**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549





**FORM
      10-Q**





[X]
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
                EXCHANGE ACT OF 1934




**For the quarterly period ended September 30, 2007**





or





[
                ]
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
                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.
                EmployerIdentification
                Number)





**1844
                Ferry Road****Naperville,
                Illinois 60563-9600**
            **(630)
                305-9500**(Address
                of principal executive offices)
            (Registrant’s
                telephone number)





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 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 Exchange Act). Yes [ ] No [X]





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date. Common stock, par value $2.50,
      outstanding at October 26, 2007, were 45,124,624 shares.











**Table
      of Contents**





**Glossary**
            
            ii**Part
                I - Financial Information**Item
                1.
            Financial
                Statements (Unaudited)Condensed
                Consolidated Statements of
                Operations:
            1Three
                and nine months ended September 30, 2007 and 2006Condensed
                Consolidated Statements of Cash
                Flows:
            2Nine
                months ended September 30, 2007 and 2006Condensed
                Consolidated Balance
                Sheets:
            3September
                30, 2007 and 2006, and December 31, 2006Notes
                to the Condensed Consolidated Financial Statements
            4Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            17Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            29Item
                4.
            Controls
                and Procedures
            29**Part
                II - Other Information**Item
                1.
            Legal
                Proceedings
            29Item
                1A.
            Risk
                Factors
            29Item
                2.
            Unregistered
                Sales of Equity Securities and
                Use of Proceeds
            30Item
                6.
            Exhibits
            30Signature
            31














i
 
 Table
          of Contents


**Glossary**





**ARO.** Asset
      retirement obligation.





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





**Degree
      day.** The
      extent to which the daily average temperature falls below 65 degrees Fahrenheit.
      Normal weather for Nicor Gas’ service territory, for purposes of this report, is
      considered to be 5,830 degree days per year.





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





**FASB.** Financial Accounting Standards Board.





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





**FIN.** FASB
      Interpretation.





**FSP.** FASB
      Staff Position.





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




**ICC.** Illinois
      Commerce Commission, the agency that establishes the rules and regulations
      governing utility rates and services in Illinois.





**IDR.** Illinois
      Department of Revenue.





**IRS.** Internal
      Revenue Service.





**Jobs
      Act.** American
      Jobs Creation Act of 2004.





**LIFO.** Last in,
      first out.





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





**MMBtus.** Million
      British thermal units.





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





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





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


ii
 
 Table
          of Contents




**Nicor.** Nicor
      Inc., or the registrant.





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





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





**PBR.** Performance-based
      rate, a regulatory plan which ended on January 1, 2003, that provided economic
      incentives based on natural gas cost performance.





**PCBs.** Polychlorinated
      Biphenyls.





**PGA.** Nicor
      Gas’ Purchased Gas Adjustment.





**SEC.** The
      United States Securities and Exchange Commission.





**SFAS.** Statement of Financial Accounting Standards.





**TEL.** Tropic
      Equipment Leasing Inc., an indirectly wholly owned subsidiary of Nicor, holds
      the company’s interests in Triton.





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





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





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





**U.S.** United
      States of America.





**USEPA.** United
      States Environmental Protection Agency.





iii
 
 Table
          of Contents


**Part
                I - FINANCIAL INFORMATION****Item
                1.  Financial Statements****Nicor
                Inc.****Condensed
                Consolidated Statements of Operations (Unaudited)****(millions,
                except per share data)****Three
                months ended**
            
            **Nine
                months ended****September
                30**
            
            **September
                30****2007**
            
            2006
            
            **2007**
            
            2006Operating
                revenuesGas
                distribution (includes revenue taxes of$12.8,
                $12.9, $114.0 and $111.5, respectively)
            
            
            
            
            **$**
            **238.9**
            
            $
            226.7
            
            **$**
            **1,878.7**
            
            $
            1,775.6Shipping
            
            
            
            
            
            **97.5**
            
            
            98.3
            
            
            **293.6**
            
            
            288.1Other
                energy ventures
            
            
            
            
            
            **37.3**
            
            
            34.0
            
            
            **159.0**
            
            
            135.1Corporate
                and eliminations
            
            
            
            
            
            **(8.5**
            **)**
            
            (7.9
            )
            
            **(74.5**
            **)**
            
            (77.0
            )Total
                operating revenues
            
            
            
            
            
            **365.2**
            
            
            351.1
            
            
            **2,256.8**
            
            
            2,121.8Operating
                expensesGas
                distributionCost
                of gas
            
            
            
            
            
            **118.4**
            
            
            108.0
            
            
            **1,348.4**
            
            
            1,258.8Operating
                and maintenance
            
            
            
            
            
            **59.7**
            
            
            56.6
            
            
            **201.5**
            
            
            199.9Depreciation
            
            
            
            
            
            **41.4**
            
            
            40.1
            
            
            **124.4**
            
            
            120.3Taxes,
                other than income taxes
            
            
            
            
            
            **17.0**
            
            
            17.0
            
            
            **126.1**
            
            
            123.2Mercury-related
                recoveries, net
            
            
            
            
            
            **-**
            
            
            -
            
            
            **(8.0**
            **)**
            
            (3.6
            )Property
                sale gains
            
            
            
            
            
            **(1.2**
            **)**
            
            (.6
            )
            
            **(2.0**
            **)**
            
            (3.2
            )Shipping
            
            
            
            
            
            **88.8**
            
            
            87.8
            
            
            **266.7**
            
            
            258.6Other
                energy ventures
            
            
            
            
            
            **26.8**
            
            
            27.1
            
            
            **143.2**
            
            
            134.4Litigation
                charge
            
            
            
            
            
            **-**
            
            
            -
            
            
            **-**
            
            
            10.0Other
                corporate expenses and eliminations
            
            
            
            
            
            **(8.5**
            **)**
            
            (13.4
            )
            
            **(72.8**
            **)**
            
            (88.1
            )Total
                operating expenses
            
            
            
            
            
            **342.4**
            
            
            322.6
            
            
            **2,127.5**
            
            
            2,010.3Operating
                income
            
            **22.8**
            
            
            28.5
            
            
            **129.3**
            
            
            111.5Interest
                expense, net of amounts capitalized
            
            **10.4**
            
            
            11.1
            
            
            **34.3**
            
            
            35.5Equity
                investment income, net
            
            **2.4**
            
            
            5.4
            
            
            **4.4**
            
            
            9.2Interest
                income
            
            **2.3**
            
            
            2.5
            
            
            **7.1**
            
            
            7.9Other
                income, net
            
            **-**
            
            
            -
            
            
            **.2**
            
            
            .4Income
                before income taxes
            
            **17.1**
            
            
            25.3
            
            
            **106.7**
            
            
            93.5Income
                tax expense
            
            **2.6**
            
            
            7.7
            
            
            **27.0**
            
            
            23.5Net
                income
            **$**
            **14.5**
            
            $
            17.6
            
            **$**
            **79.7**
            
            $
            70.0Average
                shares of common stock outstandingBasic
            
            
            
            
            
            **45.2**
            
            
            44.7
            
            
            **45.1**
            
            
            44.5Diluted
            
            
            
            
            
            **45.3**
            
            
            44.8
            
            
            **45.2**
            
            
            44.6Earnings
                per average share of common stockBasic
            
            
            
            
            **$**
            **.32**
            
            $
            .39
            
            **$**
            **1.77**
            
            $
            1.57Diluted
            
            
            
            
            
            **.32**
            
            
            .39
            
            
            **1.76**
            
            
            1.57Dividends
                declared per share of common stock
            **$**
            **.465**
            
            $
            .465
            
            **$**
            **1.395**
            
            $
            1.395The
                accompanying notes are an integral part of these
                statements.





1


Table
          of Contents


**Nicor
                Inc.****Condensed
                Consolidated Statements of Cash Flows (Unaudited)****(millions)****Nine
                months ended****September
                30****2007**
            
            2006Operating
                activitiesNet
                income
            
            **$**
            **79.7**
            
            $
            70.0Adjustments
                to reconcile net income to net cash flowprovided
                from operating activities:Depreciation
            
            
            **138.4**
            
            
            133.7Deferred
                income tax benefit
            
            
            **(2.5**
            **)**
            
            (45.2
            )Gain
                on sale of property, plant and equipment
            
            
            **(1.8**
            **)**
            
            (3.1
            )Gain
                on sale of equity investment
            
            
            **-**
            
            
            (2.4
            )Changes
                in assets and liabilities:Receivables,
                less allowances
            
            
            **260.5**
            
            
            554.9Gas
                in storage
            
            
            **(59.1**
            **)**
            
            58.0Accrued
                gas costs
            
            
            **4.6**
            
            
            (114.3
            )Other
                assets
            
            
            **(11.6**
            **)**
            
            14.1Accounts
                payable
            
            
            **17.1**
            
            
            (138.8
            )Litigation
                charge
            
            
            **(10.0**
            **)**
            
            -Other
                liabilities
            
            
            **(53.1**
            **)**
            
            48.7Other
                items
            
            
            **7.2**
            
            
            (27.1
            )Net
                cash flow provided from operating activities
            
            
            **369.4**
            
            
            548.5Investing
                activitiesAdditions
                to property, plant & equipment
            
            
            **(119.1**
            **)**
            
            (128.5
            )Release
                of (additions to) restricted short-term investments
            
            
            **10.0**
            
            
            (10.0
            )Purchases
                of available-for-sale securities
            
            
            **(156.7**
            **)**
            
            -Proceeds
                from the sales of available-for-sale securities
            
            
            **156.7**
            
            
            -Net
                increase in other short-term investments
            
            
            **(23.9**
            **)**
            
            (8.3
            )Proceeds
                from sale of equity investment
            
            
            **-**
            
            
            7.0Net
                proceeds from sale of property, plant and equipment
            
            
            **1.8**
            
            
            3.6Other
                investing activities
            
            
            **(.9**
            **)**
            
            4.1Net
                cash flow used for investing activities
            
            
            **(132.1**
            **)**
            
            (132.1
            )Financing
                activitiesRepayments
                of long-term debt
            
            
            **-**
            
            
            (28.0
            )Net
                repayments of commercial paper with maturities of90
                days or less
            
            
            **(188.0**
            **)**
            
            (435.0
            )Dividends
                paid
            
            
            **(63.0**
            **)**
            
            (62.1
            )Proceeds
                from exercise of stock options
            
            
            **8.1**
            
            
            14.1Other
                financing activities
            
            
            **.4**
            
            
            3.7Net
                cash flow used for financing activities
            
            
            **(242.5**
            **)**
            
            (507.3
            )Net
                decrease in cash and cash equivalents
            
            
            **(5.2**
            **)**
            
            (90.9
            )Cash
                and cash equivalents, beginning of period
            
            
            **41.1**
            
            
            118.9Cash
                and cash equivalents, end of period
            
            **$**
            **35.9**
            
            $
            28.0The
                accompanying notes are an integral part of these
                statements.







