UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





**FORM
      10-K**





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


**For
      the fiscal year ended December 31, 2005**





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)





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


Title
                of each class
            
            Name
                of each exchange on which registeredCommon
                Stock, par value $2.50 per share
            
            New
                York Stock ExchangeChicago
                Stock Exchange


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





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes
      [X]
      No [ ]





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





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





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





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





Large
                accelerated filer [X]
            Accelerated
                filer [  ]
            Non-accelerated
                filer [  ]





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





The
      aggregate market value of common stock (based on the June 30, 2005 closing
      price
      of $41.17) held by non-affiliates of the registrant was approximately $1.8
      billion. As of February 21, 2006, there were 44,192,259 shares of common stock
      outstanding.


DOCUMENTS
      INCORPORATED BY REFERENCE





Portions
      of the company’s 2006 Annual Meeting Definitive Proxy Statement, to be filed on
      or about March 10, 2006, are incorporated by reference into Part
      III.

















**Nicor
      Inc.**





**Table
                of Contents****Item
                No.**
            **Description**
            **Page
                No.****Glossary**
            ii**Part
                I**1.
            Business
            11A.
            Risk
                Factors
            61B.
            Unresolved
                Staff Comments
            102.
            Properties
            103.
            Legal
                Proceedings
            104.
            Submission
                of Matters to a Vote of Security Holders
            10Executive
                Officers of the Registrant
            11**Part
                II**5.
            Market
                for Registrant’s Common Equity, Related Stockholder Matters and issuer
                Purchases of Equity Securities
            126.
            Selected
                Financial Data
            137.
            Management’s
                Discussion and Analysis of Financial Condition and Results of Operations
            147A.
            Quantitative
                and Qualitative Disclosures about Market Risk
            348.
            Financial
                Statements and Supplementary Data
            369.
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosure
            719A.
            Controls
                and Procedures
            719B.
            Other
                Information
            73**Part
                III**10.
            Directors
                and Executive Officers of the Registrant
            7311.
            Executive
                Compensation
            7312.
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            7413.
            Certain
                Relationships and Related Transactions
            7414.
            Principal
                Accountant Fees and Services
            74**Part
                IV**15.
            Exhibits
                and Financial Statement Schedules
            75Signatures
            77Exhibit
                Index
            78





































i


**Nicor
      Inc.**





**Glossary**





**Chicago
      Hub.** A
      venture of Northern Illinois Gas Company, doing business as Nicor Gas Company
      (“Nicor Gas”) which provides natural gas storage and transmission-related
      services to marketers and other gas distribution companies.





**Degree
      day.** The
      extent to which the daily average temperature falls below 65 degrees
      Fahrenheit. Normal
      weather for Nicor Gas service territory, for purposes of this report, is
      considered to be 5,830 degree days per year for 2005 and 6,000 degree days
      per
      year for 2004 and 2003.





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





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





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




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





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





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





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





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





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





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





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





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











ii


**Glossary**




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





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















































































































































iii


**PART
      I**




**Item
      1.  Business**




Nicor
      Inc. (“Nicor”), an Illinois corporation formed in 1976, is a holding company.
      Gas distribution is Nicor’s primary business. Nicor’s principal subsidiaries are
      Northern Illinois Gas Company (doing business as Nicor Gas Company (“Nicor
      Gas”)), one of the nation’s largest distributors of natural gas, and Tropical
      Shipping, a leading transporter of containerized freight in the Bahamas and
      the
      Caribbean region. Nicor also owns several energy-related ventures, including
      Nicor Services and Nicor Solutions, which provide energy-related products and
      services to retail markets, and Nicor Enerchange, a wholesale natural gas
      marketing company. As a consolidated group, Nicor had approximately 3,700
      employees at year-end 2005.





Summary
      financial information for Nicor’s major business segments is included in Item 8
      - Notes to the Consolidated Financial Statements - Note 13 - Business Segment
      and Geographic Information. The following sections describe Nicor’s larger
      businesses. Certain terms used herein are defined in the glossary on pages
      ii
      and iii.





**GAS
      DISTRIBUTION**





**General**





Nicor
      Gas, a regulated natural gas distribution utility, serves over 2.1 million
      customers in a service territory that encompasses most of the northern third
      of
      Illinois, excluding the city of Chicago. The company’s service territory is
      diverse and its customer base has grown steadily over the years, providing
      the
      company with a well-balanced mix of residential, commercial and industrial
      customers. Residential customers typically account for 45 to 50 percent of
      natural gas deliveries, while commercial and industrial customers each typically
      account for 25 to 30 percent. See Gas Distribution Statistics on page 22 for
      operating revenues, deliveries and number of customers by customer
      classification. Nicor Gas had approximately 2,200 employees at year-end
      2005.





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





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





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

















1


**Sources
      of Natural Gas Supply**





Nicor
      Gas
      purchases natural gas supplies in the open market by contracting with producers
      and marketers. It also purchases transportation and storage services from the
      interstate pipelines that are regulated by the Federal Energy Regulatory
      Commission (“FERC”). When firm pipeline services are temporarily not needed,
      Nicor Gas may release the services in the secondary market under FERC-mandated
      capacity release provisions, with proceeds reducing the cost of gas charged
      to
      customers.





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





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





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





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





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





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





Availability
            
            Contract
                ExpirationNatural
                Gas Pipeline Company (NGPL)
            
            698,000
            
            March
                2009Horizon
                Pipeline
            
            300,000
            
            May
                2012Tennessee
                Gas Pipeline Company (TGPC)
            
            300,000
            
            October
                2009Midwestern
                Gas Transmission Company
            
            297,000
            
            October
                2009Northern
                Natural Gas Company
            
            206,000
            
            October
                2008Natural
                Gas Pipeline Company (NGPL)
            
            140,000
            
            March
                2007Natural
                Gas Pipeline Company (NGPL)
            
            60,000
            
            March
                2008ANR
                Pipeline
            
            25,000
            
            October
                2009





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











2


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





**Competition/Demand**





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





Natural
      gas deliveries are temperature-sensitive and seasonal since about one-half
      of
      all deliveries are used for space heating. Typically, about three-quarters
      of
      the deliveries and revenues occur from October through March. Fluctuations
      in
      weather have the potential to significantly impact year-to-year comparisons
      of
      operating income and cash flow. It is estimated that a 100 degree-day variation
      from normal (5,830 degree days annually) would impact Nicor Gas’ net income by
      about $1.5 million to $2.0 million.





In
      the
      first quarter of 2003, Nicor Gas purchased earnings protection against the
      impact of significantly warmer-than-normal or colder-than-normal weather. No
      such protection has been purchased since the first quarter of 2003, in part
      due
      to weather risks within the consolidated Nicor group that are expected to be
      partially offsetting with the utility-bill management products marketed by
      Nicor
      Solutions. The amount of this offset will vary depending upon the time of year,
      weather patterns, the number of customers for these products and the market
      price for natural gas. In 2004, the offsetting impact related to utility-bill
      management products was about one-third of the gas distribution weather
      effect.





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





**Regulation**





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





**·**
            Base
                rates, which are set by the ICC, are designed to allow the company
                an
                opportunity to recover its costs and earn a fair return for investors.
                In
                the fourth quarter of 2005, the company received approval from the
                ICC for
                a base rate increase. For additional information about the rate order,
                see








3





Item
      7 -
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations and Item 8 - Notes to the Consolidated Financial Statements - Note
      17
      - Rate proceeding.





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





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





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





A
      performance-based rate (“PBR”) plan for natural gas costs went into effect in
      2000 and was terminated by the company effective January 1, 2003. Under the
      PBR
      plan, Nicor Gas’ total gas supply costs were compared to a market-sensitive
      benchmark. Savings and losses relative to the benchmark were determined annually
      and shared equally with sales customers. The results of the PBR plan are
      currently under ICC review. Additional information on the plan and the ICC
      review are presented in Item 8 - Notes to the Consolidated Financial Statements
      - Note 19 - Contingencies - Performance-Based Rate Plan.





**Gas
      distribution, transmission and storage system, and other
      properties**





The
      gas
      distribution, transmission and storage system includes approximately
      33,000 miles of steel, plastic and cast iron main; approximately
      1.9 million steel, plastic/aluminum composite, plastic and copper services
      connecting the mains to customers’ premises; and eight underground storage
      fields. Other properties include buildings, land, motor vehicles, meters,
      regulators, compressors, construction equipment, tools, communication and
      computer equipment, software and office equipment.





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





Substantially
      all gas distribution properties are subject to the lien of the indenture
      securing Nicor Gas’ first mortgage bonds.





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





**SHIPPING**





Tropical
      Shipping is one of the largest containerized cargo carriers in the Bahamas
      and
      the Caribbean, a region characterized by modest market growth and intense
      competition. Tropical Shipping’s financial results can be significantly affected
      by general economic conditions in the United States, the Caribbean region and
      Canada. The company is a major carrier of exports from the east coast of the
      United States and Canada to the Caribbean region. The company’s shipments
      consist primarily of southbound cargo such as building materials, food and
      other
      necessities for developers, manufacturers and residents in the





4





Caribbean
      and the Bahamas, as well as tourist-related shipments intended for use in hotels
      and resorts, and on cruise ships. The balance of Tropical Shipping’s cargo
      consists primarily of northbound shipments of apparel and agricultural products,
      and inter-island shipments. Other related services such as inland transportation
      and cargo insurance are also provided by Tropical Shipping or other Nicor
      subsidiaries.





