Edgar Filing: NICOR INC

Nicor Inc 12/31/2005 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, 2005

[ ]	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. [X]

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, 2005 closing price of $41.17) held by non-affiliates of the registrant was approximately $1.8 billion. As of February 21, 2006, there were 44,192,259 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the company’s 2006 Annual Meeting Definitive Proxy Statement, to be filed on or about March 10, 2006, 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	13
	7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
	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	73

		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	74
	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

Nicor Inc.

Glossary

Chicago Hub. A venture of Northern Illinois Gas Company, doing business as Nicor Gas Company (“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 2005 and 6,000 degree days per year for 2004 and 2003.

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

FERC. Federal Energy Regulatory Commission, the agency that regulates the interstate transportation of natural gas, oil and electricity.

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.

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

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’ product risks.

Nicor Energy. Nicor Energy, L.L.C., a 50-percent-owned retail energy marketing joint venture which disposed of its customer contracts and ceased operations during 2003.

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.

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.

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

Glossary

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 leading carrier of containerized freight in the Bahamas and the Caribbean region.

iii

PART I

Item 1. Business

Nicor Inc. (“Nicor”), an Illinois corporation formed in 1976, is a holding company. Gas distribution is Nicor’s primary business. Nicor’s principal subsidiaries are Northern Illinois Gas Company (doing business as Nicor Gas Company (“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 and Nicor Solutions, 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 3,700 employees at year-end 2005.

Summary financial information for Nicor’s major business segments is included in Item 8 - Notes to the Consolidated Financial Statements - Note 13 - 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 over 2.1 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 22 for operating revenues, deliveries and number of customers by customer classification. Nicor Gas had approximately 2,200 employees at year-end 2005.

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’ Purchased Gas Adjustment (“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 Federal Energy Regulatory Commission (“FERC”). When firm pipeline services are temporarily not needed, Nicor Gas may release the services in 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 provide for 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 one-half 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)	698,000	March 2009
Horizon Pipeline	300,000	May 2012
Tennessee Gas Pipeline Company (TGPC)	300,000	October 2009
Midwestern Gas Transmission Company	297,000	October 2009
Northern Natural Gas Company	206,000	October 2008
Natural Gas Pipeline Company (NGPL)	140,000	March 2007
Natural Gas Pipeline Company (NGPL)	60,000	March 2008
ANR Pipeline	25,000	October 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 winter only transportation contracts and contracts that enhance Nicor Gas’ operational flexibility. The availability numbers shown above represent maximums during the winter heating season and in some cases are reduced to lower levels 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 billion cubic feet (“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.

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 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 about $1.5 million to $2.0 million.

In the first quarter of 2003, Nicor Gas purchased earnings protection against the impact of significantly warmer-than-normal or colder-than-normal weather. No such protection has been purchased since the first quarter of 2003, 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. 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 2004, the offsetting impact related to utility-bill management products was about one-third of the gas distribution weather effect.

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 Illinois Commerce Commission (“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 17 - 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. The ICC annually reviews the company’s natural gas purchasing practices for prudence, and may disallow the pass-through of costs considered imprudent.

·	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 performance-based rate (“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 19 - Contingencies - Performance-Based Rate Plan.

Gas distribution, transmission and storage system, and other properties

The gas distribution, transmission and storage system includes approximately 33,000 miles of steel, plastic and cast iron main; approximately 1.9 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. Tropical Shipping’s financial results can be significantly affected by general economic conditions in the United States, the Caribbean region and Canada. The company is a major carrier of exports from the east coast of the United States and Canada to the Caribbean region. 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, 2005, Tropical Shipping’s fleet consisted of 10 owned vessels and 8 chartered vessels with a container capacity totaling approximately 5,900 twenty-foot equivalent units (“TEUs”). In addition to the vessels, the company owns containers, container-handling equipment, chassis and other equipment. The company leases containers and 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.

OTHER ENERGY VENTURES

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

Nicor Services and Nicor Solutions 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 product warranty contracts, repair, maintenance and installation services and equipment covering heating, air conditioning and related equipment, such as natural gas piping inside homes and ductwork, 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 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’ product risks.

During 2002, Horizon Pipeline, a 50-percent-owned joint venture with NGPL, put into operation 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.

Nicor Energy was a 50-percent-owned former retail energy marketing joint venture with Dynegy Marketing and Trade. During 2003, Nicor Energy disposed of its customer contracts and ceased operations. For information about Nicor Energy, see Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Nicor Energy.

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 an equity investment in Triton Container Investments L.L.C., a cargo container leasing business.

AVAILABLE INFORMATION

Nicor files various reports with the Securities and Exchange Commission (“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.

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 1999-2005 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 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, 2005, the company had recorded a liability of $19.5 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.

An adverse decision in the proceedings concerning Nicor Gas’ Performance-Based Rate 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, SEC and U.S. Attorney for the Northern District of Illinois 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 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 these 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.

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

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 Statement of Financial Accounting Standard 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. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion.

Transporting and storing natural gas involves 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 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 to both 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 ("ISPS") Code and is also subject to the United States Maritime Transportation Security Act ("MTSA"), both of which require extensive security assessments, plans and procedures. Tropical Shipping is also subject to the regulations of both the Federal Maritime Commission (“FMC”), and the Surface Transportation Board (“STB”), 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 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 Enerchange has credit risk that could adversely affect the company’s results of operations, cash flows and financial condition.

Nicor Enerchange extends credit to its counterparties. Despite prudent credit policies and the maintenance of netting arrangements, the company is exposed to the risk that it may not be able to collect amounts owed to it. If the counterparty to such a transaction fails to perform and any collateral Nicor Enerchange has secured is inadequate, Nicor Enerchange 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 8 - Income and Other Taxes and Note 19 - 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 17 - Rate proceeding and Note 19 - Contingencies, which are incorporated herein by reference.

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

None.

Executive Officers of the Registrant

Name	Age	Current Position and Background

Russ M. Strobel	53	Chairman, Nicor and Nicor Gas (since November 2005); Chief Executive Officer, Nicor (since March 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	56	Executive Vice President and Chief Financial Officer, Nicor and Nicor Gas (since 2003); Vice President and Chief Financial Officer, Puget Energy, Inc., electric and natural gas provider (2000-2002) and Puget Sound Energy, Inc., electric and natural gas provider (1998-2002).

Claudia J. Colalillo	56	Senior Vice President Human Resources and Corporate Communications, Nicor and Nicor Gas (since 2002); Vice President Human Resources, Nicor and Nicor Gas (1998-2002).

Rocco J. D’Alessandro	47	Senior Vice President Operations, Nicor Gas (since 2002); Vice President Customer Service, Nicor Gas (1999-2002).

Daniel R. Dodge	52	Senior Vice President Diversified Ventures and Corporate Planning, Nicor and Nicor Gas (since 2002); Vice President Business Development, Nicor and Nicor Gas (1998-2002).

George M. Behrens	50	Vice President and Treasurer, Nicor and Nicor Gas (since 2004); Vice President Administration and Treasurer, Nicor and Nicor Gas (2000-2004).

Paul C. Gracey, Jr.	46	Vice President, General Counsel and Secretary, Nicor and Nicor Gas (since 2002); Vice President and General Counsel, Midwest Generation, Chicago, independent power producer (2000-2002).

Gerald P. O’Connor	54	Vice President Administration and Finance, Nicor and Nicor Gas (since 2004); 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).

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 21, 2006, there were approximately 22,300 common stockholders of record and the closing stock price was $41.76.

		Stock price				Dividends
Quarter		High		Low		Declared

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

2004
First	$	37.43	$	32.49	$	.465
Second		35.65		32.04		.465
Third		37.36		32.37		.465
Fourth		39.65		35.89		.465

In September 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 2005 or 2004. As of December 31, 2005, $21.5 million remained authorized for the repurchase of common stock.

On December 30, 2004, the company transferred 8,141 shares of its common stock to one individual in connection with the 2003 purchase of the assets and assumption of certain liabilities of a heating and air conditioning business owned by that individual. The shares were sold without registration under the Securities Act of 1933, pursuant to an exemption under Rule 505 of Regulation D under the Securities Act of 1933. The issuance was effected without general solicitation or advertising.

Nicor Inc.