2




Table
          of Contents


**Nicor
                Inc.****Condensed
                Consolidated Balance Sheets (Unaudited)****(millions)****September
                30**
            
            December
                31
            
            September
                30**2007**
            
            2006
            
            2006**Assets**
            
            
            
            *
                As Adjusted
            
            *
                As AdjustedCurrent
                assetsCash
                and cash equivalents
            
            
            
            
            **$**
            **35.9**
            
            $
            41.1
            
            $
            28.0Restricted
                short-term investments
            
            
            
            
            
            **-**
            
            
            10.2
            
            
            10.1Short-term
                investments, at cost which approximates market
            
            
            
            
            
            **40.2**
            
            
            16.3
            
            
            16.3Receivables,
                less allowances of $34.0, $33.4and
                $34.7, respectively
            
            
            
            
            
            **303.0**
            
            
            563.5
            
            
            334.2Gas
                in storage
            
            
            
            
            
            **245.1**
            
            
            186.0
            
            
            203.3Deferred
                income taxes
            
            
            
            
            
            **34.6**
            
            
            39.1
            
            
            36.3Other
            
            
            
            
            
            **74.7**
            
            
            54.5
            
            
            54.4Total
                current assets
            
            
            
            
            
            **733.5**
            
            
            910.7
            
            
            682.6Property,
                plant and equipment, at costGas
                distribution
            
            
            
            
            
            **4,234.9**
            
            
            4,157.1
            
            
            4,118.6Shipping
            
            
            
            
            
            **306.3**
            
            
            302.9
            
            
            296.7Other
            
            
            
            
            
            **22.1**
            
            
            19.7
            
            
            18.8**4,563.3**
            
            
            4,479.7
            
            
            4,434.1Less
                accumulated depreciation
            
            
            
            
            
            **1,833.1**
            
            
            1,765.0
            
            
            1,743.6Total
                property, plant and equipment, net
            
            
            
            
            
            **2,730.2**
            
            
            2,714.7
            
            
            2,690.5Pension
                benefits
            
            **169.9**
            
            
            161.0
            
            
            195.0Long-term
                investments
            
            **133.6**
            
            
            134.7
            
            
            132.1Other
                assets
            
            **162.1**
            
            
            169.0
            
            
            64.9Total
                assets
            **$**
            **3,929.3**
            
            $
            4,090.1
            
            $
            3,765.1**Liabilities
                and Capitalization**Current
                liabilitiesLong-term
                debt due within one year
            
            
            
            
            **$**
            **75.0**
            
            $
            -
            
            $
            50.0Short-term
                debt
            
            
            
            
            
            **162.0**
            
            
            350.0
            
            
            151.0Accounts
                payable
            
            
            
            
            
            **579.2**
            
            
            562.1
            
            
            517.0Accrued
                gas costs
            
            
            
            
            
            **54.6**
            
            
            50.0
            
            
            108.9Dividends
                payable
            
            
            
            
            
            **21.0**
            
            
            20.9
            
            
            20.8Obligations
                related to restricted investments
            
            
            
            
            
            **-**
            
            
            10.0
            
            
            10.0Other
            
            
            
            
            
            **115.3**
            
            
            147.0
            
            
            123.3Total
                current liabilities
            
            
            
            
            
            **1,007.1**
            
            
            1,140.0
            
            
            981.0Deferred
                credits and other liabilitiesRegulatory
                retirement cost liability
            
            
            
            
            
            **709.9**
            
            
            676.7
            
            
            662.8Deferred
                income taxes
            
            
            
            
            
            **396.4**
            
            
            399.6
            
            
            415.3Health
                care and other postretirement benefits
            
            
            
            
            
            **183.3**
            
            
            181.6
            
            
            105.9Asset
                retirement obligation
            
            
            
            
            
            **175.3**
            
            
            169.3
            
            
            170.0Regulatory
                income tax liability
            
            
            
            
            
            **51.4**
            
            
            53.8
            
            
            38.7Unamortized
                investment tax credits
            
            
            
            
            
            **28.1**
            
            
            29.6
            
            
            30.2Other
            
            
            
            
            
            **45.7**
            
            
            65.3
            
            
            69.3Total
                deferred credits and other liabilities
            
            
            
            
            
            **1,590.1**
            
            
            1,575.9
            
            
            1,492.2Commitments
                and contingenciesCapitalizationLong-term
                obligationsLong-term
                debt, net of unamortized discount
            
            
            
            
            
            **422.7**
            
            
            497.5
            
            
            459.4Mandatorily
                redeemable preferred stock
            
            
            
            
            
            **.6**
            
            
            .6
            
            
            .6Total
                long-term obligations
            
            
            
            
            
            **423.3**
            
            
            498.1
            
            
            460.0Common
                equityCommon
                stock
            
            
            
            
            
            **112.8**
            
            
            112.3
            
            
            111.6Paid-in
                capital
            
            
            
            
            
            **44.4**
            
            
            34.1
            
            
            24.5Retained
                earnings
            
            
            
            
            
            **761.1**
            
            
            743.0
            
            
            705.7Accumulated
                other comprehensive loss, net
            
            
            
            
            
            **(9.5**
            **)**
            
            (13.3
            )
            
            (9.9
            )Total
                common equity
            
            
            
            
            
            **908.8**
            
            
            876.1
            
            
            831.9Total
                capitalization
            
            
            
            
            
            **1,332.1**
            
            
            1,374.2
            
            
            1,291.9Total
                liabilities and capitalization
            **$**
            **3,929.3**
            
            $
            4,090.1
            
            $
            3,765.1


* 
Pursuant
      to FSP No. AUG AIR-1, *Accounting
      for Planned Major Maintenance Activities,*one of Nicor's subsidiaries, Tropical
      Shipping, changed its accounting method for planned major maintenance to the
      direct expensing method effective
      January 1, 2007, and retrospectively increased retained earnings by $3.5 million
      for the earliest period presented.




The
        accompanying notes are an integral part of these statements.






3




Table
          of Contents


**Nicor
      Inc.**





**Notes
      to the Condensed Consolidated Financial Statements (Unaudited)**





**1.** **BASIS
      OF PRESENTATION**





The
      unaudited Condensed Consolidated Financial Statements of Nicor have been
      prepared by the company pursuant to the rules and regulations of the SEC.
      Certain information and note disclosures normally included in financial
      statements prepared in accordance with accounting principles generally accepted
      in the United States have been condensed or omitted pursuant to SEC rules and
      regulations. The unaudited Condensed Consolidated Financial Statements and
      Notes
      should be read in conjunction with the financial statements and the notes
      thereto included in the company’s 2006 Annual Report on Form 10-K.





The
      information furnished reflects, in the opinion of the company, all adjustments
      (consisting only of normal recurring adjustments and adjustments to reflect
      the
      changes in accounting policy as described in Note 3 - New Accounting
      Pronouncements) necessary for a fair statement of the results for the interim
      periods presented. Results for the interim periods presented are not necessarily
      indicative of the results to be expected for the full fiscal year due to
      seasonal and other factors.





**2.** **ACCOUNTING
      POLICIES**





**Gas
      in storage.** Gas
      distribution segment inventory is carried at cost on a LIFO basis. Inventory
      decrements occurring during interim periods that are expected to be restored
      prior to year-end are charged to cost of gas at the estimated annual replacement
      cost, and the difference between this cost and the actual LIFO layer cost is
      recorded on the balance sheet as a current temporary LIFO liquidation. Interim
      inventory decrements not expected to be restored prior to year-end are charged
      to cost of gas at the actual LIFO cost of the layers liquidated.




At
      September 30, 2006, the company had an inventory decrement of approximately
      5
      Bcf which was not restored prior to year-end. The liquidated inventory was
      charged to cost of gas at a LIFO cost of $7.82 per Mcf. If the company had
      deemed the decrement to be temporary, it would have charged cost of gas for
      an
      estimate of the annual replacement cost, which was about $6.32 per Mcf. Applying
      LIFO cost in valuing the decrement, as opposed to the estimated annual
      replacement cost, had the effect of increasing the cost of gas distributed
      by
      $7.5 million as of September 30, 2006. However, since the cost of gas, including
      inventory costs, is charged to customers without markup, subject to ICC review,
      this difference had no impact on net income. There was no permanent inventory
      decrement as of September 30, 2007.





Nicor
      Enerchange inventory is carried at the lower of weighted-average cost or market.
      Nicor Enerchange recorded a charge of $5.0 million in the second quarter of
      2007
      resulting from a lower of cost or market valuation. Nicor Enerchange also
      recorded charges of $11.8 million and $16.5 million for the three and nine-month
      periods ended September 30, 2006 resulting from lower of cost or market
      valuations.





**Regulatory
      assets and liabilities.** Nicor
      Gas is regulated by the ICC, which establishes the rules and regulations
      governing utility rates and services in Illinois. As a rate-regulated company,
      Nicor Gas applies SFAS No. 71, *Accounting
      for the Effects of Certain Types of Regulation,* which
      allows Nicor Gas to recognize the economic effects of rate regulation and,
      accordingly, has recorded regulatory assets and liabilities. Regulatory assets
      represent probable future revenue associated with certain costs that are
      expected to be recovered from customers through rate riders or base rates,
      upon
      approval by the ICC. Regulatory liabilities represent probable future reductions
      in revenues collected from ratepayers through a rate rider or base rates. If
      Nicor Gas’ operations become no longer subject to the provisions of SFAS No. 71,
      a write-off of net regulatory liabilities would be required.


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The
      company had regulatory assets and liabilities as follows (in millions):





**September
                30**
            
            December
                31
            
            September
                30**2007**
            
            2006
            
            2006**Regulatory
                assets**Regulatory
                postretirement asset - current
            
            **$**
            **8.8**
            
            $
            8.8
            
            $
            -Regulatory
                postretirement asset - noncurrent
            
            
            **101.0**
            
            
            104.7
            
            
            -Deferred
                environmental costs
            
            
            **10.9**
            
            
            16.0
            
            
            14.2Unamortized
                losses on reacquired debt
            
            
            **16.8**
            
            
            17.6
            
            
            17.9Deferred
                rate case costs
            
            
            **2.7**
            
            
            3.0
            
            
            3.1Other
            
            
            **1.1**
            
            
            1.0
            
            
            3.8**$**
            **141.3**
            
            $
            151.1
            
            $
            39.0





**Regulatory
                liabilities**Regulatory
                retirement cost liability - current
            
            **$**
            **8.0**
            
            $
            8.0
            
            $
            9.0Regulatory
                retirement cost liability - noncurrent
            
            
            **709.9**
            
            
            676.7
            
            
            662.8Accrued
                gas costs
            
            
            **54.6**
            
            
            50.0
            
            
            108.9Regulatory
                income tax liability
            
            
            **51.4**
            
            
            53.8
            
            
            38.7Other
            
            
            **-**
            
            
            -
            
            
            .1**$**
            **823.9**
            
            $
            788.5
            
            $
            819.5





The
      current portion of the regulatory postretirement asset is classified in current
      other assets and all other regulatory assets are classified in noncurrent other
      assets. The current portion of the regulatory retirement cost liability is
      classified in current other liabilities. Regulatory liabilities - Other is
      classified in noncurrent other liabilities.





The
      ICC
      does not presently allow Nicor Gas the opportunity to earn a return on its
      regulatory postretirement asset. This regulatory asset is expected to be
      recovered from ratepayers over a period of approximately 10 to 15 years. The
      regulatory assets related to debt are not included in rate base, but are
      recovered over the term of the debt through the rate of return authorized by
      the
      ICC.





**Revenue
      taxes.** Nicor
      Gas
      classifies revenue taxes billed to customers as operating revenues and related
      taxes incurred as operating expenses. Revenue taxes included in operating
      expense for the three and nine months ended September 30, 2007 were $12.6
      million and $112.2 million, respectively, and $12.6 million and $109.0 million
      ,
      respectively, for the same periods ending September 30, 2006.





**Mercury-related
      recoveries, net.** Mercury-related
      recoveries, net reflect the estimated costs, recoveries and reserve adjustments
      associated with the company’s mercury inspection and repair program.





**Reclassifications.** Certain
      reclassifications have been made to conform the prior year’s financial
      statements to the current year’s presentation.