At
      December 31, 2005, Tropical Shipping’s fleet consisted of 10 owned vessels and 8
      chartered vessels with a container capacity totaling approximately 5,900
      twenty-foot equivalent units (“TEUs”). In addition to the vessels, the company
      owns containers, container-handling equipment, chassis and other equipment.
      The
      company leases containers and equipment. Real property, more than half of which
      is leased, includes office buildings, cargo handling facilities and warehouses
      located in the United States, Canada, and some of the ports served.





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





**OTHER
      ENERGY VENTURES**





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





Nicor
      Services and Nicor Solutions are businesses that provide energy-related products
      and services to retail markets, including residential and small commercial
      customers. Nicor Services operates primarily in northern Illinois and provides
      product warranty contracts, repair, maintenance and installation services and
      equipment covering  heating,
      air conditioning and related equipment, such as natural gas piping inside homes
      and ductwork, and customer and prospect management services. Nicor Solutions
      offers its residential and small commercial customers in the Nicor Gas service
      territory energy-related products that provide for natural gas price stability
      and management of their utility bill. These products mitigate and/or eliminate
      the risks to customers of colder-than-normal weather and/or changes in natural
      gas prices.





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





During
      2002, Horizon Pipeline, a 50-percent-owned joint venture with NGPL, put into
      operation a natural gas pipeline of approximately 70 miles, stretching from
      Joliet, Illinois to near the Wisconsin/Illinois border. Nicor Gas has contracted
      for approximately 80 percent of Horizon Pipeline’s capacity under a 10-year
      agreement at rates that have been accepted by FERC.





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





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





**CORPORATE**





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





5





**AVAILABLE
      INFORMATION**





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





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





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





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





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





Nicor
      Gas
      is permitted by the ICC’s PGA regulation to adjust the charge to its sales
      customers on a monthly basis to recover the company’s prudently incurred actual
      costs to acquire the natural gas it delivers to them. The company’s gas costs
      are subject to subsequent prudence reviews by the ICC for which the company
      makes annual filings. The annual prudence reviews for calendar years 1999-2005
      are open for review and any disallowance of costs in those proceedings could
      adversely affect Nicor Gas’ results of operations, cash flows and financial
      condition.  See Item 7 - Management's Discussion and Analysis of
      Financial Condition and Results of Operations for further discussion of
      annual prudence reviews.





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




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





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





Current
      environmental laws may require the cleanup of coal tar at certain former
      manufactured gas plant sites. To date, Nicor Gas has identified about 40
      properties for which it may in part be responsible. As of December 31, 2005,
      the
      company had recorded a liability of $19.5 million associated with certain
      remediation efforts. Management believes that any such costs that are not
      recoverable from other entities





6





or
      from
      insurance carriers are recoverable through rates for utility services under
      ICC-approved mechanisms for the recovery of prudently incurred costs. A change
      in these rate recovery mechanisms, however, or a decision by the ICC that some
      or all of these costs were not prudently incurred, could adversely affect the
      company’s results of operations, cash flows and financial condition. See Item 7-
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations for further discussion.





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





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





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





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





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





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





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





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





7





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





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





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





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





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




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





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





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





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











8





Nicor
      Gas’ gas distribution activities involve a variety of inherent hazards and
      operating risks, such as leaks, accidents and mechanical problems, which could
      cause substantial financial losses. In addition, these risks could result in
      loss of human life, significant damage to property, environmental pollution
      and
      impairment of Nicor’s operations, which in turn could lead to substantial
      losses. In accordance with customary industry practice, Nicor maintains
      insurance against some, but not all, of these risks and losses. The location
      of
      pipelines and storage facilities near populated areas, including residential
      areas, commercial business centers and industrial sites, could increase the
      level of damages resulting from these risks. The occurrence of any of these
      events if not fully covered by insurance could adversely affect Nicor’s results
      of operations, cash flows and financial condition.





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




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





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





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





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




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




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




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










9





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





Nicor
      Enerchange extends credit to its counterparties. Despite prudent credit policies
      and the maintenance of netting arrangements, the company is exposed to the
      risk
      that it may not be able to collect amounts owed to it. If the counterparty
      to
      such a transaction fails to perform and any collateral Nicor Enerchange has
      secured is inadequate, Nicor Enerchange could experience financial
      losses.





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





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





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





**Item
      1B.**  **Unresolved
      Staff Comments**





None.




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




**Item
      3.  Legal Proceedings**




See
      Item
      8 - Notes to the Consolidated Financial Statements - Note 17 - Rate proceeding
      and Note 19 - Contingencies, which are incorporated herein by reference.




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


None.





























10


**Executive
      Officers of the Registrant**





Name
            
            Age
            
            Current
                Position and BackgroundRuss
                M. Strobel
            
            53
            
            Chairman,
                Nicor and Nicor Gas (since November 2005); Chief Executive Officer,
                Nicor
                (since March 2005); Chief Executive Officer, Nicor Gas (since 2003);
                President, Nicor and Nicor Gas (since 2002); Executive Vice President,
                General Counsel and Secretary, Nicor and Nicor Gas (2002); Senior
                Vice
                President, General Counsel and Secretary, Nicor and Nicor Gas
                (2000-2002).Richard
                L. Hawley
            
            56
            
            Executive
                Vice President and Chief Financial Officer, Nicor and Nicor Gas (since
                2003); Vice President and Chief Financial Officer, Puget Energy,
                Inc.,
                electric and natural gas provider (2000-2002) and Puget Sound Energy,
                Inc., electric and natural gas provider (1998-2002).Claudia
                J. Colalillo
            
            56
            
            Senior
                Vice President Human Resources and Corporate Communications, Nicor
                and
                Nicor Gas (since 2002); Vice President Human Resources, Nicor and
                Nicor
                Gas (1998-2002).Rocco
                J. D’Alessandro
            
            47
            
            Senior
                Vice President Operations, Nicor Gas (since 2002); Vice President
                Customer
                Service, Nicor Gas (1999-2002).Daniel
                R. Dodge
            
            52
            
            Senior
                Vice President Diversified Ventures and Corporate Planning, Nicor
                and
                Nicor Gas (since 2002); Vice President Business Development, Nicor
                and
                Nicor Gas (1998-2002).George
                M. Behrens
            
            50
            
            Vice
                President and Treasurer, Nicor and Nicor Gas (since 2004); Vice President
                Administration and Treasurer, Nicor and Nicor Gas (2000-2004).Paul
                C. Gracey, Jr.
            
            46
            
            Vice
                President, General Counsel and Secretary, Nicor and Nicor Gas (since
                2002); Vice President and General Counsel, Midwest Generation, Chicago,
                independent power producer (2000-2002).Gerald
                P. O’Connor
            
            54
            
            Vice
                President Administration and Finance, Nicor and Nicor Gas (since
                2004);
                Temporary General Manager - Internal Audit, Nicor and Nicor Gas
                (2003-2004); Partner, Tatum Partners L.L.C., professional services
                (2003-2004); Vice President and Chief Financial Officer, Aux Sable
                Liquid
                Products L.L.P., natural gas processing (2000-2002).





























11


**PART
      II**


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




Nicor
      common stock is listed on the New York and Chicago Stock Exchanges. At February
      21, 2006, there were approximately 22,300 common stockholders of record and
      the
      closing stock price was $41.76.


Stock
                  price
              
              
              DividendsQuarter
              
              
              High
              
              
              Low
              
              
              Declared**2005****First**
              
              **$**
              **38.33**
              
              **$**
              **35.50**
              
              **$**
              **.465****Second**
              
              
              **41.87**
              
              
              **35.76**
              
              
              **.465****Third**
              
              
              **42.59**
              
              
              **39.10**
              
              
              **.465****Fourth**
              
              
              **42.97**
              
              
              **37.42**
              
              
              **.465**2004First
              
              $
              37.43
              
              $
              32.49
              
              $
              .465Second
              
              
              35.65
              
              
              32.04
              
              
              .465Third
              
              
              37.36
              
              
              32.37
              
              
              .465Fourth
              
              
              39.65
              
              
              35.89
              
              
              .465





In
      September 2001, Nicor announced a $50 million common stock repurchase program,
      under which N icor
      may
      purchase its common stock as market conditions permit through open market
      transactions and to the extent cash flow is available after other cash needs
      and
      investment opportunities. There have been no repurchases under this program
      during 2005 or 2004. As of December 31, 2005, $21.5 million remained authorized
      for the repurchase of common stock.