Item 6. Selected Financial Data
(in millions, except per share data)
Year ended December 31
		2005		2004		2003		2002		2001

Operating revenues	$	3,357.8	$	2,739.7	$	2,662.7	$	1,897.4	$	2,366.3

Operating income	$	201.7	$	137.7	$	189.4	$	226.5	$	219.2

Income before cumulative effect of
accounting change	$	136.3	$	75.1	$	109.8	$	128.0	$	122.1

Net income	$	136.3	$	75.1	$	105.3	$	128.0	$	122.1

Earnings per common share
Basic
Before cumulative effect of
accounting change	$	3.08	$	1.71	$	2.49	$	2.90	$	2.70
Basic earnings per share		3.08		1.71		2.39		2.90		2.70

Diluted
Before cumulative effect of
accounting change	$	3.07	$	1.70	$	2.48	$	2.88	$	2.69
Diluted earnings per share		3.07		1.70		2.38		2.88		2.69

Dividends declared per
common share	$	1.86	$	1.86	$	1.86	$	1.84	$	1.76

Property, plant and equipment
Gross	$	4,351.3	$	4,143.6	$	3,999.5	$	3,872.8	$	3,733.0
Net		2,659.1		2,549.8		2,484.2		2,421.8		2,343.6

Total assets	$	4,391.2	$	3,975.2	$	3,797.2	$	3,524.4	$	3,182.2

Capitalization
Long-term bonds and notes, net of
current maturities	$	485.8	$	495.3	$	495.1	$	396.2	$	446.4
Mandatorily redeemable preferred stock		.6		1.6		1.8		4.3		6.1
Common equity		811.3		749.1		754.6		728.4		704.2
	$	1,297.7	$	1,246.0	$	1,251.5	$	1,128.9	$	1,156.7

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.

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 2003 to 2005 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 Inc. (“Nicor”) is a holding company with two principal business segments - gas distribution and shipping. Northern Illinois Gas Company (doing business as Nicor Gas Company (“Nicor Gas”)) is one of the nation’s largest natural gas distribution companies, and it is Nicor’s primary business. Tropical Shipping is a containerized shipping business serving the Bahamas and the Caribbean region that typically represents most of the balance of Nicor’s operating income. Nicor also owns or has equity interests in several energy-related businesses.

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

	2005		2004		2003

Income before cumulative effect of accounting change	$	136.3	$	75.1	$	109.8
Net income		136.3		75.1		105.3
Earnings per average share of common stock:
Diluted - before cumulative effect of accounting change		3.07		1.70		2.48
Diluted - after cumulative effect of accounting change		3.07		1.70		2.38

Net income and diluted earnings per share for 2005 compared with 2004 were impacted significantly by the absence of last year’s first-quarter securities class action settlement charge ($38.5 million pretax or $0.52 per share) coupled with net 2005 insurance recoveries and earnings thereon ($29.9 million pretax or $0.41 per share) related to the securities class action and shareholder derivative lawsuit settlements. The current year was also significantly impacted by a tax benefit recognized in the fourth quarter of 2005 (approximately $17 million or $0.38 per share) in connection with the American Jobs Creation Act (the “Jobs Act”). For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Securities Class Actions, Shareholder Derivative Lawsuits and Other, and Note 8 - Income and Other Taxes.

Year over year comparisons also reflect 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. See Item 8 - Notes to the Consolidated Financial Statements - Note 17 - Rate proceeding for further discussion of the rate order.

Net income and diluted earnings per share were lower in 2004 compared with 2003 due in large part to a $38.5 million pretax litigation charge recorded in the first quarter of 2004 related to an agreement to settle securities class action lawsuits. The charge reduced net income by $23.2 million and diluted earnings per share by $0.52. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Securities Class Actions.

Results for 2004 were also impacted by lower operating results in the gas distribution segment and an absence of gains that occurred in 2003 related to the company’s previously written off investment in Nicor Energy. Partially offsetting these negative factors were higher operating results in the shipping segment and at Nicor’s other energy ventures, a decrease in the effective income tax rate, and the absence of a cumulative effect loss that occurred in 2003 due to a change in accounting method at Nicor Enerchange.

Rate proceeding. Nicor Gas filed a request with the Illinois Commerce Commission (“ICC”) for an overall increase in base rates on November 4, 2004. In late 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’ Purchased Gas Adjustment (“PGA”) rider and the shifting of certain 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. The new 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 estimates that, under normal weather conditions, the annual net revenue increase resulting from implementing the new rate order will be about $34.7 million under the tariffs that 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. The ICC granted rehearing on seven issues, only two of which relate to the amount of the approved annual net revenue increase, and denied rehearing on all other issues raised in the applications. The ICC is expected to issue its decision on rehearing in March 2006. As a result of the rehearing process, the actual annual net revenue increase approved by the ICC could change. Based on the positions of the parties on the rehearing issues, the outcome could range from an approximate $7.1 million reduction to the annual net revenue increase to an approximate $0.9 million additional annual increase. Rate changes, if any, resulting from the outcome of the rehearing process would be prospective.

Shifting of certain storage-related costs from the PGA rider to base rates results in Nicor Gas bearing the impact that changes in natural gas prices have on those costs. During 2005 these costs approximated $17.5 million, $6.5 million of which were incurred after the effective date of the rate order and were therefore classified as operating and maintenance expense. Costs incurred prior to the effective date of the rate order are classified as cost of gas.

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):

	2005		2004			2003

Gas distribution	$	116.9	$	130.8		$	166.2
Shipping		40.4		31.6			22.7
Other energy ventures		14.1		19.3			7.9
Corporate and eliminations		30.3		(44.0	)		(7.4	)
	$	201.7	$	137.7		$	189.4

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

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 due in part to the rate increase which became effective during the fourth quarter of 2005 ($12.8 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). After consideration of the impacts of the rate order on gas distribution margin and operating and maintenance expenses, the fourth quarter rate increase added approximately $9 million to gas distribution operating income.

Gas distribution operating income decreased $35.4 million in 2004 as compared with 2003 due primarily to decreased mercury-related recoveries ($17.8 million decrease, net of costs), higher operating and maintenance expenses ($14.8 million increase), the negative impact of warmer weather than in 2003 (approximately $6 million decrease) and higher depreciation expense ($5.3 million increase). These negative factors were partially offset by an increase in gains on property sales ($5.5 million increase) and the impact of an increased number of customers ($3.3 million increase).

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 and payroll-related costs, driven by 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 to take advantage of the benefits of the Jobs Act.

Earnings during 2005 were positively impacted due to favorable economic conditions and the rebuilding efforts following the 2004 hurricanes. Shipping operating income for 2004 increased $8.9 million compared with 2003 due primarily to an increase in revenue ($38.5 million increase) driven by increased volumes shipped and higher average rates, partially offset by lower charter income and increased operating expenses ($29.6 million increase), primarily voyage and transportation, inland freight, port and other costs. Unfavorable economic conditions in the Caribbean, the Bahamas and the United States in 2003 had a negative impact on tourism and on construction projects.

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. These losses are expected to reverse in the future as the underlying transactions are settled. 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.

Operating income from Nicor’s other energy ventures for 2004 increased $11.4 million compared with 2003 due primarily to higher operating results at Nicor Enerchange ($5.8 million increase) and at Nicor’s energy-related products and services businesses ($4.2 million increase), and the absence of prior-year losses from former business activities ($0.8 million decrease). The improvements were due predominantly to an increased average number of utility-bill management customers at Nicor Solutions and related risk-management activities handled by Nicor Enerchange instead of by an outside party.

The $74.3 million increase in operating income for 2005 as compared with 2004 attributed to “Corporate and eliminations” is due primarily to the absence of last year’s securities class action settlement charge ($38.5 million) and 2005 net insurance recoveries and earnings thereon ($29.9 million) related to the securities class action and shareholder derivative lawsuit settlements. For more information, see Litigation charges (recoveries), net and Other corporate expenses and eliminations discussion below and Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Securities Class Actions, Shareholder Derivative Lawsuits and Other.

The 2004 increase in operating loss attributed to “Corporate and eliminations” as compared with 2003 is due primarily to the 2004 litigation charge of $38.5 million as noted above.

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):

	2005			2004			2003

Gas distribution	$	2,909.6		$	2,362.1		$	2,351.6
Shipping		378.5			310.7			272.2
Other energy ventures		157.0			155.3			96.5
Corporate and eliminations		(87.3	)		(88.4	)		(57.6	)
	$	3,357.8		$	2,739.7		$	2,662.7

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 2005, gas distribution revenues increased $547.5 million as compared with 2004 due primarily to higher natural gas costs ($526.1 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 $12.8 million.

For the year 2004, gas distribution revenues increased $10.5 million as compared with 2003 due primarily to higher natural gas costs ($96.5 million increase) and higher revenue taxes ($16.5 million increase). These positive factors were largely offset by the negative effect of warmer weather than in 2003 (approximately $100 million decrease).

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.

In 2004, shipping segment operating revenues increased over 2003 due primarily to increased volumes shipped ($31.9 million increase) and higher average rates ($8.7 million increase), partially offset by decreased charter income ($2.1 million decrease). These higher volumes reflect increased tourism and post-hurricane construction activity in the Caribbean region and the Bahamas. Rates were higher due to a general rate increase and higher cost-recovery surcharges for fuel and security.

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.

The 2004 increase in revenues for other energy ventures was due primarily to higher revenues at Nicor’s energy-related products and services businesses ($52.4 million increase), and Nicor Enerchange ($7.2 million increase). The improvements were due predominantly to an increased average number of utility-bill management customers at Nicor Solutions and related risk-management activities handled by Nicor Enerchange instead of by an outside party.