**3.** **NEW
      ACCOUNTING PRONOUNCEMENTS**





**Uncertain
      tax positions.** The
      company adopted the provisions of FIN 48, *Accounting
      for Uncertainty in Income Taxes* ,
      on
      January 1, 2007. As of the date of adoption, the company recorded a cumulative
      effect adjustment that resulted in increasing retained earnings by $1.4 million.
      This Interpretation sets forth a recognition threshold and valuation method
      to
      recognize and measure an income tax position taken, or expected to be taken,
      in
      a tax return. The evaluation is based on a two-step approach. The first step
      requires an entity to evaluate whether the tax position would “more likely than
      not,” based upon its technical merits, be sustained upon examination by the
      appropriate taxing authority. The second step requires the tax position to
      be
      measured at the largest amount of tax benefit that is greater than 50 percent
      likely of being realized upon ultimate settlement. In addition, previously


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recognized
      benefits from tax positions that no longer meet the new criteria are required
      to
      be derecognized.





The
      company’s major tax jurisdictions include the United States and the State of
      Illinois with tax returns examined by the IRS and the IDR, respectively. As
      of
      January 1, 2007, the years that remain subject to examination by
      the IRS include years beginning after 2001, and the years that remain subject
      to
      examination by the IDR include years beginning after 2002.  For tax
      positions within years that remain subject to examination, management has
      recognized the largest amount of tax benefit that it believes is greater than
      50
      percent likely of being realized upon settlement with the taxing authority.
      The
      company’s liability for unrecognized tax benefits was approximately $5 million
      at January 1, 2007, of which approximately $5 million, if recognized, would
      impact the company’s effective tax rate. There have been no significant changes
      to these amounts during the three and nine month periods ended September 30,
      2007. Due to a number of factors, including the potential closure of
      examinations, the expiration of statute of limitations, and the potential
      resolution of court cases, the company anticipates that it is reasonably
      possible that a change to its unrecognized tax benefits could occur within
      12
      months, potentially increasing by $6 million or decreasing by $7 million its
      unrecognized tax benefit.





The
      company records interest accrued related to unrecognized tax benefits in
      interest expense, and penalties, if any, are recorded in operating expense.
      Amounts accrued for the payment of interest totaled approximately $11 million
      and $17 million at January 1, 2007 and September 30, 2007, respectively.





**Planned
      major maintenance activities.** The
      company adopted the provisions of FSP No. AUG AIR-1, *Accounting
      for Planned Major Maintenance Activities* ,
      on
      January 1, 2007. As of the date of adoption, the company retrospectively
      increased retained earnings by $3.5 million with an offsetting adjustment to
      accounts payable of $2.4 million and other non-current liabilities of $1.1
      million for the earliest period presented in this report . This
      FSP
      disallowed the accrue-in-advance method of accounting for planned major
      maintenance activities, which was the method utilized by Tropical Shipping
      for
      the planned major maintenance of its owned vessels. Pursuant to this FSP,
      Tropical Shipping changed its accounting method for planned major maintenance
      to
      the direct expensing method. Since
      the
      adoption of the new method had no material impact on previously issued
      statements of operations, those statements have not been retrospectively
      adjusted.





**Fair
      value measurements.** In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* .
      This
      Statement defines fair value, establishes a framework for measuring fair value
      and expands disclosures about fair value measurements. The Statement does not
      require any new fair value measurements, rather it provides guidance on how
      to
      perform fair value measurements as required or permitted under other accounting
      pronouncements. This Statement is effective for Nicor no later than January
      1,
      2008 and is expected to be adopted prospectively at that time. The company
      is
      currently evaluating the Statement and the impact it may have on the company’s
      results of operations and financial condition.





**Offsetting
      of amounts related to certain contracts.** In April
      2007, FSP No. FIN 39-1, *Amendment
      of FIN 39, Offsetting of Amounts Related to Certain Contracts* ,
      was
      issued. This FSP amends FIN 39 to replace the terms “conditional contracts” and
“exchange contracts” with the term “derivative instruments” as defined in SFAS
      No. 133, *Accounting
      for Derivative Instruments and Hedging Activities* .
      Also,
      this FSP provides guidance on whether the receivable or liability recognized
      upon payment or receipt of cash collateral in a master netting agreement must
      be
      offset against fair value amounts recognized for contracts that have been offset
      in the same master netting agreement. This FSP is effective for Nicor no later
      than January 1, 2008 and is expected to be adopted retrospectively at that
      time.
      The company is currently evaluating the FSP and the impact it may have on the
      company’s financial condition and related disclosures.


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**4.** **RESTRICTED
      SHORT-TERM INVESTMENTS**





In
      July
      2006, Nicor reached a tentative agreement with the staff of the Enforcement
      Division of the SEC in settlement of an anticipated civil action against the
      company for a payment of $10 million. At that time, the company deposited $10
      million in an escrow account pending review and final approval of the tentative
      settlement by the SEC commissioners. The SEC commissioners approved the
      tentative settlement in March 2007. A final judgment, dated April 30, 2007,
      was
      entered by a federal court approving the settlement and the funds held in
      escrow were released. For further information, see Note 14 - Contingencies
      - SEC
      and U.S. Attorney Inquiries.





**5.** **SHORT-TERM
      AND LONG-TERM DEBT**





In
      October 2007, Nicor Gas established a $400 million, 210-day seasonal revolver,
      which expires in May 2008, to replace the $400 million, 210-day seasonal
      revolver, which expired in May 2007. In September 2005, Nicor and Nicor Gas
      established a $600 million, five-year revolver, expiring September 2010. These
      facilities were established with major domestic and foreign banks and serve
      as
      backup for the issuance of commercial paper. The company had $162 million,
      $350
      million and $151 million of commercial paper borrowings outstanding at September
      30, 2007, December 31, 2006 and September 30, 2006, respectively.





At
      September 30, 2006, Tropical Shipping had $12 million outstanding on a $40
      million two-year senior unsecured term loan, which was paid in full by the
      fourth quarter of 2006.





The
      company believes it is in compliance with all debt covenants.





**6.** **INCOME
      AND OTHER TAXES**





Effective
      January 2006, the company reorganized certain of its shipping and related
      operations primarily to take advantage of certain provisions of the Jobs Act
      that provide the opportunity for future tax savings. In connection with these
      activities, a net income tax benefit of approximately $6 million was recorded
      in
      the first quarter of 2006 from the elimination of certain deferred taxes offset,
      in part, by approximately $3 million in current tax expense recognized in the
      first nine months of 2006 also associated with these activities. Generally,
      to
      the extent foreign shipping earnings are not repatriated to the United States,
      such earnings are not expected to be subject to current taxation. In addition,
      to the extent such earnings are determined to be indefinitely reinvested
      offshore, no deferred income tax expense would be recorded by the company.
      For
      the three and nine-month periods ended September 30, 2007, income tax expense
      has not been provided on approximately $6 million and $19 million, respectively,
      of foreign company shipping earnings that are expected to be indefinitely
      reinvested offshore compared to approximately $6 million and $17 million,
      respectively, for the comparable periods in 2006.





The
      effective income tax rate for the quarter ended September 30, 2007 decreased
      to
      15.2 percent from 30.3 percent for the quarter ended September 30, 2006 due
      primarily to a reduction in taxable foreign earnings which was recognized in
      the
      third quarter of 2007. The effective income tax rate for the nine months ended
      September 30, 2007 increased to 25.3 percent from 25.1 percent for the
      prior-year period. The rate for the first nine months of 2006 reflects the
      recognition of additional tax benefits related to the first quarter 2006
      reorganization of the company’s shipping and related operations and second
      quarter 2006 favorable adjustments associated with tax audits (which occur
      in
      the ordinary course of business) offset, in part, by the second quarter of
      2006
      non-deductible $10 million charge associated with the company’s SEC inquiry. The
      rate for the first nine months of 2007 reflects the previously mentioned
      reduction in taxable foreign earnings recognized in the third quarter of 2007.
      Both nine-month periods reflect the ongoing benefit of untaxed foreign shipping
      earnings.





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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 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 required repayment in 2005 and 2006 of amounts previously
      taken as current tax deductions. During 2006 and 2005, the company reclassified
      income tax expense from deferred to current and repaid approximately $135
      million equally over those years.




**7.** **ACCRUED
      UNBILLED REVENUES**





Receivables
      include accrued unbilled revenues of $57.4 million, $159.5 million and $52.9
      million at September 30, 2007, December 31, 2006 and September 30, 2006,
      respectively, related primarily to gas distribution operations. Nicor Gas
      accrues revenues for estimated deliveries to customers from the date of their
      last bill until the balance sheet date.





**8.** **FAIR
      VALUE OF FINANCIAL INSTRUMENTS**





The
      recorded amount of short-term investments, restricted short-term investments
      and
      short-term borrowings approximates fair value because of the short maturity
      of
      the instruments. Long-term debt outstanding, including current maturities,
      is
      recorded at the principal balance outstanding, net of unamortized discounts.
      The
      principal balance of Nicor Gas’ First Mortgage Bonds **** outstanding
      at September 30, 2007, December 31, 2006 and September 30, 2006 was $500
      million. Based on quoted market interest rates, the fair value of the company’s
      First Mortgage Bonds outstanding was approximately $508 million, $518 million
      and $515 million at September 30, 2007, December 31, 2006 and September 30,
      2006, respectively.





Derivative
      financial instruments are recorded at fair value as determined primarily from
      actively quoted prices. The fair value of derivative financial instruments
      relates largely to Nicor Gas. The majority of derivative financial instruments
      held by Nicor Gas are for the purpose of hedging natural gas purchases for
      its
      customers, and their settlement is passed directly through to customers without
      markup, subject to ICC review. The gross asset and liability fair values of
      these instruments are reflected on the Condensed Consolidated Balance Sheets
      as
      follows (in millions):





**September
                30**
            
            December
                31
            
            September
                30**2007**
            
            2006
            
            2006Current
                other assets
            
            **$**
            **7.5**
            
            $
            5.3
            
            $
            13.0Noncurrent
                other assets
            
            
            **.5**
            
            
            .5
            
            
            1.1**$**
            **8.0**
            
            $
            5.8
            
            $
            14.1Current
                other liabilities
            
            **$**
            **17.8**
            
            $
            51.3
            
            $
            50.3Noncurrent
                other liabilities
            
            
            **.8**
            
            
            1.2
            
            
            4.9**$**
            **18.6**
            
            $
            52.5
            
            $
            55.2





Nicor
      maintains margin accounts related to financial derivative transactions. At
      September 30, 2007, December 31, 2006 and September 30, 2006, the balance of
      these accounts was $22.8 million, $16.2 million and $35.7 million, respectively,
      and was reflected on the Condensed Consolidated Balance Sheets as
      Receivables.


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**9.** **POSTRETIREMENT
      BENEFITS**





Nicor
      Gas
      maintains a noncontributory defined benefit pension plan covering substantially
      all employees hired prior to 1998. Pension benefits are based on years of
      service and highest average salary for management employees and job level for
      unionized employees. The benefit obligation related to collectively bargained
      benefits considers the company’s past practice of regular benefit increases to
      reflect current wages. Nicor Gas also provides health care and life insurance
      benefits to eligible retired employees under a plan that includes limits on
      the
      company’s share of cost for employees hired after 1982. The company’s
      postretirement benefit costs have historically been considered in rate
      proceedings in the period they are accrued. To the extent eligible employees
      perform services for non-regulated affiliates, such affiliates are charged
      for
      the cost of these benefits.


