of certain shipping and related operations.

Net income and diluted earnings per common share for 2005 compared with 2004 were impacted significantly by the absence of the 2004 first-quarter securities class action settlement charge of $38.5 million ($.52 per share) coupled with the 2005 pretax benefit of $29.9 million ($.41 per share) related to net insurance recoveries mentioned earlier. 2005 was also significantly impacted by a tax benefit of approximately $17 million ($.38 per share) in connection with the Jobs Act. Year over year comparisons were also impacted by higher operating results at Tropical Shipping and lower corporate overhead costs, partially offset by lower operating results in the gas distribution and other energy-related businesses. Results of the gas distribution business reflect the impact of the base rate increase which became effective in the fourth quarter of 2005.

For more information on the SEC inquiry, see the Contingencies section of this discussion.

Rate proceeding. In 2005, Nicor Gas received approval from the ICC for a $54.2 million base rate increase which reflected an allowed rate of return on original-cost rate base of 8.85 percent, including a 10.51 percent cost of common equity. The order also included the authorization to pass all Chicago Hub revenues directly through to customers as a credit to Nicor Gas’ PGA rider and the shifting of certain

Table of Contents

storage-related costs from the PGA rider to base rates. In addition, rates were established using a 10-year average for weather as opposed to the previous use of a 30-year average. These rates were implemented in the fourth quarter of 2005. Because the order shifts certain items between base rates and Nicor Gas’ PGA rider, the company estimated that, under normal weather conditions and demand as reflected in the rate case, the annual net revenue increase resulting from implementing the rate order would have been about $34.7 million under the tariffs that would have been placed into effect.

In October 2005, Nicor Gas and six other parties filed applications for rehearing of the final order of the rate case. In March 2006, the ICC issued its decision on rehearing in which it adjusted the amount of the annual net rate increase to $49.7 million from the $54.2 million that had been approved in the earlier order. The company estimates that because the revised order similarly shifts certain items between base rates and Nicor Gas’ PGA rider, under normal weather conditions and demand as reflected in the rate case, the increase in annual net revenue decreased to $30.2 million from the estimated $34.7 million under the previous order. Rate changes resulting from the rehearing order were prospective and went into effect on April 11, 2006. Parties, including Nicor Gas, that appealed the ICC’s rate case decision to the state appellate courts have since withdrawn their appeals. As a result, the ICC rate order is no longer subject to judicial review.

As a result of the rate order which became effective in the fourth quarter of 2005, certain storage-related costs have been recorded in operating and maintenance expense. Storage related gas costs recorded in operating and maintenance expense during 2006 and 2005 totaled $21.4 million and $6.5 million, respectively. Storage-related gas costs incurred prior to the effective date of the rate order and recorded as cost of gas in 2005 totaled $11.1 million.

Details of various financial and operating information by segment can be found on the pages that follow.

Operating income by segment. Operating income (loss) by major business segment is presented below (in millions):

	2006		2005		2004

Gas distribution	$	123.9	$	116.9	$	130.8
Shipping		47.5		40.4		31.6
Other energy ventures		26.6		14.1		19.3
Corporate and eliminations		4.5		30.3		(44.0	)
	$	202.5	$	201.7	$	137.7

The following summarizes operating income (loss) comparisons by major business segments:

Gas distribution operating income increased $7.0 million in 2006 as compared with 2005 due to the positive effects of higher gas distribution margin ($19.0 million increase), a first quarter mercury-related recovery of $3.8 million and higher gains on property sales ($2.9 million increase). These positive factors were partially offset by higher operating and maintenance expenses ($13.7 million increase) and higher depreciation expense ($5.6 million increase). Higher gas distribution margin was primarily due to the impact of the base rate increase (approximately $36 million) and higher demand unrelated to weather (approximately $5 million increase), partially offset by the negative impact of warmer weather than in 2005 (approximately $17 million decrease) and the passage of Chicago Hub revenues through the PGA effective with the rate order (approximately $8 million decrease).