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.

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

	2005			2004			2003

Gas distribution revenues	$	2,909.6		$	2,362.1		$	2,351.6
Cost of gas		(2,212.4	)		(1,695.0	)		(1,692.7	)
Revenue tax expense		(152.0	)		(139.4	)		(130.9	)
Gas distribution margin	$	545.2		$	527.7		$	528.0

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 ($12.8 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).

For the year 2004, gas distribution margin was essentially unchanged from 2003, although affected by a number of offsetting factors. Warmer weather than in 2003 (approximately $6 million decrease) and an adjustment related to prior-year performance-based rate (“PBR”) plan results ($1.8 million) had a negative effect on margin. These negative factors were partially offset by the impact of an increased number of customers ($3.3 million increase), higher average rates charged during the period ($2.2 million increase) and higher revenue tax administration fees ($1.0 million increase).

Gas distribution operating and maintenance expense. 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 gas storage-related costs ($6.5 million increase in the fourth quarter). 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, these storage-related gas costs were charged to cost of gas and passed through to customers as part of the PGA rider. These increases were partially offset by lower net legal and claims expenses ($4.7 million decrease).

Gas distribution operating and maintenance expense for 2004 of $234.9 million was $14.8 million higher than 2003 due primarily to increases in legal defense costs associated with the PBR-related litigation ($5.4 million increase) and payroll costs ($3.5 million increase), adjustments related to customer reimbursements ($3.1 million), higher bad debt expense ($2.7 million increase), due in part to high natural gas prices, and higher compliance costs ($2.6 million increase). These negative factors were partially offset by higher pension credits ($3.6 million increase).

Other gas distribution operating expenses. Property sale gains and losses vary from year-to-year depending upon property sales activity. Property sale gains and losses were insignificant during 2005 and 2003. During 2004, Nicor Gas realized a $5.9 million pretax gain on the sale of land. The company continues to assess its ownership of real estate holdings.

Mercury-related costs (recoveries), net reflect the estimated costs, credits and recoveries associated with the company’s mercury inspection and repair program. Net mercury-related costs (recoveries) were insignificant in 2005 and 2004, and approximately $(17.8) million in 2003. The 2003 net recoveries resulted from agreements reached with insurers of independent contractors of Nicor Gas. Additional information about the company’s mercury inspection and repair program is presented in Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Mercury.

Shipping operating expenses. 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 to take advantage of the benefits of the Jobs Act.

Shipping segment operating expenses increased $29.6 million in 2004 as compared with 2003 due primarily to higher voyage and transportation, inland freight and port costs ($16.0 million increase), payroll and related costs ($4.7 million increase), leased equipment costs ($2.7 million increase) and vessel charter costs ($2.0 million increase). The increases were due primarily to increased volumes shipped.

Operating expenses of other energy ventures. 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 expense related to new business initiatives, partially offset by the impact of a decreased average number of fixed utility bill management customers.

The $47.4 million increase in the 2004 operating expenses compared with 2003 was due mainly to higher expenses at Nicor’s energy-related products and services businesses ($48.2 million increase), reflecting an increased average number of utility-bill management customers and the higher average cost of gas.

Litigation charges (recoveries), net. In the first quarter of 2005, the company recorded a $0.5 million pretax net recovery which was comprised of a shareholder derivative action settlement ($3.5 million pretax) and a related Directors and Officers (“D&O”) insurance recovery ($4.0 million). During the second quarter of 2005, the company recorded $29.4 million of pretax 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. In the first quarter of 2004, the company recorded a $38.5 million pretax litigation charge related to an agreement to settle the securities class actions. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Securities Class Actions, Shareholder Derivative Lawsuits and Other.

Other corporate expenses and eliminations. Other corporate operating expenses (income) were $(0.8) million, $5.5 million and $8.3 million in 2005, 2004 and 2003, respectively, consisting primarily of legal and business development costs.

Intercompany eliminations were $(86.9) million, $(88.4) million and $(58.5) million in 2005, 2004 and 2003, respectively, and related primarily to utility-bill management products.

Interest expense. Interest expense for 2005 increased $5.6 million over the 2004 period. This increase reflects the impact of higher average interest rates ($6.2 million increase) and higher estimated interest on income tax matters ($3.7 million increase), partially offset by the impact of lower average borrowing levels ($4.8 million decrease).

Interest expense increased $3.9 million in 2004 over 2003 due to the impact of higher average interest rates ($4.4 million increase) and higher estimated interest on income tax matters ($1.8 million increase), partially offset by the impact of lower average borrowing levels ($2.3 million decrease).

Net equity investment income. Net equity investment income increased $3.0 million in 2005 over the 2004 period due primarily to higher results related to low income housing investments ($1.1 million increase) and higher income from Triton Container Investments L.L.C. (“Triton”), a cargo container leasing business ($0.9 million increase).

Equity investment results for 2004 decreased by $9.0 million as compared with 2003 due primarily to the absence of a $9.6 million cash recovery related to Nicor Energy that occurred in 2003. Information related to this investment is more fully described in Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Nicor Energy.

Equity investment results include $7.4 million, $6.5 million and $5.5 million for 2005, 2004 and 2003, respectively, for Nicor’s share of income from Triton.

Interest income. Interest income increased $3.7 million in 2005 over 2004 due to higher average rates and higher investment balances. The 2004 change in interest income over the 2003 period was insignificant.

Income tax expense. The overall effective income tax rate for 2005 decreased to 20.3 percent from the prior year rate of 28.7 percent, due primarily to the 2005 tax benefits recorded in connection with the Jobs Act (approximately $17 million).

The decline in the effective income tax rate to 28.7 percent in 2004 from 35.2 percent in 2003 was primarily a result of lower pretax income (which typically causes a lower effective income tax rate since permanent differences and tax credits are a larger share of pretax income).

Cumulative effect of accounting change. The cumulative effect of a January 1, 2003 required accounting change relates to the application of accrual accounting, rather than fair value accounting, to gas in storage and certain energy-related contracts, such as storage and transportation contracts, at Nicor Enerchange.

Nicor Inc.

Gas Distribution Statistics		2005			2004			2003

Operating revenues (millions)
Sales
Residential	$	2,031.4		$	1,625.5		$	1,611.9
Commercial		453.5			349.9			351.7
Industrial		61.8			49.3			51.2
		2,546.7			2,024.7			2,014.8
Transportation
Residential		27.9			23.6			22.7
Commercial		73.1			69.9			71.6
Industrial		39.2			39.9			41.7
Other		11.7			14.0			12.0
		151.9			147.4			148.0
Other revenues
Revenue taxes		156.4			143.5			134.0
Environmental cost recovery		21.0			20.6			31.3
Chicago Hub		11.5			7.9			7.3
Performance-based rate plan		-			(1.8	)		-
Other		22.1			19.8			16.2
		211.0			190.0			188.8
	$	2,909.6		$	2,362.1		$	2,351.6

Deliveries (Bcf)
Sales
Residential		200.2			204.8			214.9
Commercial		44.7			44.3			46.7
Industrial		6.3			6.4			7.0
		251.2			255.5			268.6
Transportation
Residential		18.9			16.6			16.6
Commercial		87.5			84.1			87.8
Industrial		113.0			117.0			121.2
		219.4			217.7			225.6
		470.6			473.2			494.2

Year-end customers (thousands)
Sales
Residential		1,796.2			1,777.3			1,745.2
Commercial		120.3			116.5			114.5
Industrial		7.4			7.4			7.3
		1,923.9			1,901.2			1,867.0
Transportation
Residential		157.1			147.9			145.1
Commercial		58.2			59.5			58.3
Industrial		5.9			6.0			6.2
		221.2			213.4			209.6
		2,145.1			2,114.6			2,076.6

Other statistics
Degree days		5,783			5,637			6,068
Colder (warmer) than normal*		(1	)%		(6	)%		1	%
Average gas cost per Mcf sold	$	8.74		$	6.56		$	6.24

* Normal weather for Nicor Gas' service territory, for purposes of this report, is considered to be about 5,830 degree days per year for 2005 and 6,000 degree days for 2004 and 2003. On a 6,000 degree day basis, 2005 would have been 4% warmer than normal.

Shipping Statistics
		2005		2004		2003

TEUs shipped (thousands)			214.2		198.0		177.1
Average revenue per TEU		$	1,764	$	1,569	$	1,525

At end of period
	Ports served		25		24		25
	Vessels operated at year-end		18		20		15

FINANCIAL CONDITION AND LIQUIDITY

The company believes it has access to adequate resources to meet its needs for capital expenditures, debt redemptions, dividend payments and working capital. These resources include net cash flow from operating activities, access to capital markets, lines of credit and short-term investments.