About
      one-fourth of the net periodic benefit cost or credit related to these plans
      has
      been capitalized as a cost of constructing gas distribution facilities and
      the
      remainder is included in gas distribution operating and maintenance expense.
      Net
      periodic benefit cost (credit) included the following components (in
      millions):


Pension
                benefits
            
            Health
                care and
              other
                benefits**2007**
            
            2006
            
            **2007**
            
            2006**Three
                months ended September 30**Service
                cost
            
            **$**
            **2.2**
            
            $
            2.3
            
            **$**
            **.5**
            
            $
            .6Interest
                cost
            
            
            **3.8**
            
            
            3.8
            
            
            **2.7**
            
            
            2.5Expected
                return on plan assets
            
            
            **(9.0**
            **)**
            
            (8.8
            )
            
            **-**
            
            
            (.1
            )Recognized
                net actuarial loss
            
            
            **-**
            
            
            .1
            
            
            **1.3**
            
            
            1.4Amortization
                of prior service cost
            
            
            **.1**
            
            
            .1
            
            
            **(.1**
            **)**
            
            (.1
            )Net
                periodic benefit cost (credit)
            
            **$**
            **(2.9**
            **)**
            $
            (2.5
            )
            **$**
            **4.4**
            
            $
            4.3**Nine months ended September 30**Service
                cost
            
            **$**
            **6.8**
            
            $
            7.0
            
            **$**
            **1.7**
            
            $
            1.8Interest
                cost
            
            
            **11.3**
            
            
            11.2
            
            
            **8.1**
            
            
            7.7Expected
                return on plan assets
            
            
            **(27.0**
            **)**
            
            (26.2
            )
            
            **-**
            
            
            (.2
            )Recognized
                net actuarial loss
            
            
            **-**
            
            
            .2
            
            
            **3.6**
            
            
            3.8Amortization
                of prior service cost
            
            
            **.4**
            
            
            .4
            
            
            **(.1**
            **)**
            
            (.1
            )Net
                periodic benefit cost (credit)
            
            **$**
            **(8.5**
            **)**
            $
            (7.4
            )
            **$**
            **13.3**
            
            $
            13.0





In
      the
      first quarter of 2007, the company received a federal subsidy of $1.2 million
      under the Medicare Prescription Drug, Improvement and Modernization Act of
      2003.
      The subsidy relates to the company’s 2006 retiree health care benefits and is
      comparable to the benefit assumed in the most recent actuarial valuation.





**10.** **EQUITY
      INVESTMENT INCOME, NET**





Net
      equity investment income includes investment income from Triton of $1.5 million
      and $3.7 million, respectively, for the three and nine-month periods ended
      September 30, 2007 and $2.0 million and $4.5 million for the same periods ended
      September 30, 2006, respectively. Also included in net equity investment income
      for the three and nine months ended September 30, 2006 is a $2.4 million gain
      on
      a sale of an equity investment. Nicor received cash distributions from equity
      investees for the three and nine-month periods ended September 30, 2007 of
      $2.6
      million and $8.9 million, respectively, and $1.5 million and $4.8 million,
      respectively, for the same periods ended September 30, 2006.


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**11.** **COMPREHENSIVE
      INCOME**





Total
      comprehensive income, as defined by SFAS No. 130, *Reporting
      Comprehensive Income* ,
      is
      equal to net income plus other comprehensive income and is as follows (in
      millions):




Three
                  months ended
              
              Nine
                  months endedSeptember
                  30
              
              September
                  30**2007**
              
              2006
              
              **2007**
              
              2006Net
                  income
              
              **$**
              **14.5**
              
              $
              17.6
              
              **$**
              **79.7**
              
              $
              70.0Other
                  comprehensive income (loss), after tax
              
              
              **(1.6**
              **)**
              
              (4.6
              )
              
              **3.8**
              
              
              (8.3
              )Total
                  comprehensive income
              
              **$**
              **12.9**
              
              $
              13.0
              
              **$**
              **83.5**
              
              $
              61.7




Other
      comprehensive income (loss) consists primarily of net unrealized gains and
      losses from derivative financial instruments accounted for as cash flow hedges,
      including Nicor’s share of such amounts from joint ventures and other
      equity-method investees.





**12.** **BUSINESS
      SEGMENT INFORMATION**





Financial
      data by major business segment is presented below (in millions):


Gas
              distribution
            
            Shipping
            
            Other
                energy ventures
            
            Corporate
                and
              eliminations
            
            Consolidated**Three
                months ended September 30, 2007**Operating
                revenuesExternal
                customers
            
            **$**
            **232.8**
            
            **$**
            **97.5**
            
            **$**
            **34.9**
            
            **$**
            **-**
            
            **$**
            **365.2**Intersegment
            
            
            **6.1**
            
            
            **-**
            
            
            **2.4**
            
            
            **(8.5**
            **)**
            
            **-****$**
            **238.9**
            
            **$**
            **97.5**
            
            **$**
            **37.3**
            
            **$**
            **(8.5**
            **)**
            **$**
            **365.2**Operating
                income
            
            **$**
            **3.6**
            
            **$**
            **8.7**
            
            **$**
            **10.5**
            
            **$**
            **-**
            
            **$**
            **22.8****Three
                months ended September 30, 2006**Operating
                revenuesExternal
                customers
            
            $
            219.7
            
            $
            98.3
            
            $
            33.1
            
            $
            -
            
            $
            351.1Intersegment
            
            
            7.0
            
            
            -
            
            
            .9
            
            
            (7.9
            )
            
            -$
            226.7
            
            $
            98.3
            
            $
            34.0
            
            $
            (7.9
            )
            $
            351.1Operating
                income
            
            $
            5.6
            
            $
            10.5
            
            $
            6.9
            
            $
            5.5
            
            $
            28.5**Nine
                months ended September 30, 2007**Operating
                revenuesExternal customers
            
            **$**
            **1,825.8**
            
            **$**
            **293.6**
            
            **$**
            **137.4**
            
            **$**
            **-**
            
            **$**
            **2,256.8**Intersegment
            
            
            **52.9**
            
            
            **-**
            
            
            **21.6**
            
            
            **(74.5**
            **)**
            
            **-****$**
            **1,878.7**
            
            **$**
            **293.6**
            
            **$**
            **159.0**
            
            **$**
            **(74.5**
            **)**
            **$**
            **2,256.8**Operating
                income (loss)
            
            **$**
            **88.3**
            
            **$**
            **26.9**
            
            **$**
            **15.8**
            
            **$**
            **(1.7**
            **)**
            **$**
            **129.3****Nine
                months ended September 30, 2006**Operating
                revenuesExternal customers
            
            $
            1,714.4
            
            $
            288.1
            
            $
            119.3
            
            $
            -
            
            $
            2,121.8Intersegment
            
            
            61.2
            
            
            -
            
            
            15.8
            
            
            (77.0
            )
            
            -$
            1,775.6
            
            $
            288.1
            
            $
            135.1
            
            $
            (77.0
            )
            $
            2,121.8Operating
                income
            
            $
            80.2
            
            $
            29.5
            
            $
            .7
            
            $
            1.1
            
            $
            111.5





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The
      majority of intersegment revenues represent gas distribution revenues related
      to
      customers entering into utility-bill management contracts with Nicor Solutions.
      Under the utility-bill management contracts, Nicor
      Solutions bills a fixed amount to a customer, regardless of changes in natural
      gas prices or weather, and in exchange pays the customer’s utility bills from
      Nicor Gas. Intersegment revenues are eliminated in the Condensed Consolidated
      Financial Statements.





Operating
      income in the “Corporate and eliminations” column includes the following
      items:





·
            In
                the third quarter of 2006, the company recognized $5.2 million of
                insurance recoveries related to previously incurred legal expenses
                associated with the securities class action and shareholder derivative
                lawsuit settlements.


·
            In
                the year-to-date 2006 period, the company recorded a $10 million
                charge
                (non-deductible for tax purposes) associated with the SEC inquiry.
                For
                more information, see Note 14 - Contingencies - SEC and U.S. Attorney
                Inquiries.


·
            Benefits
                (costs) associated with Nicor’s other energy ventures’ utility-bill
                management contracts attributable to warmer (colder) than normal
                weather
                for the three and nine months ended September 30, 2007 were $0.3
                million
                and $0.2 million, respectively, and $(0.1) million and $6.3 million,
                respectively, for the same periods ending September 30, 2006. The
                weather
                impact of these contracts generally serves to offset the gas distribution
                segment’s weather risk. This benefit (cost) is recorded at the corporate
                level as a result of an agreement between the parent company and
                certain
                of its subsidiaries.





**13.** **GUARANTEES
      AND INDEMNITIES**





Nicor
      and
      certain subsidiaries enter into various financial and performance guarantees
      and
      indemnities providing assurance to third parties.





**Financial
      guarantees.** The
      company has issued guarantees of affiliate obligations to vendors and other
      third parties, requiring Nicor to pay the obligations should its affiliates
      default. The obligations of the company’s wholly owned subsidiaries are
      reflected in Nicor’s Condensed Consolidated Balance Sheets, while the
      obligations of its unconsolidated equity investments are not.





TEL
      has a
      contingent liability to restore to zero any deficit in its equity account for
      income tax purposes in the unlikely event that Triton is liquidated and a
      deficit balance remains. This contingent liability continues for the life of
      the
      Triton partnerships and any payment is effectively limited to the assets of
      TEL,
      which were approximately $18 million at September 30, 2007. Nicor believes
      the
      likelihood of any such payment by TEL is remote, and no liability has been
      recorded for this contingency.





**Performance
      guarantees.** Nicor
      Services markets separately priced product warranty contracts that provide
      for
      the repair of heating, ventilation and air conditioning equipment, natural
      gas
      lines, and other appliances within homes. Revenues from these product warranty
      contracts are recognized ratably over the coverage period, and related repair
      costs are charged to expense as incurred. Repair expenses of $1.5 million and
      $4.7 million were incurred in the three and nine months ended September 30,
      2007, respectively, and $1.5 million and $4.3 million, respectively, for the
      same periods last year.





**Indemnities.** In
      certain instances, Nicor has undertaken to indemnify current property owners
      and
      others against costs associated with the effects and/or remediation of
      contaminated sites for which the company may be responsible under applicable
      federal or state environmental laws, generally with no limitation as to the
      amount. Aside from liabilities recorded in connection with coal tar clean-up,
      as
      discussed in Note 14 - Contingencies - Manufactured Gas Plant Sites, Nicor
      believes that the likelihood of payment under these indemnifications is either
      remote, or the fair value of the indemnification is immaterial, and no liability
      has been recorded for these indemnifications.


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Nicor
      has
      also indemnified, to the fullest extent permitted under the laws of the State
      of
      Illinois and any other applicable laws, its present and former directors,
      officers and employees against expenses they may incur in connection with
      litigation they are a party to by reason of their association with the company.
      There is generally no limitation as to the amount. During the second quarter
      of
      2007, the SEC filed a civil injunctive action against three former officers
      of
      Nicor relating to the PBR Plan. Defense costs that are being incurred by these
      former officers in connection with the SEC action currently are being tendered
      to, and paid by, the company’s insurer. While the company does not expect to
      incur significant costs relating to the indemnification of present and former
      directors, officers and employees after taking into account available insurance,
      it is not possible to estimate the maximum future potential payments.





**14.** **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.





**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 plan 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. 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.





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 2004 increasing the recorded
      liability to $26.6 million. 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. In addition,
      interest due to the company on certain components of these amounts has not
      been
      recognized in the financial statements due to the same uncertainties. 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.


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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. In 2004, the
      evidentiary hearings on this matter were stayed in order to permit the parties
      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. In December 2006, the additional
      third party discovery from EKT was obtained, Nicor Gas withdrew its previously
      filed testimony and the Administrative Law Judges issued a scheduling order
      that
      provided for Nicor Gas to submit direct testimony by April 13, 2007. In its
      direct testimony filed pursuant to the scheduling order, Nicor Gas seeks a
      reimbursement of approximately $6 million, which includes interest due to the
      company as noted above of $1.6 million, as of March 31, 2007. No date has been
      set for evidentiary hearings on this matter.