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



























































12









**Nicor
                Inc.****Item
                6.  Selected Financial Data**(in
              millions, except per share data)Year
                ended December 31**2005**
            
            
            2004
            
            
            2003
            
            
            2002
            
            
            2001Operating
                revenues
            
            
            
            
            **$**
            **3,357.8**
            
            $
            2,739.7
            
            $
            2,662.7
            
            $
            1,897.4
            
            $
            2,366.3Operating
                income
            
            
            
            
            **$**
            **201.7**
            
            $
            137.7
            
            $
            189.4
            
            $
            226.5
            
            $
            219.2Income
                before cumulative effect ofaccounting
                change
            
            
            
            
            **$**
            **136.3**
            
            $
            75.1
            
            $
            109.8
            
            $
            128.0
            
            $
            122.1Net
                income
            
            
            
            
            **$**
            **136.3**
            
            $
            75.1
            
            $
            105.3
            
            $
            128.0
            
            $
            122.1Earnings
                per common shareBasicBefore
                cumulative effect ofaccounting
                change
            
            
            
            
            **$**
            **3.08**
            
            $
            1.71
            
            $
            2.49
            
            $
            2.90
            
            $
            2.70Basic
                earnings per share
            
            
            
            
            
            **3.08**
            
            
            1.71
            
            
            2.39
            
            
            2.90
            
            
            2.70DilutedBefore
                cumulative effect ofaccounting
                change
            
            
            
            
            **$**
            **3.07**
            
            $
            1.70
            
            $
            2.48
            
            $
            2.88
            
            $
            2.69Diluted
                earnings per share
            
            
            
            
            
            **3.07**
            
            
            1.70
            
            
            2.38
            
            
            2.88
            
            
            2.69Dividends
                declared percommon
                share
            
            
            
            
            **$**
            **1.86**
            
            $
            1.86
            
            $
            1.86
            
            $
            1.84
            
            $
            1.76Property,
                plant and equipmentGross
            
            
            
            
            **$**
            **4,351.3**
            
            $
            4,143.6
            
            $
            3,999.5
            
            $
            3,872.8
            
            $
            3,733.0Net
            
            
            
            
            
            **2,659.1**
            
            
            2,549.8
            
            
            2,484.2
            
            
            2,421.8
            
            
            2,343.6Total
                assets
            
            
            
            
            **$**
            **4,391.2**
            
            $
            3,975.2
            
            $
            3,797.2
            
            $
            3,524.4
            
            $
            3,182.2CapitalizationLong-term
                bonds and notes, net ofcurrent
                maturities
            
            
            
            
            **$**
            **485.8**
            
            $
            495.3
            
            $
            495.1
            
            $
            396.2
            
            $
            446.4Mandatorily
                redeemable preferred stock
            
            
            
            
            
            **.6**
            
            
            1.6
            
            
            1.8
            
            
            4.3
            
            
            6.1Common
                equity
            
            
            
            
            
            **811.3**
            
            
            749.1
            
            
            754.6
            
            
            728.4
            
            
            704.2**$**
            **1,297.7**
            
            $
            1,246.0
            
            $
            1,251.5
            
            $
            1,128.9
            
            $
            1,156.7See
                Item 1A - Risk Factors and Item 7 - Management's Discussion and Analysis
                of Financial Condition and Results of Operations for factors that
                can
                impact year-to-year comparisons and may affect the future performance
                of
                Nicor's business.




13









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





The
      purpose of this financial review is to explain changes in operating results
      and
      financial condition from 2003 to 2005 and to discuss business trends that might
      affect Nicor. Certain terms used herein are defined in the glossary on pages
      ii
      and iii. The discussion is organized into six sections - Summary, Results of
      Operations, Financial Condition and Liquidity, Outlook, Contingencies and
      Critical Accounting Estimates.





**SUMMARY**





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





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





**2005**
            
            2004
            
            2003Income
                before cumulative effect of accounting change
            **$**
            **136.3**
            
            
            $
            75.1
            
            
            $
            109.8Net
                income
            
            **136.3**
            
            
            
            75.1
            
            
            
            105.3Earnings
                per average share of common stock:Diluted
                - before cumulative effect of accounting change
            
            **3.07**
            
            
            
            1.70
            
            
            
            2.48Diluted
                - after cumulative effect of accounting change
            
            **3.07**
            
            
            
            1.70
            
            
            
            2.38





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





Year
      over
      year comparisons also reflect higher operating results at Tropical Shipping
      and
      lower corporate overhead costs, partially offset by lower operating results
      in
      the gas distribution and other energy-related businesses. Results of the gas
      distribution business reflect the impact of the base rate increase which became
      effective in the fourth quarter. See Item 8 - Notes to the Consolidated
      Financial Statements - Note 17 - Rate proceeding for further discussion of
      the
      rate order.





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














14


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





*Rate
      proceeding.*  Nicor
      Gas
      filed a request with the Illinois Commerce Commission (“ICC”) for an overall
      increase in base rates on November 4, 2004.  In late 2005, Nicor Gas
      received approval from the ICC for a $54.2 million base rate increase which
      reflected an allowed rate of return on original-cost rate base of 8.85 percent,
      including a 10.51 percent cost of common equity. The order also included the
      authorization to pass all Chicago Hub revenues directly through to customers
      as
      a credit to Nicor Gas’ Purchased Gas Adjustment (“PGA”) rider and the shifting
      of certain storage-related costs from the PGA rider to base rates.  In
      addition, rates were established using a 10-year average for weather as opposed
      to the previous use of a 30-year average. The new rates were implemented in
      the
      fourth quarter of 2005. Because the order shifts certain items between base
      rates and Nicor Gas’ PGA rider, the company estimates that, under normal weather
      conditions, the annual net revenue increase resulting from implementing the
      new
      rate order will be about $34.7 million under the tariffs that have been placed
      into effect.





In
      October 2005, Nicor Gas and six other parties filed applications for rehearing
      of the final order of the rate case.  The ICC granted rehearing on seven
      issues, only two of which relate to the amount of the approved annual net
      revenue increase, and denied rehearing on all other issues raised in the
      applications.  The ICC is expected to issue its decision on rehearing in
      March 2006. As a result of the rehearing process, the actual annual net revenue
      increase approved by the ICC could change. Based on the positions of the parties
      on the rehearing issues, the outcome could range from an approximate $7.1
      million reduction to the annual net revenue increase to an approximate $0.9
      million additional annual increase. Rate changes, if any, resulting from the
      outcome of the rehearing process would be prospective.





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





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





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





**2005**
            
            2004
            
            2003Gas
                distribution
            **$**
            **116.9**
            
            
            $
            130.8
            
            
            $
            166.2Shipping
            
            **40.4**
            
            
            
            31.6
            
            
            
            22.7Other
                energy ventures
            
            **14.1**
            
            
            
            19.3
            
            
            
            7.9Corporate
                and eliminations
            
            **30.3**
            
            
            
            (44.0
            )
            
            
            (7.4
            )**$**
            **201.7**
            
            
            $
            137.7
            
            
            $
            189.4




















15





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





**·**
            Gas
                distribution operating income decreased $13.9 million in 2005 as
                compared
                with 2004 due to higher operating and maintenance expenses ($19.9
                million
                increase), higher depreciation expense ($5.7 million increase), and
                lower
                gains on property sales ($5.5 million decrease). The adverse impact
                of
                these factors was partially offset by higher gas distribution margin
                ($17.5 million increase). Higher gas distribution margin was largely
                driven by higher average rates due in part to the rate increase which
                became effective during the fourth quarter of 2005 ($12.8 million)
                and the
                positive impact of colder weather than in 2004 (approximately $4
                million
                increase), partially offset by lower demand unrelated to weather
                (approximately $6 million decrease). After consideration of the impacts
                of
                the rate order on gas distribution margin and operating and maintenance
                expenses, the fourth quarter rate increase added approximately $9
                million
                to gas distribution operating
                income.




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





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





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





**·**
            Operating
                income from Nicor’s other energy ventures for 2005 decreased $5.2 million
                compared with 2004 due primarily to lower operating results at Nicor
                Enerchange ($6.3 million decrease). Lower Nicor Enerchange results
                reflect
                unfavorable fair value adjustments related to derivative instruments
                used
                to hedge future sales of natural gas inventory. These losses are
                expected
                to reverse in the future as the underlying transactions are settled.
                Nicor
                Enerchange purchases and holds natural gas in storage to earn a profit
                margin from its ultimate sale. Nicor Enerchange uses derivatives
                to
                mitigate commodity price risk in order to substantially lock-in the
                profit
                margin that will ultimately be realized. However, gas stored in inventory
                is required to be accounted for at the lower of weighted-average
                cost or
                market, whereas the derivatives used to reduce the risk associated
                with a
                change in the value of the inventory are accounted for at fair value,
                with
                changes in fair value recorded in operating results in the period
                of
                change. As a result, earnings are subject to volatility as the market
                price of derivatives change, even when the underlying hedged value
                of the
                inventory is unchanged. The volatility resulting from this accounting
                can
                be significant from period to
                period.





16


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





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





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





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





**RESULTS
      OF OPERATIONS**





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





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





**2005**
            
            2004
            
            2003Gas
                distribution
            **$**
            **2,909.6**
            
            
            $
            2,362.1
            
            
            $
            2,351.6Shipping
            
            **378.5**
            
            
            
            310.7
            
            
            
            272.2Other
                energy ventures
            
            **157.0**
            
            
            
            155.3
            
            
            
            96.5Corporate
                and eliminations
            
            **(87.3**
            **)**
            
            
            (88.4
            )
            
            
            (57.6
            )**$**
            **3,357.8**
            
            
            $
            2,739.7
            
            
            $
            2,662.7





Gas
      distribution revenues are impacted by changes in natural gas costs, which are
      passed directly through to customers without markup, subject to ICC review.
      For
      the year 2005, gas distribution revenues increased $547.5 million as compared
      with 2004 due primarily to higher natural gas costs ($526.1 million increase)
      and the positive impact of colder weather than in 2004 (approximately $60
      million increase), partially offset by lower demand unrelated to weather
      (approximately $70 million decrease). These results also reflect the impact
      of
      the rate order tariffs, which became effective during the fourth quarter of
      2005, and increased revenues by approximately $12.8 million.