Operating cash flows. The gas distribution business is highly seasonal and operating cash flow may fluctuate significantly during the year and from year-to-year due to factors such as weather, natural gas prices, the timing of collections from customers, natural gas purchasing, and storage and hedging practices. The company relies on short-term financing to meet seasonal increases in working capital needs. Cash requirements generally increase over the last half of the year due to increases in natural gas purchases, gas in storage and accounts receivable. During the first half of the year, positive cash flow generally results from the sale of gas in storage and the collection of accounts receivable. This cash is typically used to substantially reduce short-term debt during the first half of the year.

Nicor maintains margin accounts related to financial derivative transactions. These margin accounts may cause large fluctuations in cash needs or sources in a relatively short period of time due to daily settlements resulting from changes in natural gas futures prices. The company manages these fluctuations with short-term borrowings and investments.

Net cash flow provided from (used for) operating activities was $206.2 million, $317.7 million and $(12.6) million in 2005, 2004 and 2003, respectively. The decrease in operating cash flow provided in 2005 compared to 2004 is due in part to the impact of higher gas prices on working capital, coupled with the partial repayment of the income tax refund received in 2003, as discussed below. These effects were partially offset by the $29.9 million of Directors and Officers (“D&O”) net insurance recoveries, including earnings thereon, received during 2005 related to settlement costs incurred by Nicor in connection with a securities class action and a related shareholder derivative action, and the absence of the $38.5 million pretax litigation charge in 2004 related to an agreement to settle the securities class action litigation.

Operating cash flow for 2003 was negative due primarily to changes in working capital items in the gas distribution segment. Two decisions in 2003 were the primary factors underlying the working capital changes. First, the company significantly increased the quantity of owned gas in storage at December 31, 2003 as compared to December 31, 2002. In addition, the company chose to fund a significant portion of those purchases through short-term borrowings (which are shown outside the operating section, in the financing section, of the Consolidated Statements of Cash Flows) instead of through accounts payable. As noted in the financing activities section of Management’s Discussion and Analysis, the company had increased its short-term debt borrowing capacity in anticipation of these two and other factors (including higher gas costs), to accommodate the funding of these decisions.

In 2003, Nicor received an income tax refund of approximately $100 million attributable to a tax loss carryback associated with a change in tax accounting method (which increased its deferred income tax liability), subject to Internal Revenue Service (“IRS”) review and approval as part of normal ongoing audits. Through December 31, 2004, the total current tax benefits previously recorded under this accounting method approximated $135 million (amounts recorded were offset by increases to the deferred tax liability with no net effect on reported net federal income tax expense). In 2005, the IRS revised the regulations pertaining to the aforementioned tax accounting method. The new regulations require repayment in 2005 and 2006 of amounts previously taken as current tax deductions. As a result of this revision, the company reclassified from deferred to current income tax expense approximately $67 million, reflecting the amount repaid during 2005. The company expects to repay the remaining amounts during 2006. The anticipated repayment is expected to have no direct impact on earnings and no material impact on the company’s financial condition.

Investing activities. Net cash flow used for investing activities was $154.7 million, $204.7 million and $186.0 million in 2005, 2004 and 2003, respectively.

Capital expenditures. Capital expenditures by business segment are presented below (in millions):

	Estimated
	2006		2005		2004		2003

Gas distribution	$	175	$	188	$	175	$	173
Shipping		16		11		9		6
Other energy ventures		7		3		3		2
	$	198	$	202	$	187	$	181

Gas distribution capital expenditures for 2005 increased over 2004 due primarily to increased storage system expenditures attributable to the acquisition of a storage compressor (about $9 million increase). Capital expenditures in the gas distribution segment were nearly unchanged for 2004 compared with 2003 as increased costs in 2004 for information technology system improvements (about $8 million increase) were largely offset by adjustments related to customer reimbursements (about $3 million), the absence of expenditures related to a 2003 service outage (about $2 million decrease) and reduced storage system expenditures (about $2 million decrease).

Gas distribution segment capital expenditures are expected to decrease in 2006 versus 2005 due to the absence of expenditures related to the acquisition of a storage compressor in 2005 and a reduction in costs for information technology system improvements. In early 2006, the company is planning to implement a new customer care and billing system.

Shipping segment capital expenditures for 2005 increased $2 million over 2004 due primarily to the purchase of freight handling equipment. Shipping segment capital expenditures for 2004 increased $3 million over 2003 due primarily to the purchase of freight handling equipment and facilities renovations.

Capital expenditures in the Shipping segment are expected to increase in 2006 versus 2005 due primarily to facilities expansion, partially offset by lower expenditures related to freight handling equipment.

Additional investing activities. Cash provided by other investing activities in 2005 was approximately $61.5 million higher than in the prior year due primarily to an increase of proceeds from the 2005 sale of various investments coupled with the absence of $21.8 million of purchases of available-for-sale securities in 2004. In 2004, Nicor Gas also realized net proceeds of $7.6 million on the sale of land.

Nicor invested $10 million in 2003 in Triton. No investment was made in 2005 and 2004. Nicor’s equity investment in this business at December 31, 2005 was $92.9 million.

Nicor’s equity investment in Nicor Energy was written off during 2002. During 2003, Nicor recorded gains of $9.6 million upon the receipt of cash from Nicor Energy. Additional information about transactions with Nicor Energy is provided within the Nicor Energy section of Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies. In 2003, Nicor Services acquired an existing heating, ventilation and air conditioning business. The purchase was made with shares of Nicor common stock.

Financing activities. Nicor Gas has credit ratings that are among the highest in the gas distribution industry. The current credit ratings for Nicor Inc. and Nicor Gas are as follows:

	Standard & Poor’s		Moody’s		Fitch
Nicor Inc.
Commercial Paper		A-1+		P-1		F-1
Senior Unsecured Debt		AA-		n/a		A
Corporate Credit Rating		AA		n/a		n/a

Nicor Gas
Commercial Paper	A-1+	P-1	F-1+
First Mortgage Bonds	AA	Aa3	AA-
Senior Unsecured Debt	AA-	A1	A+
Corporate Credit Rating	AA	n/a	n/a

During 2005, Standard and Poor’s (“S&P”), Moody’s and Fitch reaffirmed Nicor Inc.’s and Nicor Gas’ credit ratings. In June 2004, Fitch upgraded the ratings outlook to stable from negative while in December 2004, S&P changed its outlook from stable to negative. Moody’s outlook has been negative since April of 2003.

Nicor’s debt-related financial statistics at December 31 include:

	2005		2004		2003
Long-term obligations, net of current maturities, as a percent of capitalization	37.5	%	39.9	%	39.7	%
Times interest earned, before income taxes	4.5		3.5		5.5

Long-term debt. The company typically uses the net proceeds from long-term debt for refinancing outstanding debt, for construction programs to the extent not provided by internally generated funds, and for general corporate purposes.

At December 31, 2005, Nicor Gas had the capacity to issue approximately $375 million of First Mortgage Bonds under the terms of its indenture, of which $75 million was available for issuance under a July 2001 shelf registration filing. Nicor believes it is in compliance with its debt covenants and believes it will continue to remain so. Nicor’s long-term debt agreements do not include ratings triggers or material adverse change provisions.

In December 2005, Tropical Shipping obtained a $40 million two-year senior unsecured term loan which was used along with cash available from foreign subsidiaries to fund the repatriation of $132 million of its cumulative undistributed foreign earnings under the provisions of the Jobs Act. The term loan bears

interest at London Inter-bank Offered Rate (“LIBOR”) plus 0.50 percent per annum. For the purpose of obtaining a lower borrowing rate, the term loan was guaranteed by Nicor.

As a result of the repatriation, Nicor has approximately $83 million of cash it expects to use for qualifying investment uses under the Jobs Act. Qualifying investment uses include funding of United States-based employee-related costs, capital investments, and advertising and marketing expenditures.

In 2003, Nicor Gas issued the following First Mortgage Bonds: $50 million due in 2023 at 5.80 percent, $50 million due in 2032 at 5.90 percent and $50 million due in 2033 at 5.90 percent. Retirements of First Mortgage Bonds in 2003 were as follows: $50 million due in 2003 at 5.75 percent and $50 million due in 2027 at 7.375 percent.

In April 2003, Nicor Gas refinanced $50 million of 3 percent unsecured notes due in April 2003 with $50 million of 1.6 percent unsecured notes due and paid in October 2003.

Short-term debt. The company relies upon short-term financing to meet temporary operating cash flow needs resulting from seasonal changes in working capital. In September 2005, Nicor and Nicor Gas established two revolving credit facilities totaling $1 billion with major domestic and foreign banks, which replaced the $500 million, three-year revolver, which was to expire in September 2007 and the $400 million, 210-day seasonal revolver, which expired in April 2005. The new replacement facilities, which serve as backup for the issuance of commercial paper, consist of a $600 million, 5-year revolver, expiring September 2010, available to Nicor Inc. and Nicor Gas, and a $400 million, 210-day seasonal revolver, expiring in April 2006, available to Nicor Gas.