During
      the course of the 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 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 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 2004.





Nicor
      is
      unable to predict the outcome of the ICC’s review 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 September 30,
      2007.


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**SEC
      and U.S. Attorney Inquiries.** In 2002,
      the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that
      the SEC was conducting a formal inquiry regarding the PBR plan. A representative
      of the Office of the United States Attorney for the Northern District of
      Illinois (the “U.S Attorney”) also notified Nicor that that office was
      conducting an inquiry on the same matter that the SEC is investigating, and
      a
      grand jury was also reviewing this matter. In April 2004, Nicor was advised
      by
      the SEC Staff 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. In July 2006, the company announced
      that it reached a tentative agreement with the SEC Staff in settlement of an
      anticipated civil action to which the company and the SEC would be parties.
      The
      SEC commissioners approved the settlement in March 2007, and a final judgment
      was entered by a federal court approving the settlement on April 30, 2007.
      Under
      the terms of the settlement, the company was required to disgorge one dollar
      and
      pay a monetary fine of $10 million and is subject to an injunction prohibiting
      violations of certain provisions of the federal securities laws. The company
      neither admits nor denies any wrongdoing. In July 2006, the company deposited
      the $10 million in escrow. Those funds were released following entry of the
      federal court judgment approving the settlement. Nicor recorded a $10 million
      charge to its 2006 second quarter earnings in connection with this matter.
      The
      $10 million fine is not deductible for federal or state income tax purposes.
      In
      December 2006, the U.S. Attorney advised that it was closing its separate
      inquiry and would not seek to prosecute the company in connection with this
      matter.





**Fixed
      Bill Service.** On April
      29, 2003, a second amended purported class action complaint was filed in the
      Circuit Court of Cook County, Illinois against Nicor Energy Services Company
      (“Nicor Services”) alleging violation of the Illinois Consumer Fraud Act
      (“ICFA”) by Nicor Services relating to the fixed bill service offered by Nicor
      Services. Nicor Services offered a fixed bill product under which it paid the
      annual gas service portion of a customer’s Nicor Gas utility bill in exchange
      for twelve equal monthly payments by the customer to Nicor Services, regardless
      of changes in the price of natural gas or weather. The plaintiff sought
      compensatory damages, prejudgment and postjudgment interest, punitive damages,
      attorneys’ fees and injunctive relief on behalf of a proposed class consisting
      of all purchasers of the fixed bill service from February 1, 2002 through
      December 31, 2002. On October 7, 2005, the Circuit Court denied plaintiffs’
motion to certify the proposed class. In March 2007, Nicor Services settled
      this
      matter and the lawsuit was dismissed with prejudice.





**Mercury** .
      Nicor
      Gas has incurred, and expects to continue to incur, costs related to its
      historical use of mercury in various kinds of company equipment.





In
      the
      first quarter of 2007, Nicor Gas recorded a $7.2 million reduction to its
      previously established reserve for mercury-related matters. The reduction was
      attributable primarily to the favorable settlement during that quarter of
      certain lawsuits that had been pending against Nicor Gas. As of September 30,
      2007, Nicor Gas had remaining an estimated liability of $2.9 million related
      to
      inspection, clean-up and legal defense costs. This represents management’s best
      estimate of future costs based on an evaluation of currently available
      information. Actual costs may vary from this estimate.





Nicor
      Gas
      remains a defendant in several private lawsuits, all in the Circuit Court of
      Cook County, Illinois, seeking a variety of unquantified damages (including
      bodily injury and property damages) allegedly caused by mercury spillage
      resulting from the removal of mercury-containing regulators. Potential
      liabilities relating to these claims have been assumed by a contractor’s insurer
      subject to certain limitations.





Nicor
      Gas
      continues to pursue recovery from insurers and independent contractors that
      had
      performed work for the company. When received, these recoveries are recorded
      as
      a reduction to gas distribution operating expense. Nicor Gas received
      approximately $3.8 million, net of legal fees, from an independent contractor
      in
      the first quarter of 2006. In 2004, the Circuit Court of Cook County, Illinois
      entered judgment in favor of Nicor and Nicor Gas and against various insurers
      in
      the amount of $10.2 million with respect to one of Nicor’s and Nicor Gas’
mercury-related insurance claims. The insurers filed an


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appeal
      of
      the judgment. In 2005, the First District Appellate Court reversed the Circuit
      Court’s judgment in favor of Nicor and Nicor Gas and remanded the case to the
      Circuit Court for proceedings consistent with the Appellate Court’s decision. In
      November 2006, the Illinois Supreme Court upheld the decision of the Appellate
      Court and remanded the case to the trial court. In the first quarter of 2007,
      an
      agreement to
      settle
      this matter was reached with the lead insurers resulting in an additional net
      insurance recovery of approximately $0.7 million.





The
      final
      disposition of these mercury-related matters is not expected to have a material
      adverse impact on the company’s liquidity or financial condition.





**Manufactured
      Gas Plant Sites.** Manufactured gas plants were used in the 1800’s and early to mid 1900’s to
      produce manufactured gas from coal, creating a coal tar byproduct. Current
      environmental laws may require the clean-up of coal tar at certain former
      manufactured gas plant sites.





To
      date,
      Nicor Gas has identified about 40 properties for which it may have some
      responsibility. Most of these properties are not presently owned by the company.
      Nicor Gas and Commonwealth Edison Company (“ComEd”) are parties to an interim
      agreement to cooperate in cleaning up residue at many of these properties.
      Under
      the interim agreement, mutually agreed costs are to be evenly split between
      Nicor Gas and ComEd until such time as they are finally allocated either through
      negotiation or arbitration. On April 17, 2006, Nicor Gas initiated arbitration
      to determine the final allocations of these costs between Nicor Gas and ComEd.
      On July 24, 2007, Nicor Gas and ComEd entered into an agreement in principle
      concerning final cost allocations. The agreement in principle provides for
      final
      cost sharing that would have the effects of preserving the equal sharing with
      respect to mutually agreed clean-up costs incurred to date under the interim
      agreement and of allocating to Nicor Gas 51.73 percent of future clean-up costs
      for twenty-four sites and no portion of the future clean-up costs for fourteen
      other sites. The agreement in principle is subject, among other things, to
      negotiation of a definitive agreement and approval of that definitive agreement
      by the ICC. The matter currently is stayed pursuant to the panel’s order and is
      expected to be stayed pending the negotiation and ICC review of the definitive
      agreement. Information regarding preliminary site reviews has been presented
      to
      the Illinois Environmental Protection Agency for certain properties. More
      detailed investigations and remedial activities are complete, in progress or
      planned at many of these sites. The results of the detailed site-by-site
      investigations will determine the extent additional remediation is necessary
      and
      provide a basis for estimating additional future costs. As of September 30,
      2007, the company had recorded a liability in connection with these matters
      of
      $15.9 million. In accordance with ICC authorization, the company has been
      recovering, and expects to continue to recover, these costs from its customers,
      subject to annual prudence reviews.





In
      December 2001, a purported class action lawsuit was filed against Exelon
      Corporation, ComEd and Nicor Gas in the Circuit Court of Cook County alleging,
      among other things, that the clean-up of a former manufactured gas plant site
      in
      Oak Park, Illinois was inadequate. Additional lawsuits were later filed related
      to this same former manufactured gas plant site. These lawsuits have sought,
      in
      part, unspecified damages for property damage, nuisance, and various personal
      injuries that allegedly resulted from exposure to contaminants allegedly
      emanating from the site, injunctive relief to compel the defendants to engage
      in
      various clean-up activities and punitive damages. An agreement in principle
      to
      settle the purported class action was reached in the first quarter of 2006
      at
      which time a $2.3 million reserve for this matter was recorded by the company.
      The settlement was approved by the trial court and the lawsuit was dismissed
      during the second quarter of 2007. Under the settlement, the company made a
      payment of $2.2 million which was charged against the previously established
      reserve. In accordance with ICC authorization, the company expects to recover
      costs of such settlement from its customers, subject to an annual prudence
      review. Management cannot predict the outcome of certain other pending lawsuits
      relating to the Oak Park site or the company’s potential exposure thereto, if
      any, and has not recorded a liability associated with those other pending
      matters.





In
      April
      2002, Nicor Gas was named as a defendant, together with ComEd, in a lawsuit
      brought by the Metropolitan Water Reclamation District of Greater Chicago (the
      “MWRDGC”) under the Federal


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Comprehensive
      Environmental Response, Compensation and Liability Act seeking recovery of
      past
      and future remediation costs and a declaration of the level of appropriate
      clean-up for a former manufactured gas plant site in Skokie, Illinois now owned
      by the MWRDGC. In January 2003, the suit was amended to include a claim under
      the Federal Resource Conservation and Recovery Act. The suit was filed in the United
      States District Court for the Northern District of Illinois. Management cannot
      predict the outcome of this litigation or the company’s potential exposure
      thereto, if any, and has not recorded a liability associated with this
      contingency.





Since
      costs and recoveries relating to the clean-up of manufactured gas plant sites
      are passed directly through to customers in accordance with ICC regulations,
      subject to an annual ICC prudence review, the final disposition of manufactured
      gas plant matters is not expected to have a material impact on the company’s
      financial condition or results of operations.





**PCBs.** In
      June
      2007, Nicor Gas notified the USEPA of the discovery by Nicor Gas of PCBs at
      four
      homes in Park Ridge, Illinois. Nicor Gas has cleaned up the PCBs at these four
      homes. On July 13, 2007, the USEPA issued a subpoena to Nicor Gas pursuant
      to
      Section 11 of the Toxic Substances Control Act. In the subpoena, the USEPA
      indicated that it was investigating Nicor Gas’ identification of
      PCB-contaminated liquids in its distribution system. The subpoena sought
      documents related to Nicor Gas’ pipeline liquids and the extent and location
      of PCBs contained therein.  The Illinois Attorney General made a
      similar request for information from Nicor Gas. Nicor Gas has provided
      documentation to the USEPA and the Illinois Attorney General, including
      information about the presence of PCBs in its system, and has conducted sample
      testing at additional customer locations. While Nicor is unable to predict
      the
      outcome of these inquiries or to reasonably estimate its potential exposure
      related thereto, if any, and has not recorded a liability associated with this
      contingency, the final disposition of this matter is not expected to have a
      material adverse impact on the company’s liquidity or financial
      condition.





**Other.** In
      addition to the matters set forth above, the company is involved in legal or
      administrative proceedings before various courts and agencies with respect
      to
      general claims, taxes, environmental, gas cost prudence reviews and other
      matters. Although unable to determine the ultimate outcome of these other
      contingencies, management believes that these amounts are appropriately
      reflected in the financial statements, including the recording of appropriate
      liabilities when reasonably estimable.





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





The
      following discussion should be read in conjunction with the Management’s
      Discussion and Analysis section of the Nicor 2006 Annual Report on Form 10-K.
      Results for the interim periods presented are not necessarily indicative of
      the
      results to be expected for the full fiscal year due to seasonal and other
      factors.





**SUMMARY**





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





Net
      income and diluted earnings per common share are presented below for the three
      and nine-month periods ended September 30, 2007 and 2006 (in millions, except
      per share data):





Three
                months ended
            
            Nine
                months endedSeptember
                30
            
            September
                30**2007**
            
            2006
            
            **2007**
            
            2006Net
                income
            
            **$**
            **14.5**
            
            $
            17.6
            
            **$**
            **79.7**
            
            $
            70.0Diluted
                earnings per common share
            
            **$**
            **.32**
            
            $
            .39
            
            **$**
            **1.76**
            
            $
            1.57





Year-to-date
      2007 net income and diluted earnings per common share include pretax
      mercury-related recoveries of $8.0 million ($.11 per share) associated with
      Nicor Gas’ mercury inspection and repair program which included a reduction of
      $7.2 million to the company’s previously established reserve and $0.8 million in
      cost recoveries. Included in year-to-date 2006 net income and diluted earnings
      per common share is a $10 million charge ($.22 per share and non-deductible
      for
      tax purposes) associated with the company’s SEC inquiry and a pretax recovery of
      $3.8 million ($.05 per share) associated with Nicor Gas’ mercury inspection and
      repair program.