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

















17


In
      2005,
      shipping segment operating revenues increased over 2004 due primarily to higher
      average rates ($41.8 million increase) and increased volumes shipped ($25.3
      million increase). Rates were higher due to general rate increases across all
      markets and higher cost-recovery surcharges for fuel and security. The
      volume increases were recognized across substantially all ports, reflecting
      improvements in the economy, significant increases in Bahamian and Caribbean
      investment, and rebuilding efforts following the 2004 hurricanes.





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





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





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





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





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





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




**2005**
            
            2004
            
            2003Gas
                distribution revenues
            **$**
            **2,909.6**
            
            
            $
            2,362.1
            
            
            $
            2,351.6Cost
                of gas
            
            **(2,212.4**
            **)**
            
            
            (1,695.0
            )
            
            
            (1,692.7
            )Revenue
                tax expense
            
            **(152.0**
            **)**
            
            
            (139.4
            )
            
            
            (130.9
            )Gas
              distribution margin
            **$**
            **545.2**
            
            
            $
            527.7
            
            
            $
            528.0


For
      the
      year 2005, gas distribution margin increased $17.5 million from 2004 due
      primarily to higher average rates (approximately $19 million increase) driven
      by
      the rate increase ($12.8 million), and the positive impact of colder weather
      than in 2004 (approximately $4 million increase), partially offset by lower
      demand unrelated to weather (approximately $6 million decrease).

















18


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





**Gas
      distribution operating and maintenance expense.** The
      $19.9
      million increase in gas distribution operating and maintenance expense in 2005
      as compared with the prior year reflects higher bad debt expense ($12.1 million
      increase), company use gas ($4.0 million increase) and gas storage-related
      costs
      ($6.5 million increase in the fourth quarter). The rate order, which became
      effective in the fourth quarter of 2005, results in certain storage-related
      gas
      costs **** being **** charged
      to operating and maintenance expense. Prior to the effective date of the rate
      order, these storage-related gas costs were charged to cost of gas and passed
      through to customers as part of the PGA rider. These increases were partially
      offset by lower net legal and claims expenses ($4.7 million decrease).





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





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




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





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




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




















19





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





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





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





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





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





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





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





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





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





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





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








20





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





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





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
































































































































21


**Nicor
                  Inc.****Gas
                  Distribution Statistics**
              
              
              
              
              
              **2005**
              
              
              2004
              
              
              2003**Operating
                  revenues**(millions)SalesResidential
              
              
              
              
              **$**
              **2,031.4**
              
              $
              1,625.5
              
              $
              1,611.9Commercial
              
              
              
              
              
              **453.5**
              
              
              349.9
              
              
              351.7Industrial
              
              
              
              
              
              **61.8**
              
              
              49.3
              
              
              51.2**2,546.7**
              
              
              2,024.7
              
              
              2,014.8TransportationResidential
              
              
              
              
              
              **27.9**
              
              
              23.6
              
              
              22.7Commercial
              
              
              
              
              
              **73.1**
              
              
              69.9
              
              
              71.6Industrial
              
              
              
              
              
              **39.2**
              
              
              39.9
              
              
              41.7Other
              
              
              
              
              
              **11.7**
              
              
              14.0
              
              
              12.0**151.9**
              
              
              147.4
              
              
              148.0Other
                  revenuesRevenue
                  taxes
              
              
              
              
              
              **156.4**
              
              
              143.5
              
              
              134.0Environmental
                  cost recovery
              
              
              
              
              
              **21.0**
              
              
              20.6
              
              
              31.3Chicago
                  Hub
              
              
              
              
              
              **11.5**
              
              
              7.9
              
              
              7.3Performance-based
                  rate plan
              
              
              
              
              
              **-**
              
              
              (1.8
              )
              
              -Other
              
              
              
              
              
              **22.1**
              
              
              19.8
              
              
              16.2**211.0**
              
              
              190.0
              
              
              188.8**$**
              **2,909.6**
              
              $
              2,362.1
              
              $
              2,351.6**Deliveries**(Bcf)SalesResidential
              
              
              
              
              
              **200.2**
              
              
              204.8
              
              
              214.9Commercial
              
              
              
              
              
              **44.7**
              
              
              44.3
              
              
              46.7Industrial
              
              
              
              
              
              **6.3**
              
              
              6.4
              
              
              7.0**251.2**
              
              
              255.5
              
              
              268.6TransportationResidential
              
              
              
              
              
              **18.9**
              
              
              16.6
              
              
              16.6Commercial
              
              
              
              
              
              **87.5**
              
              
              84.1
              
              
              87.8Industrial
              
              
              
              
              
              **113.0**
              
              
              117.0
              
              
              121.2**219.4**
              
              
              217.7
              
              
              225.6**470.6**
              
              
              473.2
              
              
              494.2**Year-end
                  customers**(thousands)SalesResidential
              
              
              
              
              
              **1,796.2**
              
              
              1,777.3
              
              
              1,745.2Commercial
              
              
              
              
              
              **120.3**
              
              
              116.5
              
              
              114.5Industrial
              
              
              
              
              
              **7.4**
              
              
              7.4
              
              
              7.3**1,923.9**
              
              
              1,901.2
              
              
              1,867.0TransportationResidential
              
              
              
              
              
              **157.1**
              
              
              147.9
              
              
              145.1Commercial
              
              
              
              
              
              **58.2**
              
              
              59.5
              
              
              58.3Industrial
              
              
              
              
              
              **5.9**
              
              
              6.0
              
              
              6.2**221.2**
              
              
              213.4
              
              
              209.6**2,145.1**
              
              
              2,114.6
              
              
              2,076.6**Other
                  statistics**Degree
                  days
              
              
              
              
              
              **5,783**
              
              
              5,637
              
              
              6,068Colder
                  (warmer) than normal*
              
              
              
              
              
              **(1**
              **)%**
              
              (6
              )%
              
              1
              %Average
                  gas cost per Mcf sold
              
              
              
              
              **$**
              **8.74**
              
              $
              6.56
              
              $
              6.24*
                  Normal weather for Nicor Gas' service territory, for purposes of
                  this
                  report, is considered to be about 5,830 degree days per year for
                  2005 and
                  6,000 degree days for 2004 and 2003.  On a 6,000 degree day basis,
                  2005 would have been 4% warmer than normal.
  22


**Shipping
                Statistics****2005**
            
            2004
            
            2003TEUs
                shipped (thousands)
            
            **214.2**
            
            
            
            198.0
            
            
            
            177.1Average
                revenue per TEU
            **$**
            **1,764**
            
            
            $
            1,569
            
            
            $
            1,525At
                end of periodPorts
                served
            
            **25**
            
            
            
            24
            
            
            
            25Vessels
                operated at year-end
            
            **18**
            
            
            
            20
            
            
            
            15





**FINANCIAL
      CONDITION AND LIQUIDITY**





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





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





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





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





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

















23


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





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





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





Estimated2006
              
              **2005**
              
              2004
              
              2003Gas
                  distribution
              $
              175
              
              
              **$**
              **188**
              
              
              $
              175
              
              
              $
              173Shipping
              
              16
              
              
              
              **11**
              
              
              
              9
              
              
              
              6Other
                  energy ventures
              
              7
              
              
              
              **3**
              
              
              
              3
              
              
              
              2$
              198
              
              
              **$**
              **202**
              
              
              $
              187
              
              
              $
              181





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





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





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





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





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











24





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





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





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





Standard
                &
                  Poor’s
              
              Moody’s
              
              FitchNicor
                  Inc.Commercial
                  Paper
              
              
              A-1+
              
              P-1
              
              F-1Senior
                  Unsecured Debt
              
              
              AA-
              
              n/a
              
              ACorporate
                  Credit Rating
              
              
              AA
              
              n/a
              
              n/a
  Nicor
                  GasCommercial
                  Paper
              
              
              A-1+
              
              P-1
              
              F-1+First
                  Mortgage Bonds
              
              
              AA
              
              Aa3
              
              AA-Senior
                  Unsecured Debt
              
              
              AA-
              
              A1
              
              A+Corporate
                  Credit Rating
              
              
              AA
              
              n/a
              
              n/a
 During
        2005, Standard and Poor’s (“S&P”), Moody’s and Fitch reaffirmed Nicor Inc.’s
        and Nicor Gas’ credit ratings. In June 2004, Fitch upgraded the ratings outlook
        to stable from negative while in December 2004, S&P changed its outlook from
        stable to negative. Moody’s outlook has been negative since April of
        2003.





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





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





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





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





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








25





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





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





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





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





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





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





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





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





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
































26





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




Payments
      due by period


Less
              than
                1
              year
            
            1-3
              years
            
            3-5
              years
            
            More
              than
                5
              years
            
            TotalPurchase
                obligations
            
            $1,002.6
            
            $757.4
            
            $
                87.5
            
            $
                16.0
            
            $1,863.5Long-term
                debt
            
            50.0
            
            115.0
            
            50.0
            
            325.0
            
            540.0Fixed
                interest on
              long-term
                debt
            
            30.4
            
            53.8
            
            41.5
            
            245.9
            
            371.6Variable
                interest on
              long-term
                debt
            
            2.0
            
            2.0
            
            -
            
            -
            
            4.0Operating
                leases
            
            36.5
            
            51.4
            
            15.1
            
            16.6
            
            119.6Other
                long-term obligations
            
            2.6
            
            3.0
            
            .6
            
            .6
            
            6.8$1,124.1
            
            $982.6
            
            $194.7
            
            $604.1
            
            $2,905.5





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





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





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





**OUTLOOK**





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





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





27


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





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





**CONTINGENCIES**





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





*Performance-based
      rate (“PBR”) plan* .
      Nicor
      Gas’ PBR plan for natural gas costs went into effect in 2000 and was terminated
      by the company effective January 1, 2003. Under the PBR plan, Nicor Gas’ total
      gas supply costs were compared to a market-sensitive benchmark. Savings and
      losses relative to the benchmark were determined annually and shared equally
      with sales customers. The PBR is currently under ICC review.