Common stock. Nicor maintained its quarterly common stock dividend rate during 2005 of $0.465 per common share. The company paid dividends on its common stock of $82.1 million, $82.0 million and $81.7 million in 2005, 2004 and 2003, respectively. Nicor currently has no contractual or regulatory restrictions on the payment of dividends.

In 2001, Nicor announced a $50 million common stock repurchase program. Purchases may be made as market conditions permit through open market transactions and to the extent cash flow is available after other cash needs and investment opportunities. There were no purchases under this program in 2003, 2004 and 2005, and at December 31, 2005, approximately $22 million remained authorized for the repurchase of common stock.

Preferred Stock. On January 19, 2006, Nicor’s Board of Directors declared quarterly dividends of $0.56 per share and $0.625 per share on the 4.48% preferred stock and the 5.00% convertible preferred stock, respectively, which are payable May 1, 2006 to stockholders of record as of March 31, 2006. On November 3, 2005 Nicor redeemed 20,062 shares of 5% Mandatorily Redeemable Preferred Stock, $50 par value, at a per share redemption price of $51 plus accrued and unpaid dividends.

Off-balance sheet arrangements. Nicor has certain guarantees, as further described in Item 8 - Notes to the Consolidated Financial Statements - Note 18 - Guarantees and Indemnities. The company believes that it is not probable that these guarantees will have a material effect on its financial condition.

Contractual obligations. As of December 31, 2005, Nicor had contractual obligations with payments due as follows (in millions):

Payments due by period

	Less than 1 year	1-3 years	3-5 years	More than 5 years	Total

Purchase obligations	$1,002.6	$757.4	$ 87.5	$ 16.0	$1,863.5
Long-term debt	50.0	115.0	50.0	325.0	540.0
Fixed interest on long-term debt	30.4	53.8	41.5	245.9	371.6
Variable interest on long-term debt	2.0	2.0	-	-	4.0
Operating leases	36.5	51.4	15.1	16.6	119.6
Other long-term obligations	2.6	3.0	.6	.6	6.8
	$1,124.1	$982.6	$194.7	$604.1	$2,905.5

Purchase obligations consist primarily of natural gas purchase agreements, and natural gas transportation and storage contracts in the gas distribution and wholesale natural gas marketing business segments. Natural gas purchase agreements include obligations to purchase natural gas at future market prices, calculated using December 31, 2005 New York Mercantile Exchange futures prices.

Operating leases are primarily for vessels, containers and equipment in the shipping segment, office space and equipment in the gas distribution segment and office space at other energy ventures. Tropical Shipping has certain equipment operating leases which include purchase and/or renewal options, at fair market amounts at the time of purchase or renewal. Rental expense under operating leases was $37.2 million, $27.5 million and $23.7 million in 2005, 2004 and 2003, respectively. The increase in rent expense from 2004 to 2005 was primarily driven by higher charter rates and the addition of equipment leases in the shipping segment.

Other. Restrictions imposed by regulatory agencies and loan agreements limiting the amount of subsidiary net assets that can be transferred to Nicor are not expected to have a material impact on the company’s ability to meet its cash obligations.

OUTLOOK

Gas Distribution. In 2006, results will reflect a full year of the rate increase granted in 2005. The rate increase received in 2005 was based on estimates for operating and maintenance expense, depreciation expense, interest expense and other costs. To the extent actual costs incurred vary from amounts recovered through base rates, operating income will be impacted. Since receipt of the rate order, natural gas prices have been extremely volatile and are currently higher than estimates used in the rate case. In 2006, the impact of such increases could substantially offset the impacts of the rate increase. In addition, fluctuations from normal weather have the potential to significantly impact 2006 operating income. The ICC’s rehearing on certain rate case issues, the PBR plan review, the related PGA review and other contingencies could significantly affect future operating results, but the outcomes are not estimable.

Operating and maintenance expenses at Nicor Gas are expected to continue to rise in part because of the full year impact of the 2005 rate order which requires that certain storage-related costs will now be charged to operating and maintenance expense rather than being recorded in cost of gas (as such costs were passed through to customers as part of the PGA rider prior to the implementation of the late 2005 rate order). In addition, the company continues to be impacted by fluctuations in natural gas prices and the related impact on bad debt expense, company use gas, storage-related and other costs.

Shipping. Strong economic conditions in the Caribbean and the Bahamas are expected to continue into 2006. Nicor anticipates that 2006 pretax operating results in the shipping segment will be comparable to 2005. Effective January 1, 2006, Tropical Shipping has reorganized its operations to take advantage of provisions of the Jobs Act to minimize the federal income taxes on its ongoing earnings. To the extent shipping earnings are not repatriated to the United States, such earnings are not expected to be subject to current federal taxation. In addition, to the extent such earnings are determined to be indefinitely reinvested offshore, no deferred income tax expense will be recorded by the company.

Other Energy Ventures. Nicor anticipates 2006 results in the other energy ventures will be improved compared to 2005. This projection does not reflect the variability in earnings due to fair value accounting adjustments in its wholesale natural gas marketing business that could occur because of additional volatility in the natural gas markets.

CONTINGENCIES

The following contingencies of Nicor are in various stages of investigation or disposition. Although in some cases the company is unable to estimate the amount of loss reasonably possible in addition to any amounts already recognized, it is possible that the resolution of these contingencies, either individually or in aggregate, will require the company to take charges against, or will result in reductions in, future earnings. It is the opinion of management that the resolution of these contingencies, either individually or in aggregate, could be material to earnings in a particular period but is not expected to have a material adverse impact on Nicor’s liquidity or financial condition.

Performance-based rate (“PBR”) plan. Nicor Gas’ 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 PBR is currently under ICC review.

There are allegations that the company acted improperly in connection with the PBR plan, and the ICC and others are reviewing these allegations. On June 27, 2002 the Citizens Utility Board (“CUB”) filed a motion to reopen the record in the ICC’s proceedings to review the PBR plan (the “ICC Proceedings”). As a result of the motion to reopen, Nicor Gas, the Cook County State’s Attorney Office (“CCSAO”), the staff of the ICC and CUB entered into a stipulation providing for additional discovery. The Illinois Attorney General’s Office (“IAGO”) has also intervened in this matter. In addition, the IAGO issued Civil Investigation Demands (“CIDs”) to CUB and the ICC staff. The CIDs ordered that CUB and the ICC staff produce all documents relating to any claims that Nicor Gas may have presented, or caused to be presented, false information related to its PBR plan. Parties who were plaintiffs in a dismissed class action proceeding against the company could potentially intervene in these proceedings. The company has committed to cooperate fully in the reviews of the PBR plan.

In response to these allegations, on July 18, 2002, the Nicor Board of Directors appointed a special committee of independent, non-management directors to conduct an inquiry into issues surrounding natural gas purchases, sales, transportation, storage and such other matters as may come to the attention of the special committee in the course of its investigation. The special committee presented the report of its counsel (“Report”) to Nicor’s Board of Directors on October 28, 2002. A copy of the report is available at the Nicor website and has been previously produced to all parties in the ICC Proceedings.

In response, the Nicor Board of Directors directed the company’s management to, among other things, make appropriate adjustments to account for, and fully address, the adverse consequences to ratepayers of the items noted in the Report, and conduct a detailed study of the adequacy of internal accounting and regulatory controls. The adjustments were made in prior years’ financial statements resulting in a $24.8 million liability. Included in such $24.8 million liability is a $4.1 million loss contingency. A $1.8

million adjustment to the previously recorded liability, which is discussed below, was made in the third quarter of 2004 increasing the recorded liability to $26.6 million. In addition, Nicor Gas estimates that there is $26.9 million due to the company from the 2002 PBR plan year, which has not been recognized in the financial statements due to uncertainties surrounding the PBR plan. The net of these items and interest income on certain components results in a $1.0 million reimbursement the company is seeking as of December 31, 2005, pending resolution of the proceedings discussed below. By the end of 2003 the company completed steps to correct the weaknesses and deficiencies identified in the detailed study of the adequacy of internal controls.

Pursuant to the agreement of all parties, including the company, the ICC re-opened the 1999 and 2000 purchased gas adjustment filings for review of certain transactions related to the PBR plan and consolidated the reviews of the 1999-2002 purchased gas adjustment filings with the PBR plan review.

On February 5, 2003, the CCSAO and CUB filed a motion for $27 million in sanctions against the company in the ICC Proceedings. In that motion, CCSAO and CUB alleged that Nicor Gas’ responses to certain CUB data requests were false. Also on February 5, 2003, CUB stated in a press release that, in addition to $27 million in sanctions, it would seek additional refunds to consumers. On March 5, 2003, the ICC staff filed a response brief in support of CUB’s motion for sanctions. On May 1, 2003, the Administrative Law Judges issued a ruling denying CUB and CCSAO’s motion for sanctions. CUB has filed an appeal of the motion for sanctions with the ICC, and the ICC has indicated that it will not rule on the appeal until the final disposition of the ICC Proceedings. It is not possible to determine how the ICC will resolve the claims of CCSAO, CUB or other parties to the ICC Proceedings.