Gas distribution operating income decreased $13.9 million in 2005 as compared with 2004 due to higher operating and maintenance expenses ($19.9 million increase), higher depreciation expense ($5.7 million increase), and lower gains on property sales ($5.5 million decrease). The adverse impact of these factors was partially offset by higher gas distribution margin ($17.5 million increase). Higher gas distribution margin was largely driven by higher average rates (approximately $19 million

Table of Contents

increase) due in part to the rate increase which became effective during the fourth quarter of 2005 (approximately $13 million) and the positive impact of colder weather than in 2004 (approximately $4 million increase), partially offset by lower demand unrelated to weather (approximately $6 million decrease).

Shipping operating income for 2006 increased $7.1 million as compared with 2005 due to higher operating revenues ($19.8 million increase) which were partially offset by higher operating costs ($12.7 million increase). Higher operating revenues were attributable to higher average rates ($40.0 million increase), partially offset by lower volumes shipped ($19.5 million decrease). Higher operating costs were due to higher transportation-related costs including fuel ($6.3 million increase), employee-related costs ($5.0 million increase), repairs and maintenance ($2.7 million increase) and leased freight equipment ($2.5 million increase), partially offset by lower legal and audit fees ($4.2 million decrease). Included in legal and audit fees for 2005 were approximately $5.1 million of costs incurred in connection with the repatriation of funds and the reorganization of Tropical Shipping to take advantage of the benefits of the Jobs Act.

Shipping operating income for 2005 increased $8.8 million compared with 2004 due primarily to an increase in revenue ($67.8 million increase) driven by higher average rates and increased volumes shipped across substantially all ports, partially offset by increased operating expenses ($59.0 million increase). Shipping segment operating expenses increased due primarily to higher transportation ($37.7 million increase) and payroll-related costs ($6.2 million increase), driven by general price increases and higher volumes shipped. Transportation-related costs include fuel, inland freight, vessel charter, voyage and transportation, and port costs. Higher legal and audit fees also contributed to the increase in expenses, reflecting approximately $5.1 million of costs incurred in connection with the repatriation of funds and the reorganization of Tropical Shipping.

Operating income from Nicor’s other energy ventures for 2006 increased $12.5 million primarily due to higher operating income at Nicor Enerchange ($13.2 million increase), offset by lower operating results at Nicor’s energy-related products and services businesses ($0.6 million decrease). Improved results at Nicor Enerchange were primarily due to a significant positive variation in fair value adjustments associated with derivatives hedging purchases and sales of inventory, partially offset by unfavorable costing of physical sales activity. Lower operating results at Nicor’s energy-related products and services businesses were due to higher operating costs ($45.4 million increase) offset, in part, by higher operating revenues ($44.8 million increase).

Operating income from Nicor’s other energy ventures for 2005 decreased $5.2 million compared with 2004 due primarily to lower operating results at Nicor Enerchange ($6.3 million decrease). Lower Nicor Enerchange results reflect unfavorable fair value adjustments related to derivative instruments used to hedge future sales of natural gas inventory.

Nicor Enerchange purchases and holds natural gas in storage to earn a profit margin from its ultimate sale. Nicor Enerchange uses derivatives to mitigate commodity price risk in order to substantially lock-in the profit margin that will ultimately be realized. However, gas stored in inventory is required to be accounted for at the lower of weighted-average cost or market, whereas the derivatives used to reduce the risk associated with a change in the value of the inventory are accounted for at fair value, with changes in fair value recorded in operating results in the period of change. As a result, earnings are subject to volatility as the market price of derivatives change, even when the underlying hedged value of the inventory is unchanged. The volatility resulting from this accounting can be significant from period to period.