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





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





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





28





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





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





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





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





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





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








29





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





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





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





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





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





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





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





30





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





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





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





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





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





*Other
      contingencies.* **** The
      company is involved in legal or administrative proceedings before various courts
      and agencies with respect to general claims, rates, taxes, environmental, gas
      cost prudence reviews and other matters. See Item 8 - Notes to the Consolidated
      Financial Statements - Note 8 - Income and Other Taxes and Note 19 -
      Contingencies.





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





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





31





**CRITICAL
      ACCOUNTING ESTIMATES**





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





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





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





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





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





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








32





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





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





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





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





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





**NEW
      ACCOUNTING PRONOUNCEMENTS**





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





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





**CAUTION
      CONCERNING FORWARD-LOOKING STATEMENTS**





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





33





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





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





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





**Item
      7A.**  **Quantitative
      and Qualitative Disclosures about Market Risk**





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





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





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





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





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








34





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





Nicor’s
      other energy businesses are subject to natural gas commodity price risk, arising
      primarily from purchase and sale agreements, transportation agreements, natural
      gas inventories and utility-bill management arrangements. Derivative instruments
      such as futures, options, forwards and swaps may be used to hedge these risks.
      Based on Nicor’s other energy businesses unhedged positions at December 31,
      2005, a 10 percent adverse change in natural gas prices would have decreased
      Nicor’s earnings at December 31, 2005 and 2004 by about $1.0 million and $0.2
      million, respectively.





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





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





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





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





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




















35







**Nicor
      Inc.**





**Item
                8.**
            **Financial
                Statements and Supplementary
                Data**





PageReport
                of Independent Registered Public Accounting Firm
            37Financial
                Statements:Consolidated
                Statements of Operations
            39Consolidated
                Statements of Cash Flows
            40Consolidated
                Balance Sheets
            41Consolidated
                Statements of Capitalization
            42Consolidated
                Statements of Common Equity
            43Consolidated
                Statements of Comprehensive Income
            43Notes
                to the Consolidated Financial Statements
            44





























































































36





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and Stockholders of Nicor Inc.





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





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





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





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











37





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
      (concluded)**





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





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





/s/
      DELOITTE & TOUCHE LLP


Chicago,
      Illinois


February
      24, 2006































































































38







**Nicor
                Inc.****Consolidated
                Statements of Operations****(millions,
                except per share data)**Year
                ended December 31**2005**
            
            
            2004
            
            
            2003Operating
                revenuesGas
                distribution (includes revenue taxes of $156.4,$143.5,
                and $134.0, respectively)
            
            **$**
            **2,909.6**
            
            $
            2,362.1
            
            $
            2,351.6Shipping
            
            
            **378.5**
            
            
            310.7
            
            
            272.2Other
                energy ventures
            
            
            **157.0**
            
            
            155.3
            
            
            96.5Corporate
                and eliminations
            
            
            **(87.3**
            **)**
            
            (88.4
            )
            
            (57.6
            )Total
                operating revenues
            
            
            **3,357.8**
            
            
            2,739.7
            
            
            2,662.7Operating
                expensesGas
                distributionCost
                of gas
            
            
            **2,212.4**
            
            
            1,695.0
            
            
            1,692.7Operating
                and maintenance
            
            
            **254.8**
            
            
            234.9
            
            
            220.1Depreciation
            
            
            **154.5**
            
            
            148.8
            
            
            143.5Taxes,
                other than income taxes
            
            
            **171.0**
            
            
            158.5
            
            
            147.3Mercury-related
                costs (recoveries), net
            
            
            **.4**
            
            
            -
            
            
            (17.8
            )Property
                sale gains
            
            
            **(.4**
            **)**
            
            (5.9
            )
            
            (.4
            )Shipping
            
            
            **338.1**
            
            
            279.1
            
            
            249.5Other
                energy ventures
            
            
            **142.9**
            
            
            136.0
            
            
            88.6Litigation
                charges (recoveries), net
            
            
            **(29.9**
            **)**
            
            38.5
            
            
            -Other
                corporate expenses and eliminations
            
            
            **(87.7**
            **)**
            
            (82.9
            )
            
            (50.2
            )Total
                operating expenses
            
            
            **3,156.1**
            
            
            2,602.0
            
            
            2,473.3Operating
                income
            
            
            **201.7**
            
            
            137.7
            
            
            189.4Interest
                expense, net of amounts capitalized
            
            
            **46.8**
            
            
            41.2
            
            
            37.3Equity
                investment income, net
            
            
            **9.3**
            
            
            6.3
            
            
            15.3Interest
                income
            
            
            **6.0**
            
            
            2.3
            
            
            1.9Other
                income, net
            
            
            **.8**
            
            
            .2
            
            
            .1Income
                before income taxes and cumulativeeffect
                of accounting change
            
            
            **171.0**
            
            
            105.3
            
            
            169.4Income
                tax expense, net of benefits
            
            
            **34.7**
            
            
            30.2
            
            
            59.6Income
                before cumulative effect of accounting change
            
            
            **136.3**
            
            
            75.1
            
            
            109.8Cumulative
                effect of accounting change, net of$3.0
                income tax benefit
            
            
            **-**
            
            
            -
            
            
            (4.5
            )Net
                income
            
            
            **136.3**
            
            
            75.1
            
            
            105.3Dividends
                on preferred stock
            
            
            **-**
            
            
            **-**
            
            
            .1Earnings
                applicable to common stock
            
            **$**
            **136.3**
            
            $
            75.1
            
            $
            105.2Average
                shares of common stock outstandingBasic
            
            
            **44.2**
            
            
            44.1
            
            
            44.0Diluted
            
            
            **44.4**
            
            
            44.3
            
            
            44.2Earnings
                per average share of common stockBasicBefore
                cumulative effect of accounting change
            
            **$**
            **3.08**
            
            $
            1.71
            
            $
            2.49Cumulative
                effect of accounting change, net of tax
            
            
            **-**
            
            
            -
            
            
            (.10
            )**$**
            **3.08**
            
            $
            1.71
            
            $
            2.39DilutedBefore
                cumulative effect of accounting change
            
            **$**
            **3.07**
            
            $
            1.70
            
            $
            2.48Cumulative
                effect of accounting change, net of tax
            
            
            **-**
            
            
            -
            
            
            (.10
            )**$**
            **3.07**
            
            $
            1.70
            
            $
            2.38The
                accompanying notes are an integral part of these
                statements.




39









**Nicor
                Inc.****Consolidated
                Statements of Cash Flows****(millions)**Year
                ended December 31**2005**
            
            
            2004
            
            
            2003Operating
                activitiesNet
                income
            
            **$**
            **136.3**
            
            $
            75.1
            
            $
            105.3Adjustments
                to reconcile net income to net cash flowprovided
                from operating activities:Depreciation
            
            
            **172.4**
            
            
            166.6
            
            
            161.7Deferred
                income tax (benefit) expense
            
            
            **(102.1**
            **)**
            
            27.3
            
            
            132.6Cumulative
                effect of accounting change
            
            
            **-**
            
            
            -
            
            
            4.5Loss
                (gain) on sale of property, plant and equipment
            
            
            **.3**
            
            
            (5.8
            )
            
            (1.9
            )Changes
                in assets and liabilities:Receivables,
                less allowances
            
            
            **(305.9**
            **)**
            
            (121.5
            )
            
            (4.1
            )Gas
                in storage
            
            
            **(40.6**
            **)**
            
            13.3
            
            
            (195.6
            )Deferred/accrued
                gas costs
            
            
            **154.9**
            
            
            21.3
            
            
            (20.3
            )Prepaid
                pension costs
            
            
            **(6.1**
            **)**
            
            (4.4
            )
            
            -Other
                assets
            
            
            **13.9**
            
            
            (.9
            )
            
            13.7Accounts
                payable
            
            
            **155.3**
            
            
            124.1
            
            
            (166.0
            )Other
                liabilities
            
            
            **21.8**
            
            
            20.2
            
            
            (30.2
            )Other
                items
            
            
            **6.0**
            
            
            2.4
            
            
            (12.3
            )Net
                cash flow provided from (used for) operating activities
            
            
            **206.2**
            
            
            317.7
            
            
            (12.6
            )Investing
                activitiesCapital
                expenditures
            
            
            **(201.9**
            **)**
            
            (190.4
            )
            
            (181.3
            )Purchase
                of equity investments
            
            
            **(2.3**
            **)**
            
            (2.6
            )
            
            (12.7
            )Purchases
                of available-for-sale securities
            
            
            **-**
            
            
            (21.8
            )
            
            -Purchases
                of held-to-maturity securities
            
            
            **(2.9**
            **)**
            
            (2.9
            )
            
            (2.5
            )Proceeds
                from sales or maturities of available-for-sale securities
            
            
            **15.1**
            
            
            6.9
            
            
            -Proceeds
                from sales or maturities of held-to-maturity securities
            