In November 2003, the ICC staff, CUB, CCSAO and the IAGO filed their respective direct testimony in the ICC Proceedings. The ICC staff is seeking refunds to customers of approximately $108 million and CUB and CCSAO were jointly seeking refunds to customers of approximately $143 million. The IAGO direct testimony alleges adjustments in a range from $145 million to $190 million. The IAGO testimony as filed is presently unclear as to the amount which IAGO seeks to have refunded to customers. On February 27, 2004 the above referenced intervenors filed their rebuttal testimony in the ICC Proceedings. In such rebuttal testimony, CUB and CCSAO amended the alleged amount to be refunded to customers from approximately $143 million to $190 million. Nicor Gas filed rebuttal testimony in January 2004, which is consistent with the findings of the special committee Report. Nicor Gas seeks a reimbursement of approximately $1 million as referenced above. The parties to the ICC Proceedings have agreed to a stay of the evidentiary hearings on this matter in order to undertake additional third party discovery from Entergy-Koch Trading, LP (“EKT”), a natural gas, storage and transportation trader and consultant with whom Nicor did business under the PBR plan.

During the course of the Securities and Exchange Commission (“SEC”) investigation discussed below, the company became aware of additional information relating to the activities of individuals affecting the PBR plan for the period from 1999 through 2002, including information consisting of third party documents and recordings of telephone conversations from EKT. Review of additional information completed in the third quarter of 2004 resulted in the $1.8 million adjustment to the previously recorded liability referenced above.

Although the Report of the special committee’s counsel did not find that there was criminal activity or fraud, a review of this additional information (which was not available to the independent counsel who prepared the Report) and re-interviews of certain Nicor Gas personnel in 2004 indicated that certain former Nicor Gas personnel may have engaged in potentially fraudulent conduct regarding the PBR plan in violation of company policy, and in possible violation of SEC rules and applicable law. Further, certain former Nicor Gas personnel also may have attempted to conceal their conduct in connection with an ICC review of the PBR plan. The company continues to cooperate with the SEC, the U.S. Attorney’s office and the ICC on this matter. The company has reviewed all third party information it has obtained

and will continue to review any additional third party information the company may obtain. The company terminated four employees in connection with this matter in the third quarter of 2004.

Nicor is unable to predict the outcome of any of the foregoing reviews or the company’s potential exposure thereunder. Because the PBR plan and historical gas costs are still under ICC review, the final outcome could be materially different than the amounts reflected in the company’s financial statements as of December 31, 2005.

Nicor Energy. Significant events occurred in 2002 and 2003 relating to Nicor’s 50 percent interest in Nicor Energy. Nicor Energy, a retail energy marketing joint venture owned 50 percent by Nicor and 50 percent by Dynegy Marketing and Trade, has been dissolved. Information about these events is presented within Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Nicor Energy.

On December 10, 2003, the United States Attorney for the Northern District of Illinois indicted three former employees of Nicor Energy and an outside lawyer for Nicor Energy. The indictments alleged that the defendants fraudulently deprived Nicor Energy of their honest services and caused a loss to investors in Nicor Inc. and Dynegy Inc. During the time period covered by the indictments, Nicor Energy was a stand alone entity with its own management and was operated independently from Nicor Inc. and Nicor Gas. None of the individuals indicted are employees of Nicor Inc. or Nicor Gas nor were they at the time of the charged conduct. The three former employees of Nicor Energy have pled guilty to certain charges. Separately, on December 10, 2003, the SEC filed its own civil enforcement action against the same three former employees and one additional former employee of Nicor Energy. While Nicor is unable to predict the final outcome of these matters, the resolution of such matters is not expected to have a material adverse impact on the company’s cash flow, financial condition or results of operations.

SEC and U.S. Attorney Inquiries. In 2002, the staff of the SEC informed Nicor and Nicor Energy that the SEC is conducting a formal inquiry regarding both the PBR plan and Nicor Energy. A representative of the Office of the United States Attorney for the Northern District of Illinois has notified Nicor that that office is conducting an inquiry on the same matters that the SEC is investigating, and a grand jury is also reviewing these matters. In April 2004, Nicor was advised by the SEC Division of Enforcement that it intended to recommend to the SEC that it bring a civil injunctive action against Nicor, alleging that Nicor violated Sections 17(a) of the Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. The SEC may also seek injunctive relief, disgorgement and civil penalties. The SEC staff invited Nicor to make a formal response (known as a Wells Submission) with respect to the proposed recommendation. In June 2004, Nicor filed its Wells Submission with the SEC. In addition, in connection with the SEC’s invitation to the company to make a Wells Submission, the SEC informed the company of additional sources of information relating to activities affecting the PBR plan, the status of which is addressed in detail in the PBR section set forth above. In August 2004, Nicor withdrew its Wells Submission in light of its continuing review of the additional sources of newly available information referenced above. Nicor continues in its efforts to resolve this matter with the SEC and has requested that the SEC allow Nicor to file an updated Wells Submission if necessary. Nicor is unable to predict the outcome of these inquiries or Nicor’s potential exposure related thereto and has not recorded a liability associated with the outcome of these contingencies.

Securities Class Actions. Nicor and certain of its executives were defendants in a consolidated class action lawsuit. Information about the settlement of this action is presented within Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Securities Class Actions.

Shareholder Derivative Lawsuits. Certain former Nicor executives and members of its Board of Directors were defendants in a consolidated derivative lawsuit. The parties reached an agreement to settle the action which was approved by the court presiding over the matter on March 29, 2005. The settlement

became final in the second quarter of 2005, when all appeal rights expired. In connection with the derivative settlement, in the first quarter of 2005, Nicor’s excess insurance carrier paid $4 million to Nicor to settle certain claims Nicor had asserted against it arising out of the derivative action and related class action securities litigation. Pursuant to the terms of the derivative settlement, Nicor paid $3.5 million of that $4 million to plaintiff’s attorneys to reimburse them for the fees and costs expended in pursuing the derivative action. The $0.5 million net of these payments was reflected in the Consolidated Statement of Operations in the first quarter of 2005. Further information about this lawsuit is presented within Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Shareholder Derivative Lawsuits. See also the “Other contingencies” section for information on additional insurance recoveries.

Mercury. Future operating results may be impacted by adjustments to the company’s estimated mercury liability or by related recoveries. Additional information about mercury contingencies is presented in Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Mercury.

Manufactured gas plant sites. The company is conducting environmental investigations and remedial activities at former manufactured gas plant sites. Additional information about these sites is presented in Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Manufactured Gas Plant Sites.

Fixed Bill Service. Nicor Services was a defendant in a purported class action. On October 7, 2005, the Circuit Court denied plaintiffs’ motion to certify the proposed class. Information about this lawsuit is presented within Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Fixed Bill Service.

Gas Line ComfortGuard Service. Nicor, Nicor Gas and Nicor Services were defendants in a purported class action that was settled on an individual basis with the named plaintiff in the first quarter of 2006. Information about this lawsuit is presented within Item 8 - Notes to the Consolidated Financial Statements - Note 19 - Contingencies - Gas Line ComfortGuard Service.

Other contingencies. 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. See Item 8 - Notes to the Consolidated Financial Statements - Note 8 - Income and Other Taxes and Note 19 - Contingencies.

On April 27, 2004 one of Nicor’s Directors and Officers (“D&O”) insurance carriers agreed to pay $29.0 million to a third party escrow agent on behalf of Nicor and its insured directors and officers to be used to satisfy Nicor directors’ and officers’ liabilities and expenses associated with claims asserted against them in a securities class action, the shareholder derivative lawsuit described above and related matters, with any remaining balance to be paid to Nicor. Under the terms of the derivative settlement, once the settlement became final (because all appeal rights had expired), the escrow was terminated and the $29.0 million, plus earnings of approximately $0.4 million, held by the escrow agent was paid to Nicor in the second quarter of 2005. These recoveries have been recorded in “Litigation charges (recoveries), net” in the Consolidated Statement of Operations for the year ended December 31, 2005. In the second half of 2005, Nicor received $2.8 million of additional insurance proceeds related to legal defense costs. These additional proceeds have been recorded in “Other corporate expenses and eliminations” in the Consolidated Statement of Operations for the year ended December 31, 2005. Nicor also continues to seek reimbursement for other expenses from its excess insurance carrier in connection with the same matters but is unable to predict the outcome of this matter and therefore no potential insurance recoveries have been reflected in the financial statements.

In addition, see Item 1A - Risk Factors and Item 7A - Quantitative and Qualitative Disclosures about Market Risk.