Quarter
      over quarter comparisons reflect lower operating results in the company’s gas
      distribution and shipping businesses and lower corporate operating income,
      partially offset by improved results in the company’s other energy-related
      businesses. Year-to-date comparisons (excluding the items noted above) reflect
      improved operating results in the company’s gas distribution and other
      energy-related businesses, partially offset by lower operating results in the
      company’s shipping business and lower corporate operating income. Year-to-date
      comparisons were also impacted by the effects of certain income tax benefits
      recognized in 2006 and higher average shares outstanding in 2007.





**Rate
      proceeding.** In
      the
      fourth quarter of 2005, Nicor Gas implemented a $54.2 million base rate
      increase. In March 2006, the ICC issued a rehearing order reducing the annual
      net rate increase to $49.7 million. Rate changes resulting from the rehearing
      order were prospective and went into effect on April 11, 2006. Because the
      orders shift certain items between base rates and Nicor Gas’ PGA rider, the company
      estimated that the annual net revenue increase resulting from implementing
      the
      rehearing order received in March 2006 is about $30.2 million (reduced from
      $34.7 million in the original order implemented in the fourth quarter of 2005).





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




Three
                months ended
            
            Nine
                months endedSeptember
                30
            
            September
                30**2007**
            
            2006
            
            **2007**
            
            2006Gas
                distribution
            
            **$**
            **3.6**
            
            $
            5.6
            
            **$**
            **88.3**
            
            $
            80.2Shipping
            
            
            **8.7**
            
            
            10.5
            
            
            **26.9**
            
            
            29.5Other
                energy ventures
            
            
            **10.5**
            
            
            6.9
            
            
            **15.8**
            
            
            .7Corporate
                and eliminations
            
            
            **-**
            
            
            5.5
            
            
            **(1.7**
            **)**
            
            1.1**$**
            **22.8**
            
            $
            28.5
            
            **$**
            **129.3**
            
            $
            111.5





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





**·**
            Gas
                distribution operating income decreased $2.0 million in the third
                quarter
                of 2007 compared to the prior-year period due to higher operating
                and
                maintenance expenses ($3.1 million increase) and higher depreciation
                expense ($1.3 million increase), partially offset by higher gas
                distribution margin ($1.8 million increase).





Operating
      income increased $8.1 million for the nine months ended September 30, 2007
      compared to the prior-year period due primarily to the positive impact of higher
      gas distribution margin ($10.3 million increase) and higher mercury-related
      recoveries ($4.4 million increase), partially offset by the negative impacts
      of
      higher depreciation expense ($4.1 million increase) and higher operating and
      maintenance expenses ($1.6 million increase).





**·**
            Shipping
                operating income decreased $1.8 million in the third quarter of 2007,
                compared to the prior-year period due to lower operating revenues
                ($0.8
                million decrease) and higher operating costs ($1.0 million increase).
                Lower operating revenues were attributable to lower average rates
                ($2.6
                million decrease), partially offset by higher volumes shipped ($1.6
                million increase). Higher operating costs were attributable to increased
                transportation-related costs on higher volumes shipped ($0.8 million
                increase) and higher employee-related costs ($0.8 million
                increase).





Operating
      income decreased $2.6 million for the nine months ended September 30, 2007
      compared to the prior-year period as higher operating revenues ($5.5 million
      increase) were more than offset by higher operating costs ($8.1 million
      increase). Higher operating revenues were attributable primarily to higher
      volumes shipped ($9.5 million increase), partially offset by lower average
      rates
      ($4.1 million decrease). Higher operating costs were attributable primarily
      to
      higher employee-related costs ($3.6 million increase) and increased
      transportation-related costs on higher volumes shipped ($3.3 million increase).





·
            Nicor’s
                other energy ventures operating income increased $3.6 million in
                the third
                quarter of 2007 compared to the prior-year period due primarily to
                higher
                operating income at Nicor’s wholesale natural gas marketing business,
                Nicor Enerchange ($3.2 million increase). For the nine months ended
                September 30, 2007, operating income increased $15.1 million compared
                to
                the prior-year period due primarily to higher operating income at
                Nicor
                Enerchange ($13.0 million increase) and higher operating income at
                Nicor’s
                energy-related products and services businesses ($2.0 million increase).





For
      the
      three and nine month periods, improved operating results at Nicor Enerchange
      were due primarily to favorable costing of physical sales activity and improved
      results from the company’s risk management activities associated with hedging
      the product risks of the utility-bill management contracts offered by Nicor’s
      energy-related products and services businesses,


18
 
 Table
          of Contents


partially
      offset by lower positive fair value adjustments related to derivative
      instruments used to hedge purchases and sales of natural gas inventory. Improved
      operating results at Nicor’s energy-related products and services businesses
      were due primarily to an increase in average customer contracts.





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




·
            Corporate
                and eliminations 2007 third quarter operating income decreased $5.5
                million when compared to the prior-year period, reflecting the absence
                of
                the prior-year $5.2 million insurance recovery related to previously
                incurred legal costs associated with the securities class action
                and
                shareholder derivative lawsuits. Year-to-date 2007 operating results
                decreased by $2.8 million compared to the prior-year period, reflecting
                the absence of the prior year $6.3 million benefit of a natural weather
                hedge associated with the utility-bill management products offered
                by
                Nicor’s energy-related products and services businesses and the previously
                mentioned $5.2 million insurance recovery, partially offset by the
                absence
                of the prior year $10 million charge associated with the SEC inquiry
                settlement. Benefits or costs resulting from variances from normal
                weather
                are recorded primarily at the corporate level as a result of an agreement
                between the parent company and certain of its subsidiaries. The weather
                impact of these contracts generally serves to partially offset the
                gas
                distribution segment’s weather risk. The amount of the offset attributable
                to the utility-bill management contracts marketed by Nicor’s other energy
                ventures will vary depending upon a number of factors including the
                time
                of year, weather patterns, the number of customers for these products
                and
                the market price for natural gas.





**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):





Three
                months ended
            
            Nine
                months endedSeptember
                30
            
            September
                30**2007**
            
            2006
            
            **2007**
            
            2006Gas
                distribution
            
            **$**
            **238.9**
            
            $
            226.7
            
            **$**
            **1,878.7**
            
            $
            1,775.6Shipping
            
            
            **97.5**
            
            
            98.3
            
            
            **293.6**
            
            
            288.1Other
                energy ventures
            
            
            **37.3**
            
            
            34.0
            
            
            **159.0**
            
            
            135.1Corporate
                and eliminations
            
            
            **(8.5**
            **)**
            
            (7.9
            )
            
            **(74.5**
            **)**
            
            (77.0
            )**$**
            **365.2**
            
            $
            351.1
            
            **$**
            **2,256.8**
            
            $
            2,121.8





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 third quarter of 2007 compared to the prior-year period, gas distribution
      revenues increased $12.2 million. Operating revenues were impacted by higher
      natural gas costs (approximately $25 million increase), partially offset by
      warmer weather than 2006 (approximately $5 million decrease) and lower demand
      unrelated to weather (approximately $5 million decrease). For the nine months
      ended September 30, 2007 compared to the prior-year period, gas


19
 
 Table
          of Contents


distribution
      revenues increased $103.1 million. Operating revenues were impacted by colder
      weather than 2006 (approximately $180 million increase) and higher demand
      unrelated to weather (approximately
      $50 million increase), partially offset by lower natural gas prices
      (approximately $105 million decrease).





For
      the
      three months ended September 30, 2007, shipping segment operating revenues
      decreased $0.8 million compared with the prior-year period due to lower average
      rates ($2.6 million decrease), partially offset by higher volumes shipped ($1.6
      million increase). For the nine months ended September 30, 2007, shipping
      segment operating revenues increased $5.5 million compared with the prior-year
      period due primarily to higher volumes shipped ($9.5 million increase),
      partially offset by lower average rates ($4.1 million decrease). Volumes were
      higher due primarily to increased interisland shipments. Volumes continue to
      be
      adversely impacted by increased competition in several of the ports served,
      the
      strategic decision not to compete for certain low margin business, and changing
      global trade patterns. Lower average rates were due primarily to the increase
      in
      interisland shipments and increased competition in several of the ports
      served.





Operating
      revenues in the third quarter of 2007 for Nicor’s other energy ventures
      increased $3.3 million from the prior-year period due to higher revenues at
      Nicor Enerchange ($3.6 million increase). Operating revenues for the nine months
      ended September 30, 2007 increased $23.9 million from the prior-year period
      due
      to higher revenues at Nicor Enerchange ($13.6 million increase) and Nicor’s
      energy-related products and services businesses ($10.3 million increase). For
      the three and nine month periods, higher revenues at Nicor Enerchange were
      due
      primarily to favorable costing of physical sales activity and improved results
      from the company’s risk management activities associated with hedging the
      product risks of the utility-bill management contracts offered by Nicor’s
      energy-related products and services businesses, partially offset by lower
      fair
      value adjustments related to derivative instruments used to hedge purchases
      and
      sales of natural gas inventory. Higher revenues at Nicor’s energy-related
      products and services businesses were due primarily to an increase in average
      customer contracts.





Corporate
      and eliminations reflects primarily 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):





Three
                months ended
            
            Nine
                months endedSeptember
                30
            
            September
                30**2007**
            
            2006
            
            **2007**
            
            2006Gas
                distribution revenues
            
            **$**
            **238.9**
            
            $
            226.7
            
            **$**
            **1,878.7**
            
            $
            1,775.6Cost
                of gas
            
            
            **(118.4**
            **)**
            
            (108.0
            )
            
            **(1,348.4**
            **)**
            
            (1,258.8
            )Revenue
                tax expense
            
            
            **(12.6**
            **)**
            
            (12.6
            )
            
            **(112.2**
            **)**
            
            (109.0
            )Gas
                distribution margin
            
            **$**
            **107.9**
            
            $
            106.1
            
            **$**
            **418.1**
            
            $
            407.8





Gas
      distribution margin increased $1.8 million in the third quarter of 2007 compared
      with the corresponding prior-year period due to the impact of customer interest
      (approximately $2 million increase). Year-to-date 2007 gas distribution margin
      increased $10.3 million compared with the corresponding prior-year period due
      primarily to colder weather than in 2006 (approximately $12 million


20
 
 Table
          of Contents


increase)
      and higher demand unrelated to weather (approximately $8 million increase),
      partially offset by lower average distribution rates (approximately $7 million
      decrease which included the negative impact of approximately $2 million
      attributable to the ICC’s rate order rehearing decision that went into effect in
      April 2006) and the impact of customer interest (approximately $3 million
      decrease).





**Gas
      distribution operating and maintenance expense.** Gas
      distribution operating and maintenance expense increased **** $3.1
      million to $59.7 million in the third quarter of 2007 from $56.6 million in
      the
      prior-year period due to higher bad debt expense ($5.2 million increase) and costs
      associated with the investigation by the USEPA and the Illinois Attorney General
      into the presence of PCBs in the company’s distribution system ($1.5
      million increase), partially offset by lower company use gas and storage-related
      gas costs ($2.9 million decrease). Additional information about the PCB
      investigation is presented in Item 1 - Notes to the Condensed Consolidated
      Financial Statements - Note 14 - Contingencies - PCBs.