            
            **3.6**
            
            
            2.8
            
            
            1.9Net
                (increase) decrease in other short-term investments
            
            
            **29.7**
            
            
            (4.7
            )
            
            (6.6
            )Repayments
                from joint ventures
            
            
            **-**
            
            
            -
            
            
            8.3Net
                proceeds from sale of property, plant and equipment
            
            
            **1.0**
            
            
            8.0
            
            
            3.5Other
                investing activities
            
            
            **3.0**
            
            
            -
            
            
            3.4Net
                cash flow used for investing activities
            
            
            **(154.7**
            **)**
            
            (204.7
            )
            
            (186.0
            )Financing
                activitiesNet
                proceeds from issuing long-term debt
            
            
            **39.9**
            
            
            -
            
            
            147.8Disbursements
                to retire long-term obligations
            
            
            **(1.2**
            **)**
            
            -
            
            
            (152.5
            )Commercial
                paper issuances with maturities over 90 days
            
            
            **-**
            
            
            35.0
            
            
            730.0Commercial
                paper repayments with maturities over 90 days
            
            
            **-**
            
            
            (575.0
            )
            
            (190.0
            )Net
                issuances (repayments) of commercial paper with maturities of90
                days or less
            
            
            **96.0**
            
            
            455.0
            
            
            (280.0
            )Dividends
                paid
            
            
            **(82.1**
            **)**
            
            (82.0
            )
            
            (81.8
            )Borrowing
                against cash surrender value of life insurance policies
            
            
            **-**
            
            
            26.1
            
            
            -Repayment
                of loan against cash surrender value of life insurance
                policies
            
            
            **-**
            
            
            (11.7
            )
            
            -Other
                financing activities
            
            
            **1.9**
            
            
            2.2
            
            
            .2Net
                cash flow provided from (used for) financing activities
            
            
            **54.5**
            
            
            (150.4
            )
            
            173.7Net
                increase (decrease) in cash and cash equivalents
            
            
            **106.0**
            
            
            (37.4
            )
            
            (24.9
            )Cash
                and cash equivalents, beginning of year
            
            
            **12.9**
            
            
            50.3
            
            
            75.2Cash
                and cash equivalents, end of year
            
            **$**
            **118.9**
            
            $
            12.9
            
            $
            50.3Supplemental
                informationIncome
                taxes paid (refunded), net
            
            **$**
            **99.6**
            
            $
            10.4
            
            $
            (73.3
            )Interest
                paid, net of amounts capitalized
            
            
            **39.1**
            
            
            37.9
            
            
            41.1Supplemental
                schedule of noncash investing and financing activities:In
                2004, one of Nicor's Directors and Officers insurance carriers paid
                $29.0
                million into an escrow account as described in Note 4.  Assets and
                liabilities, including investment returns, were recorded as
                follows:Restricted
                short-term investments
            
            
            
            
            $
            29.1Obligation
                related to restricted investments
            
            
            
            
            
            29.1During
                the second quarter of 2005, the escrow arrangement was terminated
                and the
                full amount of the escrow of $29.0 million plus the earnings thereon
                of
                $0.4 million, was distributed to the company and recorded in
                income.The
                release of the amount from escrow and the change in the obligation
                related
                to the restricted investment are netted in Investing activities
                above.The
                accompanying notes are an integral part of these
                statements.




40









**Nicor
                Inc.****Consolidated
                Balance Sheets****(millions)**December
                31**2005**
            
            2004**Assets**Current
                assetsCash
                and cash equivalents
            
            **$**
            **118.9**
            
            $
            12.9Restricted
                short-term investments
            
            
            **-**
            
            
            29.1Short-term
                investments, at cost which approximates market
            
            
            **8.0**
            
            
            41.2Receivables,
                less allowances of $31.5 and $21.9, respectively
            
            
            **889.1**
            
            
            583.2Gas
                in storage
            
            
            **261.3**
            
            
            220.7Deferred
                income taxes
            
            
            **3.0**
            
            
            72.3Other
            
            
            **65.4**
            
            
            61.5Total
                current assets
            
            
            **1,345.7**
            
            
            1,020.9Property,
                plant and equipment, at costGas
                distribution
            
            
            **4,043.2**
            
            
            3,831.6Shipping
            
            
            **293.9**
            
            
            300.8Other
            
            
            **14.2**
            
            
            11.2**4,351.3**
            
            
            4,143.6Less
                accumulated depreciation
            
            
            **1,692.2**
            
            
            1,593.8Total
                property, plant and equipment, net
            
            
            **2,659.1**
            
            
            2,549.8Prepaid
                pension costs
            
            
            **187.6**
            
            
            181.5Long-term
                investments
            
            
            **133.2**
            
            
            137.6Other
                assets
            
            
            **65.6**
            
            
            85.4Total
                assets
            
            **$**
            **4,391.2**
            
            $
            3,975.2**Liabilities
                and Capitalization**Current
                liabilitiesLong-term
                obligations due within one year
            
            **$**
            **50.0**
            
            $
            .2Short-term
                borrowings
            
            
            **586.0**
            
            
            490.0Accounts
                payable
            
            
            **658.2**
            
            
            502.9Accrued
                gas costs
            
            
            **223.2**
            
            
            68.3Dividends
                payable
            
            
            **20.5**
            
            
            20.5Deferred
                income taxes
            
            
            **7.4**
            
            
            -Obligations
                related to restricted investments
            
            
            **-**
            
            
            29.1Other
            
            
            **77.6**
            
            
            60.4Total
                current liabilities
            
            
            **1,622.9**
            
            
            1,171.4Deferred
                credits and other liabilitiesRegulatory
                retirement cost liability
            
            
            **631.7**
            
            
            706.4Deferred
                income taxes
            
            
            **421.6**
            
            
            593.4Asset
                retirement obligation
            
            
            **164.0**
            
            
            -Regulatory
                income tax liability
            
            
            **41.3**
            
            
            44.8Unamortized
                investment tax credits
            
            
            **31.7**
            
            
            33.8Other
                liabilities
            
            
            **180.3**
            
            
            179.4Total
                deferred credits and other liabilities
            
            
            **1,470.6**
            
            
            1,557.8Commitments
                and contingenciesCapitalizationLong-term
                obligationsLong-term
                bonds and notes, net of unamortized discount
            
            
            **485.8**
            
            
            495.3Mandatorily
                redeemable preferred stock
            
            
            **.6**
            
            
            1.6Total
                long-term obligations
            
            
            **486.4**
            
            
            496.9Common
                equity
            
            
            **811.3**
            
            
            749.1Total
                capitalization
            
            
            **1,297.7**
            
            
            1,246.0Total
                liabilities and capitalization
            
            **$**
            **4,391.2**
            
            $
            3,975.2The
                accompanying notes are an integral part of these
                statements.




41









**Nicor
                Inc.****Consolidated
                Statements of Capitalization****(millions,
                except share data)**December
                31**2005**
            
            2004First
                mortgage bonds5.55%
                Series due 2006
            
            
            
            
            **$**
            **50.0**
            
            
            
            
            $
            50.05.875%
                Series due 2008
            
            
            
            
            
            **75.0**
            
            
            
            
            
            75.05.37%
                Series due 2009
            
            
            
            
            
            **50.0**
            
            
            
            
            
            50.06.625%
                Series due 2011
            
            
            
            
            
            **75.0**
            
            
            
            
            
            75.07.20%
                Series due 2016
            
            
            
            
            
            **50.0**
            
            
            
            
            
            50.05.80%
                Series due 2023
            
            
            
            
            
            **50.0**
            
            
            
            
            
            50.06.58%
                Series due 2028
            
            
            
            
            
            **50.0**
            
            
            
            
            
            50.05.90%
                Series due 2032
            
            
            
            
            
            **50.0**
            
            
            
            
            
            50.05.90%
                Series due 2033
            
            
            
            
            
            **50.0**
            
            
            
            
            
            50.0**500.0**
            
            
            
            
            
            500.0Less: 
                Amount due within one year
            
            
            
            
            
            **50.0**
            
            
            
            
            
            -Unamortized
                debt discount, net of premium
            
            
            
            
            
            **4.2**
            
            
            
            
            
            4.7**445.8**
            
            
            **34.4**
            **%**
            
            495.3
            
            
            39.8
            %Other
                long-term debtSenior
                unsecured term loan, variable interest rate ofLondon
                Inter-bank Offered Rate plus .5%, due 2007
            
            
            
            
            
            **40.0**
            
            
            **3.1**
            
            
            **-**
            
            
            **-**Total
                long-term bonds and notes
            
            
            
            
            
            **485.8**
            
            
            **37.5**
            
            
            495.3
            
            
            39.8Mandatorily
                redeemable preferred and preference stockCumulative,
                $50 par value, 1,600,000 preferredshares
                authorized; and cumulative, without parvalue,
                20,000,000 preference shares authorized(11,681
                shares of redeemable preferred stock,4.48%
                series, outstanding at December 31, 2005and
                35,444 shares of redeemable preferred stock,4.48%
                and 5.00% series, outstanding atDecember
                31, 2004)
            
            
            
            
            
            **.6**
            
            
            
            
            
            1.8Less: 
                Amount due within one year
            
            
            
            
            
            **-**
            
            
            
            
            
            .2Total
                mandatorily redeemable preferred and preference stock
            
            
            
            
            