·	“Corporate and eliminations” operating income for 2006, 2005 and 2004 were impacted by the following items:

Table of Contents

In 2006, the company reached a tentative agreement with the staff of the SEC Enforcement Division in settlement of an anticipated civil action for a payment of $10 million. Nicor recorded a $10 million charge (non-deductible for tax purposes) in the second quarter associated with the outstanding SEC inquiry. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies - SEC and U.S. Attorney Inquiries.

Included in corporate and eliminations’ 2006 operating income is approximately $9.5 million of benefits associated with Nicor’s other energy ventures’ utility-bill management products attributable to warmer than normal weather (excludes costs of approximately $0.7 million recorded within other energy ventures). Benefits or costs resulting from variances from normal weather are recorded primarily at the corporate level as a result of an agreement between the parent company and certain of its subsidiaries. The weather impact of these contracts generally serves to partially offset the gas distribution segment’s weather risk. The amount of the offset attributable to the utility-bill management products marketed by Nicor’s other energy ventures will vary depending upon a number of factors including the time of year, weather patterns, the number of customers for these products and the market price for natural gas.

In 2006 and 2005, the company recognized insurance recoveries related to previously incurred legal expenses associated with the securities class action and shareholder derivative lawsuits. The recoveries totaled $5.2 million and $2.8 million, respectively.

In 2005, the company recorded a $29.4 million recovery from an insurance carrier related to costs previously incurred by Nicor in connection with a securities class action and a related shareholder derivative action which were previously settled and a $0.5 million net recovery which was comprised of a shareholder derivative action settlement ($3.5 million) and a related Directors and Officers (“D&O”) insurance recovery ($4.0 million).

In 2004, the company recorded a $38.5 million settlement charge relating to a securities class action settlement. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies - Other.

These factors are discussed in more detail in the Results of Operations section.

RESULTS OF OPERATIONS

Details of various financial and operating information by segment can be found in the tables throughout this review. The following discussion summarizes the major items impacting Nicor’s operating income.

Operating revenues. Operating revenues by major business segment are presented below (in millions):

	2006			2005			2004

Gas distribution	$	2,452.3		$	2,909.6		$	2,362.1
Shipping		398.3			378.5			310.7
Other energy ventures		215.9			157.0			155.3
Corporate and eliminations		(106.5	)		(87.3	)		(88.4	)
	$	2,960.0		$	3,357.8		$	2,739.7

Gas distribution revenues are impacted by changes in natural gas costs, which are passed directly through to customers without markup, subject to ICC review. For the year 2006, gas distribution revenues decreased $457.3 million as compared to 2005 due to lower natural gas costs (approximately $300 million decrease) and the negative impact of warmer weather than the corresponding period in 2005 (approximately $250 million decrease), partially offset by higher demand unrelated to weather

Table of Contents

(approximately $35 million increase) and the impact of the base rate increase (approximately $36 million increase).

For the year 2005, gas distribution revenues increased $547.5 million as compared with 2004 due primarily to higher natural gas costs (approximately $525 million increase) and the positive impact of colder weather than in 2004 (approximately $60 million increase), partially offset by lower demand unrelated to weather (approximately $70 million decrease). These results also reflect the impact of the rate order tariffs, which became effective during the fourth quarter of 2005, and increased revenues by approximately $13 million.

In 2006, shipping segment operating revenues increased over 2005 due to higher average rates ($40.0 million increase), partially offset by lower volumes shipped ($19.5 million decrease). Rates were higher due to general rate increases across all markets and higher cost-recovery surcharges for fuel and security. Volumes were lower due to the adverse impact of increased competition in several of the ports served, the strategic decision not to compete for certain low margin business, and changing global trade patterns.

In 2005, shipping segment operating revenues increased over 2004 due primarily to higher average rates ($41.8 million increase) and increased volumes shipped ($25.3 million increase). Rates were higher due to general rate increases across all markets and higher cost-recovery surcharges for fuel and security.