Year-to-date
      operating and maintenance expense increased $1.6 million to $201.5 million
      from
      $199.9 million in the prior-year period. Factors contributing to the change
      include higher bad debt expense ($9.8 million increase), the previously
      mentioned costs associated with the PCB investigation ($1.5 million increase),
      and lower company use gas and storage-related gas costs ($11.3 million decrease)
      attributable primarily to lower natural gas prices.





**Other
      gas distribution operating expenses.** Mercury-related
      recoveries, net reflect the estimated costs, recoveries and reserve adjustments
      associated with the company’s mercury inspection and repair program.
      Year-to-date 2007 mercury-related recoveries reflect a $7.2 million reserve
      adjustment and $0.8 million in cost recoveries recorded during the first quarter
      of 2007. During the first quarter of 2006, a mercury-related recovery of $3.8
      million was realized. Additional information about the company’s mercury
      inspection and repair program is presented in Item 1 - Notes to the Condensed
      Consolidated Financial Statements - Note 14 - Contingencies -
      Mercury.





Property
      sale gains vary from year-to-year depending upon property sales activity. The
      company realized pretax gains on sales of property of $2.0 million and $3.2
      million for the nine months ended September 30, 2007 and 2006, respectively.
      The
      company continues to assess its ownership of certain real estate holdings.





**Shipping
      operating expenses.** Third
      quarter and year-to-date 2007 shipping segment operating expenses increased
      $1.0
      million and $8.1 million, respectively, compared with the corresponding
      prior-year periods. Higher operating costs were attributable primarily to
      increased employee-related costs ($0.8 million and $3.6 million increases,
      respectively) and increased transportation-related costs on higher volumes
      shipped ($0.8 million and $3.3 million increases, respectively).





**Other
      energy ventures operating expenses.** Year-to-date
      2007 other energy ventures operating expenses increased $8.8 million compared
      with the corresponding prior-year period. The increase was due primarily to
      higher expenses at Nicor’s energy-related products and services businesses ($8.3
      million increase) attributable to costs related to an increase in average
      customer contracts.





**Litigation
      charge.** In the
      second quarter of 2006, Nicor recorded a $10 million charge (non-deductible
      for
      tax purposes) associated with the SEC inquiry. In July 2006, the company reached
      a tentative agreement with the staff of the SEC Enforcement Division in
      settlement of an anticipated civil action for a payment of $10 million. The
      SEC
      Commissioners approved the tentative settlement in March 2007. A final judgment,
      dated April 30, 2007, was entered by a federal court approving the
      settlement and the funds held in escrow were released. For more
      information, see Item 1 - Notes to the Condensed Consolidated Financial
      Statements - Note 14 - Contingencies - SEC and U.S. Attorney
      Inquiries.


21
 
 Table
          of Contents




**Interest
      expense.** Interest
      expense of $10.4 million in the third quarter of 2007 decreased **** $0.7
      million over the prior-year period due primarily to lower estimated interest
      on
      income tax matters. Interest expense of $34.3 million for the nine-month period
      ended September 30, 2007 decreased $1.2 million over the corresponding
      prior-year period due to lower average borrowing levels. Lower average
      borrowings were attributable primarily to the $40 million Tropical Shipping
      term
      loan, which was paid in full by the fourth quarter of 2006, and a decrease
      in
      average commercial paper borrowings.





**Net
      equity investment income.** Net
      equity investment income decreased $3.0 million and $4.8 million for the three
      and nine-month periods ended September 30, 2007, respectively, over the
      corresponding prior-year periods due primarily to the absence of the $2.4
      million gain on a sale of an equity investment recorded in the third quarter
      of
      2006.





**Income
      taxes.** Effective January 2006, the company reorganized certain of its shipping and
      related operations primarily to take advantage of certain provisions of the
      Jobs
      Act that provide the opportunity for future tax savings. In connection with
      these activities, a net income tax benefit of approximately $6 million was
      recorded in the first quarter of 2006 from the elimination of certain deferred
      taxes offset, in part, by approximately $3 million in current tax expense
      recognized in the first nine months of 2006 also associated with these
      activities. Generally, to the extent foreign shipping earnings are not
      repatriated to the United States, such earnings are not expected to be subject
      to current taxation. In addition, to the extent such earnings are determined
      to
      be indefinitely reinvested offshore, no deferred income tax expense would be
      recorded by the company. For the three and nine-month periods ended September
      30, 2007, income tax expense has not been provided on approximately $6 million
      and $19 million, respectively, of foreign company shipping earnings that are
      expected to be indefinitely reinvested offshore compared to approximately $6
      million and $17 million, respectively, for the comparable periods in 2006.





The
      effective income tax rate for the quarter ended September 30, 2007 decreased
      to
      15.2 percent from 30.3 percent for the quarter ended September 30, 2006 due
      primarily to a reduction in taxable foreign earnings which was recognized in
      the
      third quarter of 2007. The effective income tax rate for the nine months ended
      September 30, 2007 increased to 25.3 percent from 25.1 percent for the
      prior-year period. The rate for the first nine months of 2006 reflects the
      recognition of additional tax benefits related to the first quarter 2006
      reorganization of the company’s shipping and related operations and second
      quarter 2006 favorable adjustments associated with tax audits (which occur
      in
      the ordinary course of business) offset, in part, by the second quarter of
      2006
      non-deductible $10 million charge associated with the company’s SEC inquiry. The
      rate for the first nine months of 2007 reflects the previously mentioned
      reduction in taxable foreign earnings recognized in the third quarter of 2007.
      Both nine-month periods reflect the ongoing benefit of untaxed foreign shipping
      earnings.




22
 
 Table
          of Contents


**Nicor
                Inc.****Gas
                Distribution Statistics****Three
                months ended**
            
            **Nine
                months ended****September
                30**
            
            **September
                30****2007**
            
            2006
            
            **2007**
            
            2006**Operating
                revenues**(millions)SalesResidential
            
            **$**
            **146.9**
            
            $
            136.8
            
            **$**
            **1,263.1**
            
            $
            1,207.5Commercial
            
            
            **36.3**
            
            
            29.8
            
            
            **303.8**
            
            
            275.2Industrial
            
            
            **2.3**
            
            
            2.7
            
            
            **32.3**
            
            
            31.9**185.5**
            
            
            169.3
            
            
            **1,599.2**
            
            
            1,514.6TransportationResidential
            
            
            **6.4**
            
            
            6.1
            
            
            **26.0**
            
            
            21.9Commercial
            
            
            **13.0**
            
            
            13.6
            
            
            **55.4**
            
            
            55.5Industrial
            
            
            **10.7**
            
            
            11.6
            
            
            **30.9**
            
            
            31.1Other
            
            
            **.6**
            
            
            .8
            
            
            **10.0**
            
            
            1.7**30.7**
            
            
            32.1
            
            
            **122.3**
            
            
            110.2Other
                revenuesRevenue
                taxes
            
            
            **12.8**
            
            
            12.9
            
            
            **114.0**
            
            
            111.5Environmental
                cost recovery
            
            
            **.9**
            
            
            .8
            
            
            **8.0**
            
            
            7.2Chicago
                Hub
            
            
            **3.4**
            
            
            8.1
            
            
            **13.1**
            
            
            13.9Other
            
            
            **5.6**
            
            
            3.5
            
            
            **22.1**
            
            
            18.2**22.7**
            
            
            25.3
            
            
            **157.2**
            
            
            150.8**$**
            **238.9**
            
            $
            226.7
            
            **$**
            **1,878.7**
            
            $
            1,775.6**Deliveries**(Bcf)SalesResidential
            
            
            **12.4**
            
            
            13.9
            
            
            **136.7**
            
            
            121.6Commercial
            
            
            **3.5**
            
            
            3.2
            
            
            **33.6**
            
            
            27.9Industrial
            
            
            **.2**
            
            
            .4
            
            
            **3.7**
            
            
            3.4**16.1**
            
            
            17.5
            
            
            **174.0**
            
            
            152.9TransportationResidential
            
            
            **1.3**
            
            
            1.2
            
            
            **13.4**
            
            
            10.7Commercial
            
            
            **9.2**
            
            
            9.0
            
            
            **58.0**
            
            
            54.7Industrial
            
            
            **23.8**
            
            
            25.3
            
            
            **80.4**
            
            
            80.0**34.3**
            
            
            35.5
            
            
            **151.8**
            
            
            145.4**50.4**
            
            
            53.0
            
            
            **325.8**
            
            
            298.3**Customers
                at end of period**(thousands)
                (1)SalesResidential
            
            
            **1,787**
            
            
            1,785Commercial
            
            
            **124**
            
            
            121Industrial
            
            
            **7**
            
            
            7**1,918**
            
            
            1,913TransportationResidential
            
            
            **176**
            
            
            161Commercial
            
            
            **54**
            
            
            57Industrial
            
            
            **6**
            
            
            5**236**
            
            
            223**2,154**
            
            
            2,136**Other
                statistics**Degree
                days
            
            
            **45**
            
            
            84
            
            
            **3,699**
            
            
            3,301Colder
                (warmer) than normal (2)
            
            
            **(36)%**
            
            
            20%
            
            
            **(2)%**
            
            
            (12)%Average
                gas cost per Mcf sold
            
            **$**
            **7.25**
            
            $
            6.05
            
            **$**
            **7.65**
            
            $
            8.18(1)
                The company redefined the customer count methodology in April 2006
                in
                conjunction with its new customer care and billing
                system.(2)
                Normal weather for Nicor Gas' service territory, for purposes of
                this
                report, is considered to be 5,830 degree days per
                year.




23


Table
          of Contents


**Shipping
      Statistics**


Three
                months ended
            
            Nine
                months endedSeptember
                30
            
            September
                30**2007**
            
            2006
            
            **2007**
            
            2006TEUs
                shipped (thousands)
            
            
            **50.9**
            
            
            50.0
            
            
            **152.2**
            
            
            147.3Revenue
                per TEU
            
            **$**
            **1,915**
            
            $
            1,965
            
            **$**
            **1,929**
            
            $
            1,956At
                end of periodPorts
                served
            
            
            **26**
            
            
            27Vessels
                operated
            
            
            **19**
            
            
            18





**FINANCIAL
      CONDITION AND LIQUIDITY**





**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, or eliminate, short-term debt during the first
      half of the year. Net cash flow provided from operating activities
      decreased **** $179.1
      million to $369.4 million for the nine months ended September 30, 2007 from
      $548.5 million in the prior-year period





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.





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 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 required repayment in 2005 and 2006 of amounts previously
      taken as current tax deductions. During 2006 and 2005, the company reclassified
      income tax expense from deferred to current and repaid approximately $135
      million equally over those years.





**Investing
      activities.** Net
      cash
      flow used for investing activities of $132.1 million was unchanged from the
      prior year.





**Financing
      activities.** In June
      2007, Fitch revised Nicor Gas’ short-term commercial paper rating to “F1” from
“F1+”. The revision of Nicor Gas’ short term rating reflects a change by Fitch
      in its short-term ratings methodology. Per a Fitch press release dated June
      28,
      2007, “The short-term rating revision does not reflect any change in the credit
      profile of Nicor Gas.” All other credit ratings for Nicor and Nicor Gas have not
      changed since the filing of the December 31, 2006 Annual Report on Form
      10-K .





*Long-term
      debt.* In
      the
      first nine months of 2006, Tropical Shipping repaid $28 million of its $40
      million, two-year senior unsecured term loan. The repayment was primarily
      financed through the company’s cash flows from operating activities. This loan
      was paid in full by the fourth quarter of 2006.