CRITICAL ACCOUNTING ESTIMATES

Nicor prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States, which regularly require Nicor’s management to exercise judgment in the selection and application of accounting methods. The application of accounting methods includes making estimates using subjective assumptions and judgments about matters that are inherently uncertain.

The use of estimates and the selection of accounting policies affect Nicor’s reported results and financial condition. The company has adopted several significant accounting policies and is required to make significant accounting estimates that are important to understanding its financial statements. These significant policies and estimates are described throughout Item 8 - Notes to the Consolidated Financial Statements.

Although there are numerous areas in which Nicor’s management makes significant accounting estimates, it believes its critical estimates are those that require management’s most difficult and subjective or complex judgments. Nicor’s management has a practice of reviewing its critical accounting estimates and policy decisions with the audit committee of its board of directors. Its critical estimates typically involve loss contingencies, derivative instruments, pension and other postretirement benefits, income taxes, credit risk and unbilled revenues because they are estimates which could materially impact Nicor’s financial statements.

Loss contingencies. Nicor and its subsidiaries record contingent losses as liabilities when a loss is both probable and the amount or range of loss, including related legal defense costs, is reasonably estimable. When only a range of potential loss is estimable, the company records a liability for the minimum anticipated loss. Nicor and its subsidiaries and affiliates are involved in various legal and regulatory proceedings and are exposed to various loss contingencies. These loss contingencies are in some cases resolved in stages over time, estimates may change significantly from period to period, and the company’s ultimate obligations may differ materially from its recorded amounts. Of particular note is the PBR plan contingency at Nicor Gas and the United States SEC and U.S. Attorney inquiries described in Item 8 - Notes to the Consolidated Financial Statements - Note - 19 Contingencies.

Derivative instruments. The rules for determining whether a contract meets the definition of a derivative instrument or qualifies for hedge accounting treatment are numerous and complex. The treatment of a single contract may vary from period to period depending upon accounting elections, changes in management’s assessment of the likelihood of future hedged transactions or new interpretations of accounting rules. As a result, management judgment is required in the determination of the appropriate accounting treatment. In addition, the estimated fair value of derivative instruments may change significantly from period to period depending upon market projections, and changes in hedge effectiveness may impact the accounting treatment. These determinations and changes in estimates may have a material impact on reported results.

Pension and other postretirement benefits. The company’s cost of providing postretirement benefits is dependent upon various factors and assumptions, including life expectancies, the discount rate used in determining the projected benefit obligation, the expected long-term rate of return on plan assets, the long-term rate of compensation increase and anticipated health care costs. Changes in these assumptions typically do not have a significant impact on the expenses recorded from year to year. However, actual experience in any one period, particularly the actual return on plan assets, often varies significantly from these mostly long-term assumptions. When cumulatively significant, the gains and losses generated from such variances are amortized over the remaining service lives of employees covered by the plans (approximately 12 years for the pension plan and 14 years for the health care plan). Additional information is presented in Item 8 - Notes to the Consolidated Financial Statements - Note 9 - Postretirement Benefits, including plan asset investment allocation, estimated future benefit payments,

general descriptions of the plans, significant assumptions, the impact of certain changes in assumptions, and significant changes in estimates.

The company’s estimated postretirement benefit cost included in operating income was $9.6 million, $9.1 million and $13.9 million in 2005, 2004 and 2003, respectively. Nicor Gas expects to record postretirement benefit cost for 2006 of $5.5 million. Actuarial assumptions affecting 2006 include an expected rate of return on plan assets of 8.50 percent, consistent with the prior year, and a discount rate of 5.50 percent compared with 5.75 percent a year earlier. The 5.50 percent discount rate was determined independently for the pension and health-care plans based on bond matching models, using non-callable, high quality bonds (AA- or better), whose expected cash flows match the timing and amount of future benefit payments of the plans.

Income taxes. A deferred income tax liability is not recorded on undistributed foreign earnings that are expected in management’s judgment to be indefinitely reinvested offshore. After accounting for the repatriation, Nicor has remaining at December 31, 2005 approximately $12 million of deferred income tax liabilities related to approximately $34 million of cumulative undistributed earnings of its foreign subsidiaries. Nicor has not recorded deferred income taxes of approximately $18 million on approximately $51 million of cumulative undistributed foreign earnings that are expected in management’s judgment to be indefinitely reinvested offshore. Changes in management’s investment or repatriation plans or circumstances could result in a different deferred income tax liability.

Credit risk. Nicor’s subsidiaries and affiliates are required to estimate credit risk in establishing allowances for doubtful accounts and in estimating the fair values of certain derivative instruments with counterparty credit risk being an especially difficult and critical judgment. Actual credit losses could vary materially from Nicor’s estimates. Nicor’s allowance for doubtful accounts at December 31, 2005, 2004 and 2003 was $31.5 million, $21.9 million and $21.2 million, respectively, as presented on Schedule II in Item 15 - Exhibits and Financial Statement Schedules.

Unbilled revenues. Nicor Gas estimates revenues for natural gas deliveries not yet billed to customers from the last billing date to month-end (“unbilled revenues”). Unbilled revenue estimates are dependent upon a number of customer-usage factors which require management judgment, including weather factors. These revenue estimates are adjusted when actual billings occur, and variances in estimates can be material. Estimated unbilled revenues for Nicor Gas at December 31, 2005, 2004 and 2003 were $300.4 million, $204.4 million and $139.0 million, respectively.

NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board (“FASB”) has issued the following new pronouncements that have not yet been adopted by Nicor as of December 31, 2005.

In May 2005, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. The company has not yet adopted this pronouncement. In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. For more information, see Item 8 - Notes to the Consolidated Financial Statements - Note 2 - New Accounting Pronouncements.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

This document includes certain forward-looking statements about the expectations of Nicor and its subsidiaries and affiliates. Although Nicor believes these statements are based on reasonable assumptions, actual results may vary materially from stated expectations. Such forward-looking statements may be identified by the use of forward-looking words or phrases such as “anticipate,” “believe,” “expect,” “intend,” “may,” “planned,” “potential,” “should,” “will,” “would,” “project,”

“estimate,” “ultimate,” or similar phrases. Actual results may differ materially from those indicated in the company’s forward-looking statements due to the direct or indirect effects of legal contingencies (including litigation) and the resolution of those issues, including the effects of an ICC review and SEC and U.S. Attorney inquiries, and undue reliance should not be placed on such statements.

Other factors that could cause materially different results include, but are not limited to, weather conditions; natural disasters; natural gas and other fuel prices; fair value accounting adjustments; inventory valuation; health care costs; insurance costs or recoveries; legal costs; borrowing needs; interest rates; credit conditions; economic and market conditions; tourism and construction in the Bahamas and Caribbean region; energy conservation; legislative and regulatory actions; tax rulings or audit results; asset sales; significant unplanned capital needs; future mercury-related charges or credits; changes in accounting principles, interpretations, methods, judgments or estimates; performance of major suppliers and contractors; labor relations; and acts of terrorism.

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this filing. Nicor undertakes no obligation to publicly release any revision to these forward-looking statements to reflect events or circumstances after the date of this filing.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Nicor is exposed to market risk in the normal course of its business operations, including the risk of loss arising from adverse changes in natural gas and fuel commodity prices, and interest rates. It is Nicor’s practice to manage these risks utilizing derivative instruments and other methods, as deemed appropriate.

Commodity price risk. With regard to commodity price risk, the company has established policies and procedures governing the management of such risks and the use of derivative instruments to hedge its exposure to such risks. Company management oversees compliance with such policies and procedures. The company utilizes various techniques to limit, measure and monitor market risk, including limits based on volume, dollar amounts, maturity, and in some cases value at risk (“VaR”).

VaR is the potential loss for an instrument or portfolio from adverse changes in market factors, for a specified time period and at a specified confidence level. The company has established exposure limits at such a level that material adverse economic results are not expected. The company’s commodity price risk policies and procedures continue to evolve with its businesses and are subject to ongoing review and modification.

In accordance with SEC disclosure requirements, Nicor performs sensitivity analyses to assess the potential loss in earnings based upon a hypothetical 10 percent adverse change in market prices. Management does not believe that sensitivity analyses alone provide an accurate or reliable method for monitoring and controlling risks and therefore also relies on the experience and judgment of its management to revise strategies and adjust positions as deemed necessary. Losses in excess of the amounts determined in sensitivity analyses could occur if market prices exceed the 10 percent shift used for the analyses.

As a regulated utility, Nicor Gas’ exposure to market risk caused by changes in commodity prices is substantially mitigated because of Illinois rate regulation allowing for the recovery of prudently incurred natural gas supply costs from customers. However, substantial changes in natural gas prices may impact Nicor Gas’ earnings by increasing or decreasing the cost of gas used by the company, storage-related costs, bad debt expense, and other operating and financing expenses. The company purchases about 4 billion cubic feet (“Bcf”) of natural gas annually for its own use and to cover storage-related inventory costs. The level of natural gas prices may also impact customer gas consumption and therefore gas distribution margin.