The volume increases were recognized across substantially all ports, reflecting improvements in the economy, significant increases in Bahamian and Caribbean investment, and rebuilding efforts following the 2004 hurricanes.

The 2006 increase in revenues for other energy ventures was due primarily to higher revenues at Nicor’s energy-related products and services business ($44.8 million increase) and higher revenues at Nicor Enerchange ($14.2 million increase). Higher revenues at Nicor’s energy-related products and services businesses were attributable primarily to higher average prices ($17.5 million increase) and an increase in customer contracts ($17.0 million increase). Higher revenues at Nicor Enerchange were due to a significant positive variation in fair value adjustments associated with derivatives hedging purchases and sales of inventory, partially offset by unfavorable costing of physical sales activity.

The 2005 increase in revenues for other energy ventures was due to improved revenues at Nicor’s energy-related products and services businesses ($8.3 million increase) due primarily to new business initiatives, higher contract volumes, and improved average contract pricing, partially offset by lower revenues at Nicor Enerchange ($6.5 million decrease) due primarily to unfavorable fair value adjustments discussed above under the Operating income by segment section.

Corporate and eliminations primarily reflects the elimination of gas distribution revenues against Nicor Solutions’ expenses for customers purchasing the utility-bill management products.

Gas distribution margin. Nicor utilizes a measure it refers to as “gas distribution margin” to evaluate the operating income impact of gas distribution revenues. Gas distribution revenues include natural gas costs, which are passed directly through to customers without markup, subject to ICC review, and revenue taxes, for which Nicor Gas earns a small administrative fee. These items often cause significant fluctuations in gas distribution revenues, and yet they have virtually no direct impact on gas distribution operating income.

Table of Contents

A reconciliation of gas distribution revenues and margin follows (in millions):

	2006			2005			2004

Gas distribution revenues	$	2,452.3		$	2,909.6		$	2,362.1
Cost of gas		(1,743.7	)		(2,212.4	)		(1,695.0	)
Revenue tax expense		(144.4	)		(152.0	)		(139.4	)
Gas distribution margin	$	564.2		$	545.2		$	527.7

For the year 2006, gas distribution margin increased $19.0 million from 2005 due primarily to the impact of the base rate increase (approximately $36 million) and higher demand unrelated to weather (approximately $5 million increase), partially offset by the negative impact of warmer weather than in 2005 (approximately $17 million decrease) and the passage of Chicago Hub revenues through the PGA effective with the rate order (approximately $8 million decrease).

For the year 2005, gas distribution margin increased $17.5 million from 2004 due primarily to higher average rates (approximately $19 million increase) driven by the rate increase (approximately $13 million), and the positive impact of colder weather than in 2004 (approximately $4 million increase), partially offset by lower demand unrelated to weather (approximately $6 million decrease).

Gas distribution operating and maintenance expense. The $13.7 million increase in gas distribution operating and maintenance expense in 2006 as compared with the prior year reflects higher storage-related gas costs ($14.9 million increase) and company use gas ($9.9 million increase), partially offset by lower bad debt expense ($4.5 million decrease), net claims arising from normal operations ($4.5 million decrease) and payroll and benefit-related costs ($3.1 million decrease).

The $19.9 million increase in gas distribution operating and maintenance expense in 2005 as compared with the prior year reflects higher bad debt expense ($12.1 million increase), company use gas ($4.0 million increase) and storage-related gas costs ($6.5 million increase in the fourth quarter). These increases were partially offset by lower net legal and claims expenses ($4.7 million decrease).

The rate order, which became effective in the fourth quarter of 2005, results in certain storage-related gas costs being charged to operating and maintenance expense. Prior to the effective date of the rate order, storage-related gas costs were charged to cost of gas and passed through to customers as part of the PGA rider.