*Short-term
      debt.* In
      October 2007, Nicor Gas established a $400 million, 210-day seasonal revolver,
      which expires in May 2008, to replace the $400 million, 210-day seasonal
      revolver, which expired in May


24
 
 Table
          of Contents


2007.
      In
      September 2005, Nicor and Nicor Gas established a $600 million, five-year
      revolver, expiring September 2010. These facilities were established with major
      domestic and foreign banks and serve as backup for the issuance of commercial
      paper. The company had $162 million, $350 million and $151 million of commercial
      paper borrowings outstanding at September 30, 2007, December 31, 2006 and
      September 30, 2006, respectively. The company believes it is in compliance
      with
      all debt covenants. The company expects that funding from commercial paper
      and
      related backup line-of-credit agreements will continue to be available in the
      foreseeable future and sufficient to meet estimated cash
      requirements.





*Dividends.* Nicor
      maintained its quarterly common stock dividend rate of $0.465 per common share
      during the third quarter of 2007. This quarterly dividend rate was also
      applicable in 2006. The company paid dividends on its common stock of $63.0
      million and $62.1 million for the year-to-date periods ended September 30,
      2007
      and 2006, respectively. Nicor currently has no contractual or regulatory
      restrictions on the payment of dividends.





**Gas
      in storage.** Gas
      distribution segment inventory is carried at cost on a LIFO basis. Inventory
      decrements occurring during interim periods that are expected to be restored
      prior to year-end are charged to cost of gas at the estimated annual replacement
      cost, and the difference between this cost and the actual LIFO layer cost is
      recorded on the balance sheet as a current temporary LIFO liquidation. Interim
      inventory decrements not expected to be restored prior to year-end are charged
      to cost of gas at the actual LIFO cost of the layers liquidated.





At
      September 30, 2006, the company had an inventory decrement of approximately
      5
      Bcf which was not restored prior to year-end. The liquidated inventory was
      charged to cost of gas at a LIFO cost of $7.82 per Mcf. If the company had
      deemed the decrement to be temporary, it would have charged cost of gas for
      an
      estimate of the annual replacement cost, which was about $6.32 per Mcf. Applying
      LIFO cost in valuing the decrement, as opposed to the estimated annual
      replacement cost, had the effect of increasing the cost of gas distributed
      by
      $7.5 million as of September 30, 2006. However, since the cost of gas, including
      inventory costs, is charged to customers without markup, subject to ICC review,
      this difference had no impact on net income. There was no permanent inventory
      decrement  as
      of
      September 30, 2007.





**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.





*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 plan 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. The company has committed
      to cooperate fully in the reviews of the PBR plan.


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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 2004 increasing the recorded
      liability to $26.6 million. 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. In addition,
      interest due to the company on certain components of these amounts has not
      been
      recognized in the financial statements due to the same uncertainties. 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. In 2004, the
      evidentiary hearings on this matter were stayed in order to permit the parties
      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. In December 2006, the additional
      third party discovery from EKT was obtained, Nicor Gas withdrew its previously
      filed testimony and the Administrative Law Judges issued a scheduling order
      that
      provided for Nicor Gas to submit direct testimony by April 13, 2007. In its
      direct testimony filed pursuant to the scheduling order, Nicor Gas seeks a
      reimbursement of approximately $6 million,
      which includes interest due to the company as noted above of $1.6 million,
      as of
      March 31, 2007. No date has been set for evidentiary hearings on this
      matter.





During
      the course of the 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


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conversations
      from EKT. Review of additional information completed in 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 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 2004.





Nicor
      is
      unable to predict the outcome of the ICC’s review 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 September 30,
      2007.





*SEC
      and U.S. Attorney Inquiries.* In 2002,
      the staff of the SEC Division of Enforcement (“SEC Staff”) informed Nicor that
      the SEC was conducting a formal inquiry regarding the PBR plan. A representative
      of the Office of the United States Attorney for the Northern District of
      Illinois (the “U.S. Attorney”) also notified Nicor that that office was
      conducting an inquiry on the same matter that the SEC is investigating, and
      a
      grand jury was also reviewing this matter. In April 2004, Nicor was advised
      by
      the SEC Staff 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.
      In
      July 2006, the company announced that it reached a tentative agreement with
      the
      SEC Staff in settlement of an anticipated civil action to which the company
      and
      the SEC would be parties. The SEC commissioners approved the settlement in
      March
      2007, and a final judgment was entered by a federal court approving the
      settlement on April 30, 2007. Under the terms of the settlement, the company
      was
      required to disgorge one dollar and pay a monetary fine of $10 million and
      is
      subject to an injunction prohibiting violations of certain provisions of the
      federal securities laws. The company neither admits nor denies any wrongdoing.
      In July 2006, the company deposited the $10 million in escrow. Those funds
      were
      released following entry of the federal court judgment approving the settlement.
      Nicor recorded a $10 million charge to its 2006 second quarter earnings in
      connection with this matter. The $10 million fine is not deductible for federal
      or state income tax purposes. In December 2006, the U.S. Attorney advised that
      it was closing its separate inquiry and would not seek to prosecute the company
      in connection with this matter.





*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. In March
      2007, Nicor Services settled this matter and the lawsuit was dismissed with
      prejudice. Information about this lawsuit is presented within Item 1- Notes
      to
      the Condensed Consolidated Financial Statements - Note 14 - Contingencies -
      Fixed Bill Service.





*Mercury.* Information about mercury contingencies is presented in Item 1 - Notes to the
      Condensed Consolidated Financial Statements - Note 14 - 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 1 - Notes to the Condensed Consolidated Financial Statements
      -
      Note 14 - Contingencies - Manufactured Gas Plant Sites.





*PCBs.* Information about PCB contingencies is presented in Item 1 - Notes to the
      Condensed Consolidated Financial Statements - Note 14 - Contingencies -
      PCBs.


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*Other
      contingencies.* **** The
      company is involved in legal or administrative proceedings before various courts
      and agencies with respect to general claims, taxes, environmental, gas cost
      prudence reviews and other matters. See Item 1 - Notes to the Condensed
      Consolidated Financial Statements - Note 3 - New Accounting Pronouncements
      -
      Uncertain tax positions, Note 6 - Income and Other Taxes and Note 14 -
      Contingencies.




**CRITICAL
      ACCOUNTING ESTIMATES**





See
      Item
      7 - Management’s Discussion and Analysis of Financial Condition and Results of
      Operations - Critical Accounting Estimates in the 2006 Annual Report on Form
      10-K for a discussion of the company’s critical accounting estimates.





**NEW
      ACCOUNTING PRONOUNCEMENTS**





In
      2006,
      the FASB issued FIN No. 48, *Accounting
      for Uncertainty in Income Taxes* ,
      FSP No.
      AUG AIR-1, *Accounting
      for Planned Major Maintenance Activities* ,
      and
      SFAS No. 157, *Fair
      Value Measurements* .
      In
      2007, the FASB issued FSP No. FIN 39-1, *Amendment
      of FIN 39, Offsetting of Amounts Related to Certain Contracts* .
      For
      more information, see Item 1 - Notes to the Condensed Consolidated Financial
      Statements - Note 3 - 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 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; accidents, leaks,
      equipment failures, service interruptions, environmental pollution, and other
      operating risks; 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
      customers, transporters, 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.


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**Item
      3.** **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.





There
      has
      been no material change in the company’s exposure to market risk since the
      filing of the 2006 Annual Report on Form 10-K.




**Item
      4.** **Controls and Procedures** ****





The
      company carried out an evaluation under the supervision and with the
      participation of the company’s management, including its Chief Executive Officer
      and Chief Financial Officer, of the effectiveness of the design and operation
      of
      the company’s disclosure controls and procedures as of the end of the period
      covered by this Quarterly Report on Form 10-Q (the “Evaluation”).





In
      designing and evaluating the disclosure controls and procedures, management
      recognizes that any disclosure controls and procedures, no matter how well
      designed and operated, can provide only reasonable assurance of achieving the
      desired control objectives, and management is required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible disclosure controls and
      procedures. Based on the Evaluation, the company’s Chief Executive Officer and
      Chief Financial Officer concluded that the company’s disclosure controls and
      procedures, as of the end of the period covered by this Quarterly Report on
      Form
      10-Q, were effective at the reasonable assurance level to ensure that
      information required to be disclosed by the company in reports that it files
      or
      submits under the Securities Exchange Act of 1934 is recorded, processed,
      summarized and reported within the time periods specified in United States
      Securities and Exchange Commission rules and forms.




There
      has
      been no change in the company’s internal controls over financial reporting
      during the company’s most recent fiscal quarter that has materially affected, or
      is reasonably likely to materially affect, the company’s internal control over
      financial reporting.





**PART
      II - OTHER INFORMATION**





**Item
      1.** **Legal
      Proceedings**




See
      Part
      I, Item 1 - Notes to the Condensed Consolidated Financial Statements - Note
      14 -
      Contingencies, which is incorporated herein by reference.





**Item
      1A.** **Risk
      Factors**





The
      company has disclosed the most significant factors that can impact year-to-year
      comparisons and may affect the future performance of the company’s businesses in
      the company’s 2006 Annual Report on Form 10-K. On a quarterly basis, the company
      reviews these risks and makes updates as appropriate. The following are certain
      factors which have been edited or added based upon those reviews.





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





Tropical
      Shipping’s business consists primarily of the shipment of building materials,
      food and other necessities from the United States and Canada to 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 adverse general economic
      conditions in the United States, the Bahamas, Caribbean region and Canada.
      Also,
      a shift in buying patterns that results in such goods being sourced


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directly
      from other parts of the world, including China and India, rather than the United
      States and Canada, could significantly affect Tropical Shipping’s results of
      operations, cash flows and financial condition.





***Changes
      in taxation could adversely affect the company’s results of operations, cash
      flows and financial condition.***





Various
      state tax and fee increases may occur in the states in which the company
      operates. The company cannot predict whether legislation or regulation will
      be
      introduced, the form of any legislation or regulation, or whether any such
      legislation or regulation will be passed by the state legislatures or regulatory
      bodies. New taxes or an increase in tax rates would increase tax expense and
      could have a negative impact on the company’s results of operations, cash flows
      and financial condition.


**Item
      2.** **Unregistered
      Sales of Equity Securities and Use of Proceeds**





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 the first nine months of 2007 or 2006. As of September
      30, 2007, $21.5 million remained authorized for the repurchase of common stock.




**Item
      6.** **Exhibits**





ExhibitNumber
            
            Description
                of Document3.01
            *
            Restated
                Articles of Incorporation of the company. (File No. 1-7297, Form
                8-K for
                July 26, 2006, Nicor Inc.)3.02
            *
            By-Laws
                of the company as amended by the company’s Board of Directors on January
                15, 2004. (File No. 1-7297, Form 10-K for 2003, Nicor Inc., Exhibit
                3.09.)10.01
            
            210-Day
                Credit Agreement dated as of
                October 18, 2007.31.01
            
            Rule
                13a-14(a)/15d-14(a)
                Certification.31.02
            
            Rule
                13a-14(a)/15d-14(a)
                Certification.32.01
            
            Section
                1350
                Certification.32.02
            
            Section
                1350
                Certification.




*
            These
                exhibits have been previously filed with the SEC as exhibits to
                registration statements or to other filings with the SEC and are
                incorporated herein as exhibits by reference. The file number and
                exhibit
                number of each such exhibit, where applicable, are stated, in parentheses,
                in the description of such
                exhibit.


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**Signature**





Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.














Nicor
                Inc.November
                1, 2007
            
            /s/
                KAREN K. PEPPING(Date)
            
            Karen
                K. PeppingVice
                President and Controller(Principal
                Accounting Officer andDuly
                Authorized Officer)


































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