The actual impact of natural gas price fluctuations on Nicor Gas’ earnings is dependent upon several factors, including the company’s hedging practices. At December 31, 2005, Nicor Gas had hedged a significant portion of its forecasted 2006 company use and storage-related gas costs primarily through the use of fixed-price purchase agreements.

Nicor’s other energy businesses are subject to natural gas commodity price risk, arising primarily from purchase and sale agreements, transportation 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. Based on Nicor’s other energy businesses unhedged positions at December 31, 2005, a 10 percent adverse change in natural gas prices would have decreased Nicor’s earnings at December 31, 2005 and 2004 by about $1.0 million and $0.2 million, respectively.

At December 31, 2005, Nicor Enerchange, Nicor’s wholesale natural gas marketing business, held derivative contracts with the following asset (liability) fair values, net (in millions):

				Maturity
Source of Fair Value		Total Fair Value			Less than 1 Year			1 to 3 Years			3 to 5 Years
Prices actively quoted	$	(1.2	)	$	(1.1	)	$	(.1	)	$	-
Prices based on pricing models		.4			.4			-			-
Total	$	(.8	)	$	(.7	)	$	(.1	)	$	-

Tropical Shipping’s objective is to substantially mitigate its exposure to higher fuel costs through fuel surcharges.

Credit risk. Nicor Gas has a diversified customer base, which limits its exposure to concentrations of credit risk in any one industry or income class. The company believes that it maintains prudent credit policies, subject to ICC regulations. Customers also have options to help them manage their bills, such as energy assistance programs for low-income customers and a budget payment plan that spreads gas bills more evenly throughout the year. The company is also exposed to credit risk in the event a counterparty, customer or supplier defaults on a contract to pay for or deliver product at agreed-upon terms and conditions. To manage this risk, the company has established procedures to determine and monitor the creditworthiness of counterparties, to require guarantees or collateral back-up, and to limit its exposure to any one counterparty. Nicor also, in some instances, enters into netting arrangements to mitigate counterparty credit risk.

Interest rate risk. Nicor is exposed to changes in interest rates. The company manages its interest rate risk by issuing primarily fixed-rate long-term debt with varying maturities, refinancing certain debt and, at times, hedging the interest rate on anticipated borrowings. If market rates were to hypothetically increase by 10 percent from Nicor’s weighted-average floating interest rate on commercial paper and on Tropical Shipping’s $40 million two-year senior unsecured term loan, interest expense would have increased causing Nicor’s earnings to decrease by approximately $0.3 million if the two-year term loan had been outstanding for the full year. For further information about debt securities, interest rates and fair values, see Item 8 - Financial Statements - Consolidated Statements of Capitalization, and Item 8 - Notes to the Consolidated Financial Statements - Note 6 - Short-Term and Long-Term Debt and Note 7 - Fair Value of Financial Instruments.

Nicor Inc.

Item 8.

Financial Statements and Supplementary Data

		Page

Report of Independent Registered Public Accounting Firm		37

Financial Statements:

	Consolidated Statements of Operations	39

	Consolidated Statements of Cash Flows	40

	Consolidated Balance Sheets	41

	Consolidated Statements of Capitalization	42

	Consolidated Statements of Common Equity	43

	Consolidated Statements of Comprehensive Income	43

	Notes to the Consolidated Financial Statements	44

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Nicor Inc.

We have audited the accompanying consolidated balance sheets and statements of capitalization of Nicor Inc. and subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, common equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15. We also have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedule, an opinion on management’s assessment, and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (concluded)

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also, in our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

As discussed in Note 2 to the consolidated financial statements, in 2005 the Company changed its method of accounting for conditional asset retirement obligations. As discussed in Note 1 to the consolidated financial statements, in 2003 the Company changed its method of accounting for energy trading activities and gas inventories.

/s/ DELOITTE & TOUCHE LLP

Chicago, Illinois

February 24, 2006

Nicor Inc.

Consolidated Statements of Operations
(millions, except per share data)
Year ended December 31
		2005			2004			2003
Operating revenues
Gas distribution (includes revenue taxes of $156.4,
$143.5, and $134.0, respectively)	$	2,909.6		$	2,362.1		$	2,351.6
Shipping		378.5			310.7			272.2
Other energy ventures		157.0			155.3			96.5
Corporate and eliminations		(87.3	)		(88.4	)		(57.6	)
Total operating revenues		3,357.8			2,739.7			2,662.7

Operating expenses
Gas distribution
Cost of gas		2,212.4			1,695.0			1,692.7
Operating and maintenance		254.8			234.9			220.1
Depreciation		154.5			148.8			143.5
Taxes, other than income taxes		171.0			158.5			147.3
Mercury-related costs (recoveries), net		.4			-			(17.8	)
Property sale gains		(.4	)		(5.9	)		(.4	)
Shipping		338.1			279.1			249.5
Other energy ventures		142.9			136.0			88.6
Litigation charges (recoveries), net		(29.9	)		38.5			-
Other corporate expenses and eliminations		(87.7	)		(82.9	)		(50.2	)
Total operating expenses		3,156.1			2,602.0			2,473.3

Operating income		201.7			137.7			189.4
Interest expense, net of amounts capitalized		46.8			41.2			37.3
Equity investment income, net		9.3			6.3			15.3
Interest income		6.0			2.3			1.9
Other income, net		.8			.2			.1

Income before income taxes and cumulative
effect of accounting change		171.0			105.3			169.4
Income tax expense, net of benefits		34.7			30.2			59.6

Income before cumulative effect of accounting change		136.3			75.1			109.8
Cumulative effect of accounting change, net of
$3.0 income tax benefit		-			-			(4.5	)

Net income		136.3			75.1			105.3

Dividends on preferred stock		-			-			.1

Earnings applicable to common stock	$	136.3		$	75.1		$	105.2

Average shares of common stock outstanding
Basic		44.2			44.1			44.0
Diluted		44.4			44.3			44.2

Earnings per average share of common stock
Basic
Before cumulative effect of accounting change	$	3.08		$	1.71		$	2.49
Cumulative effect of accounting change, net of tax		-			-			(.10	)
	$	3.08		$	1.71		$	2.39

Diluted
Before cumulative effect of accounting change	$	3.07		$	1.70		$	2.48
Cumulative effect of accounting change, net of tax		-			-			(.10	)
	$	3.07		$	1.70		$	2.38

The accompanying notes are an integral part of these statements.

Nicor Inc.

Consolidated Statements of Cash Flows
(millions)
Year ended December 31
		2005			2004			2003
Operating activities
Net income	$	136.3		$	75.1		$	105.3
Adjustments to reconcile net income to net cash flow
provided from operating activities:
Depreciation		172.4			166.6			161.7
Deferred income tax (benefit) expense		(102.1	)		27.3			132.6
Cumulative effect of accounting change		-			-			4.5
Loss (gain) on sale of property, plant and equipment		.3			(5.8	)		(1.9	)
Changes in assets and liabilities:
Receivables, less allowances		(305.9	)		(121.5	)		(4.1	)
Gas in storage		(40.6	)		13.3			(195.6	)
Deferred/accrued gas costs		154.9			21.3			(20.3	)
Prepaid pension costs		(6.1	)		(4.4	)		-
Other assets		13.9			(.9	)		13.7
Accounts payable		155.3			124.1			(166.0	)
Other liabilities		21.8			20.2			(30.2	)
Other items		6.0			2.4			(12.3	)
Net cash flow provided from (used for) operating activities		206.2			317.7			(12.6	)

Investing activities
Capital expenditures		(201.9	)		(190.4	)		(181.3	)
Purchase of equity investments		(2.3	)		(2.6	)		(12.7	)
Purchases of available-for-sale securities		-			(21.8	)		-
Purchases of held-to-maturity securities		(2.9	)		(2.9	)		(2.5	)
Proceeds from sales or maturities of available-for-sale securities		15.1			6.9			-
Proceeds from sales or maturities of held-to-maturity securities		3.6			2.8			1.9
Net (increase) decrease in other short-term investments		29.7			(4.7	)		(6.6	)
Repayments from joint ventures		-			-			8.3
Net proceeds from sale of property, plant and equipment		1.0			8.0			3.5
Other investing activities		3.0			-			3.4
Net cash flow used for investing activities		(154.7	)		(204.7	)		(186.0	)

Financing activities
Net proceeds from issuing long-term debt		39.9			-			147.8
Disbursements to retire long-term obligations		(1.2	)		-			(152.5	)
Commercial paper issuances with maturities over 90 days		-			35.0			730.0
Commercial paper repayments with maturities over 90 days		-			(575.0	)		(190.0	)
Net issuances (repayments) of commercial paper with maturities of
90 days or less		96.0			455.0			(280.0	)
Dividends paid		(82.1	)		(82.0<