            **.6**
            
            
            **-**
            
            
            1.6
            
            
            .1Common
                equityCommon
                stock, $2.50 par value, 160,000,000 sharesauthorized
                (2,447,380 and 2,568,646 shares reservedfor
                conversion and other purposes, and 44,179,972and
                44,102,118 shares outstanding, respectively)
            
            
            
            
            
            **110.5**
            
            
            
            
            
            110.2Paid-in
                capital
            
            
            
            
            
            **8.0**
            
            
            
            
            
            5.6Retained
                earnings
            
            
            
            
            
            **694.5**
            
            
            
            
            
            640.3Unearned
                compensation
            
            
            
            
            
            **(.1**
            **)**
            
            
            
            
            (.2
            )Accumulated
                other comprehensive income (loss)Cash
                flow hedges
            
            
            
            
            
            **(1.6**
            **)**
            
            
            
            
            (5.7
            )Minimum
                pension liability
            
            
            
            
            
            **(.3**
            **)**
            
            
            
            
            (1.5
            )Foreign
                currency translation adjustment
            
            
            
            
            
            **.3**
            
            
            
            
            
            .4Total
                accumulated other comprehensive income (loss)
            
            
            
            
            
            **(1.6**
            **)**
            
            
            
            
            (6.8
            )Total
                common equity
            
            
            
            
            
            **811.3**
            
            
            **62.5**
            
            
            749.1
            
            
            60.1Total
                capitalization
            
            
            
            
            **$**
            **1,297.7**
            
            
            **100.0**
            **%**
            $
            1,246.0
            
            
            100.0
            %The
                accompanying notes are an integral part of these
                statements.




42









**Nicor
                Inc.****Consolidated
                Statements of Common Equity****(millions,
                except per share data)**Year
                ended December 31**2005**
            
            
            2004
            
            
            2003Common
                stockBalance
                at beginning of year
            
            **$**
            **110.2**
            
            $
            110.1
            
            $
            110.0Issued
                and converted stock
            
            
            **.3**
            
            
            .1
            
            
            .1Balance
                at end of year
            
            
            **110.5**
            
            
            110.2
            
            
            110.1Paid-in
                capitalBalance
                at beginning of year
            
            
            **5.6**
            
            
            3.6
            
            
            1.2Issued
                and converted stock
            
            
            **2.8**
            
            
            2.4
            
            
            2.3Reacquired
                and cancelled stock
            
            
            **(.4**
            **)**
            
            (.4
            )
            
            .1Balance
                at end of year
            
            
            **8.0**
            
            
            5.6
            
            
            3.6Retained
                earningsBalance
                at beginning of year
            
            
            **640.3**
            
            
            647.1
            
            
            623.8Net
                income
            
            
            **136.3**
            
            
            75.1
            
            
            105.3Dividends
                on common stock ($1.86, $1.86 and $1.86per
                share, respectively)
            
            
            **(82.1**
            **)**
            
            (81.9
            )
            
            (81.9
            )Dividends
                on preferred stock
            
            
            **-**
            
            
            -
            
            
            (.1
            )Balance
                at end of year
            
            
            **694.5**
            
            
            640.3
            
            
            647.1Unearned
                compensationBalance
                at beginning of year
            
            
            **(.2**
            **)**
            
            (.2
            )
            
            (.3
            )Restricted
                stock amortization
            
            
            **.1**
            
            
            -
            
            
            .1Balance
                at end of year
            
            
            **(.1**
            **)**
            
            (.2
            )
            
            (.2
            )Accumulated
                other comprehensive (loss)Balance
                at beginning of year
            
            
            **(6.8**
            **)**
            
            (6.0
            )
            
            (6.3
            )Other
                comprehensive income (loss)
            
            
            **5.2**
            
            
            (.8
            )
            
            .3Balance
                at end of year
            
            
            **(1.6**
            **)**
            
            (6.8
            )
            
            (6.0
            )Total
                common equity
            
            **$**
            **811.3**
            
            $
            749.1
            
            $
            754.6**Consolidated
                Statements of Comprehensive Income****(millions)**Year
                ended December 31**2005**
            
            
            2004
            
            
            2003Net
                income
            
            **$**
            **136.3**
            
            $
            75.1
            
            $
            105.3Other
                comprehensive income (loss), before taxGain
                (loss) on cash flow hedges
            
            
            **11.6**
            
            
            1.6
            
            
            (17.4
            )Loss
                on available-for-sale securities
            
            
            **(.1**
            **)**
            
            (.1
            )
            
            -Reclassifications
                of hedge (gains) losses to net income
            
            
            **(4.9**
            **)**
            
            (3.9
            )
            
            18.3Decrease
                (increase) to minimum pension liability
            
            
            **2.2**
            
            
            -
            
            
            (.1
            )Foreign
                currency translation adjustment
            
            
            **(.1**
            **)**
            
            .6
            
            
            (.2
            )**8.7**
            
            
            (1.8
            )
            
            .6Related
                income tax benefit (expense)
            
            
            **(3.5**
            **)**
            
            1.0
            
            
            (.3
            )Other
                comprehensive income (loss), net of tax
            
            
            **5.2**
            
            
            (.8
            )
            
            .3Comprehensive
                income
            
            **$**
            **141.5**
            
            $
            74.3
            
            $
            105.6The
                accompanying notes are an integral part of these
                statements.




43







**Notes
      to the Consolidated Financial Statements**





**1.**  **ACCOUNTING
      POLICIES**





**Consolidation.** The
      consolidated financial statements include the accounts of Nicor Inc. (“Nicor”)
      and all majority-owned subsidiaries. Nicor’s key subsidiaries are described in
      Note 13 - Business Segment and Geographic Information. All significant
      intercompany balances and transactions have been eliminated.





**Use
      of estimates.** The
      preparation of the financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      that affect reported amounts. Actual results could differ from those estimates,
      and such differences could be material. Accounting estimates requiring
      significant management judgment involve accruals for legal, regulatory,
      environmental and tax loss contingencies, unbilled revenues, the allowance
      for
      doubtful accounts receivable, postretirement benefit assets and liabilities,
      asset retirement obligations, income tax assets and liabilities, the
      identification and valuation of derivative instruments, and potential asset
      impairments.





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





**Cash
      and cash equivalents.** Cash
      equivalents are comprised of highly liquid investments of domestic subsidiaries
      with an initial maturity of three months or less. The carrying value of these
      investments approximates fair value because of their short
      maturity.





**Regulatory
      assets and liabilities.** Northern
      Illinois Gas Company (“Nicor Gas”), a wholly owned subsidiary of Nicor, is
      regulated by the Illinois Commerce Commission (“ICC”), which establishes the
      rules and regulations governing utility rates and services in Illinois. The
      company applies accounting standards that recognize the economic effects of
      rate
      regulation and, accordingly, has recorded regulatory assets and liabilities.
      The
      company had regulatory assets and liabilities at December 31 as follows (in
      millions):





**2005**
            
            
            2004**Regulatory
                assets**Deferred
                environmental costs
            
            **$**
            **15.1**
            
            $
            35.4Unamortized
                losses on reacquired debt
            
            
            **18.7**
            
            
            19.9Deferred
                rate case costs
            
            
            **3.5**
            
            
            2.9Other
            
            
            **.3**
            
            
            -**$**
            **37.6**
            
            $
            58.2**Regulatory
                liabilities**Regulatory
                retirement cost liability - current
            
            **$**
            **9.0**
            
            $
            11.6Regulatory
                retirement cost liability-
                noncurrent
            
            
            **631.7**
            
            
            706.4Accrued
                gas costs
            
            
            **223.2**
            
            
            68.3Regulatory
                income tax liability
            
            
            **41.3**
            
            
            44.8Other
            
            
            **1.8**
            
            
            .7**$**
            **907.0**
            
            $
            831.8





All
      regulatory assets noted above are classified in noncurrent other assets. The
      current portion of the regulatory retirement cost liability is classified in
      current other liabilities. Regulatory liabilities - Other are classified in
      noncurrent other liabilities.











44





**Investments** . **** The
      company classifies money market funds held by its non-U.S. subsidiaries as
      short-term investments. The company’s investments in marketable securities are
      classified at the date of acquisition into either held-to-maturity or
      available-for-sale categories. Securities are classified as held-to-maturity
      when the company has the positive intent and ability to hold the securities
      to
      maturity. The company carries held-to-maturity securities at amortized cost,
      which approximates fair value. Securities classified as available-for-sale
      are
      carried at fair value, with unrealized gains and losses, net of tax, reported
      in
      common equity as a component of accumulated other comprehensive income or loss.
      The specific identification method is used to determine realized gains or losses
      on the sale of marketable securities. These money market funds and marketable
      securities are included in either short-term or long-term investments based
      upon
      contractual maturity date.





**Equity
      investments.** The
      company invests in several partnerships and limited liability companies that
      are
      accounted for under the equity method. Related investment balances classified
      as
      long-term investments at December 31, 2005 and 2004 were $118.4 million and
      $112.3 million, respectively, and include $92.9 million and $87.1 million at
      December 31, 2005 and 2004, respectively, related to Triton Container
      Investments L.L.C. (“Triton”), a cargo container leasing company.





**Goodwill.** Goodwill
      is the excess cost of an acquired business over the amounts assigned to assets
      acquired and liabilities assumed in a business combination. Tropical Shipping
      had goodwill of $15.6 million at December 31, 2005 and 2004, and Nicor Services
      had goodwill of $3.5 million and $3.4 million at December 31, 2005 and 2004,
      respectively. Goodwill is classified in noncurrent other assets and is tested
      for impairment annually.