Other gas distribution operating expenses. Mercury-related costs (recoveries), net reflect the estimated costs, credits and recoveries associated with the company’s mercury inspection and repair program. During the first quarter of 2006, a mercury-related recovery of $3.8 million was realized. This net recovery resulted from a settlement reached with an independent contractor of Nicor Gas. Net mercury-related costs (recoveries) were insignificant in 2005 and 2004. Additional information about the company’s mercury inspection and repair program is presented in Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies - Mercury.

Property sale gains and losses vary from year-to-year depending upon property sales activity. During 2006, Nicor Gas realized a $3.3 million pretax gain on the sale of property. Property sale gains and losses were insignificant during 2005. During 2004, Nicor Gas realized a $5.9 million pretax gain on the sale of property. The company continues to assess its ownership of certain real estate holdings.

Shipping operating expenses. Shipping segment operating expenses increased $12.7 million in 2006 as compared with 2005 due to higher transportation-related costs including fuel ($6.3 million increase), employee-related costs ($5.0 million increase), repairs and maintenance ($2.7 million increase) and leased

Table of Contents

freight equipment ($2.5 million increase), partially offset by lower legal and audit fees ($4.2 million decrease). Included in legal and audit fees for 2005 were approximately $5.1 million of costs incurred in connection with the repatriation of funds and the reorganization of Tropical Shipping to take advantage of the benefits of the Jobs Act.

Shipping segment operating expenses increased $59.0 million in 2005 as compared with 2004 due primarily to higher transportation-related costs, which include fuel, inland freight, vessel charter, voyage and transportation, and port costs ($37.7 million increase), and higher payroll-related costs ($6.2 million increase). The increases were due to general price increases and increased volumes shipped. Higher legal and audit fees ($5.2 million increase) also contributed to the increase. Included in these amounts were approximately $5.1 million of costs incurred in connection with repatriation of funds and the reorganization of Tropical Shipping.

Operating expenses of other energy ventures. The $46.4 million increase in the 2006 operating expenses compared with 2005 were due to higher expenses at Nicor’s energy-related products and services businesses ($45.4 million increase) reflecting a higher average cost of gas ($14.8 million increase), costs related to an increase in customer contracts ($12.4 million increase) and higher selling, general and administrative costs attributable to acquiring new customer contracts ($8.8 million increase).

The $6.9 million increase in the 2005 operating expenses compared with 2004 was due primarily to higher expenses at Nicor’s energy-related products and services businesses ($7.1 million increase), due largely to higher risk management costs and expenses related to new business initiatives, partially offset by the impact of a decreased average number of fixed utility bill management customers.

Litigation charges (recoveries), net. In the second quarter of 2006, Nicor recorded a $10 million charge (non-deductible for tax purposes) associated with the outstanding SEC inquiry. In July 2006, the company reached a tentative agreement with the staff of the SEC Enforcement Division in settlement of an anticipated civil action for a payment of $10 million. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies - SEC and U.S. Attorney Inquiries.

In the first quarter of 2005, the company recorded a $0.5 million net recovery which was comprised of a shareholder derivative action settlement ($3.5 million) and a related D&O insurance recovery ($4.0 million). During the second quarter of 2005, the company recorded $29.4 million of income related to the recovery from an insurance carrier of costs previously incurred by Nicor in connection with a securities class action and a related shareholder derivative action which were previously settled. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 21 - Contingencies - Other.

In the first quarter of 2004, the company recorded a $38.5 million litigation charge related to an agreement to settle the securities class actions.

Other corporate expenses and eliminations. Other corporate operating expenses (income) were ($5.2) million, ($0.8) million and $5.5 million in 2006, 2005 and 2004, respectively. In 2006 and 2005, the company recorded a benefit from insurance recoveries related to legal expenses incurred in 2004 and prior. Also included in these amounts are business development costs.

Intercompany eliminations were ($115.8) million, ($86.9) million and ($88.4) million in 2006, 2005 and 2004, respectively, and related primarily to utility-bill management products.

Interest expense. Interest expense for 2006 increased $2.3 million over the 2005 period. This increase