**Asset
      retirement obligations.** The
      company records legal obligations (as defined under Statement of Financial
      Accounting Standard (“SFAS”) No. 143, *Accounting
      for*  *Asset
      Retirement Obligations* )
      associated with the retirement of long-lived assets in the period in which
      the
      obligation is incurred, if sufficient information exists to reasonably estimate
      the fair value of the obligation. The obligation is recorded as both a cost
      of
      the long-lived asset and a corresponding liability. Subsequently, the asset
      retirement cost is depreciated over the life of the asset on a straight-line
      basis and the asset retirement obligation (“ARO”) is accreted to the expected
      settlement amount.





Subject
      to rate regulation, Nicor Gas continues to accrue all future asset retirement
      costs through depreciation over the lives of its assets even when a legal
      retirement obligation does not exist or insufficient information exists to
      determine the fair value of the obligation. Amounts charged to depreciation
      by
      Nicor Gas for future retirement costs in excess of the normal depreciation
      and
      accretion described above are classified as a regulatory retirement cost
      liability.





**Derivative
      instruments.** At Nicor
      Gas, derivative instruments, such as futures contracts, options and swap
      agreements, are utilized primarily in the procurement of natural gas for
      customers. These derivative instruments are reflected on the balance sheet
      at
      fair value. Realized gains or losses on such instruments are included in the
      cost of gas delivered and are passed directly through to customers, subject
      to
      ICC review, having no direct impact on earnings. Unrealized changes in the
      fair
      value of these derivative instruments are deferred as regulatory assets or
      liabilities and classified on the balance sheet as deferred or accrued gas
      costs, respectively.





At
      times,
      Nicor Gas enters into futures contracts, options and fixed-price purchase
      agreements to reduce the earnings impact of certain forecasted operating costs
      arising from fluctuations in natural gas prices. These derivative instruments
      are carried at fair value, unless they qualify for the normal purchases and
      normal sales exception, in which case they are carried at cost. In 2003, for
      those instruments carried at fair value, cash flow hedge accounting was
      generally elected. Hedge accounting has not been elected since 2003, and
      accordingly, changes in the fair value of these derivative instruments are
      now
      recorded in earnings as operating and maintenance expense.








45





Through
      early 2003, Nicor Gas held weather-related swap agreements to limit the earnings
      impact of weather fluctuations. The benefits or losses on these agreements
      were
      recorded in operating revenues.





Derivative
      instruments, such as futures contracts, options, forward contracts, swap
      agreements and other energy-related contracts are used by Nicor’s wholesale
      natural gas marketing business, Nicor Enerchange, to economically hedge price
      risk associated with energy trading activities involving inventories of natural
      gas and fixed-price purchase and sale agreements. Nicor Enerchange records
      its
      derivative instruments at fair value and generally cannot elect hedge
      accounting. As a result, changes in derivative fair values may have a material
      impact on Nicor’s financial statements.





Nicor
      Enerchange also enters into futures contracts, options and swap agreements
      to
      hedge price and weather risks related to Nicor Solutions’ utility-bill
      management products. These instruments are carried at fair value and cash flow
      hedge accounting is generally elected. To the extent cash flow hedge accounting
      is applied, the effective portion of any changes in the fair value of the
      derivative instruments is reported as a component of accumulated other
      comprehensive income or loss. Ineffectiveness, if any, is immediately recognized
      in operating income. Such ineffectiveness was $4.0 million for the year ended
      December 31, 2005 and was immaterial for the years ended December 31, 2004
      and
      2003. The amount in accumulated other comprehensive income or loss is
      reclassified to earnings when the forecasted transaction occurs, even if the
      derivative instrument is sold, extinguished or terminated prior to the
      transaction occurring. If the forecasted transaction is no longer expected
      to
      occur, the amount in accumulated other comprehensive income or loss is
      immediately reclassified to earnings.





At
      December 31, 2005, the cash flow hedges component of accumulated other
      comprehensive loss was $1.6 million, reported net of $1.1 million of related
      income tax benefits. This loss includes $2.8 million of gains, net of $1.8
      million of income taxes, on hedges related to Nicor Solutions’ utility-bill
      management products. The gains on hedges for the utility-bill management
      products are expected to be reclassified to earnings within the next 12
      months.





At
      December 31, 2005, accumulated other comprehensive loss also included a loss
      of
      $4.2 million, reported net of $2.8 million of income tax benefits, related
      to
      losses on derivative instruments designated as hedges of interest payments
      on
      30-year bonds issued by Nicor Gas in December 2003. Nicor periodically utilizes
      derivative instruments to reduce interest rate risk associated with the
      anticipated issuance of debt. Changes in the fair value of these derivative
      instruments are reported as a component of accumulated other comprehensive
      income or loss. Upon the issuance of the debt, the amount deferred in
      accumulated other comprehensive income or loss is amortized to interest expense
      over the life of the debt instrument. The losses on hedges of interest payments
      are being amortized to interest expense on a straight-line basis over the life
      of the bonds.





Fair
      values are determined from quoted market prices and other external sources,
      where available, or are estimated using internal models. Estimates from internal
      models were not material to Nicor’s financial statements. Cash flow hedge
      accounting may be elected only for highly effective hedges, based upon an
      assessment, performed at least quarterly, of the historical and probable future
      correlation of changes in the fair value of the derivative instrument to changes
      in the expected future cash flows of the hedged item.





Derivative
      instruments are classified as current or noncurrent other assets or liabilities
      as appropriate. Cash flows from derivative instruments are recognized in the
      consolidated statements of cash flows and gains and losses are recognized in
      the
      consolidated statements of operations in the same categories as the underlying
      transactions.





**Credit
      risk.** Nicor’s
      major subsidiaries have diversified customer bases and prudent credit policies
      which mitigate customer receivable and derivative counterparty credit
      risk . The
      company is exposed to credit risk in the event a counterparty, customer or
      supplier defaults on a contract to pay for or deliver product at agreed-upon
      terms and conditions. To manage this risk, the company has
      established





46





procedures
      to determine and monitor the creditworthiness of counterparties, to require
      guarantees or collateral back-up, and to limit its exposure to any one
      counterparty. Nicor also, in some instances, enters into netting arrangements
      to
      mitigate counterparty credit risk. Credit losses are accrued as liabilities
      when
      probable and reasonably estimable.





**Operating
      revenues and gas costs.** Gas
      distribution revenues are recognized when natural gas is delivered to customers.
      In accordance with ICC regulations, the cost of gas delivered is charged to
      customers without markup, although the timing of cost recovery can vary, and
      is
      subject to ICC review. Temporary
      undercollections and overcollections of gas costs are deferred or accrued as
      a
      regulatory asset or liability with a corresponding decrease or increase to
      cost
      of gas, respectively. Nicor Gas accrues revenues and related gas costs for
      estimated deliveries to customers from the date of their last bill until the
      balance sheet date.





In
      the
      shipping segment, revenues and related delivery costs are recognized at the
      time
      vessels depart from port. While alternative methods of recognizing shipping
      revenue and related costs exist, the difference between those methods and the
      company’s policy does not have a material impact on financial results.





For
      Nicor
      Solutions, revenue is recognized on its 12-month utility-bill management
      contracts as the lesser of cumulative earned or cumulative billed amounts.
      Nicor
      Services recognizes revenue for warranty and repair contracts on a straight-line
      basis over the contract term. Revenue for maintenance services is recognized
      at
      the time such services are performed. Nicor Enerchange presents revenue for
      natural gas sales, cost of sales, and related hedging activities on a net basis
      as required for an energy trading business.





At
      December 31, 2005 and 2004, trade receivables include accrued unbilled revenues
      of $300.9 million and $205.0 million, respectively, related almost entirely
      to
      gas distribution operations.





**Repair
      and maintenance expense.** Nicor
      records expense for repair and maintenance costs as incurred, with one exception
      - Tropical Shipping uses the accrue-in-advance method for planned major
      maintenance related to dry-docking and major repairs of its owned vessels.
      These
      costs are typically accrued over a period of about three years.





**Legal
      defense costs.** The
      company accrues estimated legal defense costs associated with loss contingencies
      in the period in which it determines that such costs are probable of being
      incurred and are reasonably estimable.





**Depreciation.** Property, plant and equipment are depreciated over estimated useful lives on
      a
      straight-line basis. The gas distribution composite depreciation rate is 4.1
      percent, which includes all estimated future retirement costs. The estimated
      useful lives of shipping-segment vessels range from 20 to 25 years.





**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 2005, 2004 and 2003 were $152.0 million, $139.4 million
      and $130.9 million, respectively.





**Income
      taxes.** Deferred
      income taxes are provided at the current statutory income tax rate for temporary
      differences between the tax basis of an asset or liability and its reported
      amount in the financial statements. In the gas distribution segment, investment
      tax credits and regulatory income tax liabilities for deferred taxes in excess
      of the current statutory rate are amortized to income over the lives of related
      properties.





After
      accounting for the repatriation, Nicor has remaining at December 31, 2005
      approximately $12 million deferred income tax liabilities related to
      approximately $34 million of cumulative undistributed





47





earnings
      of its foreign subsidiaries. Nicor has not recorded deferred income taxes of
      approximately $18 million on approximately $51 million of cumulative
      undistributed foreign earnings that are expected in management’s judgment to be
      indefinitely reinvested offshore.  See Note 8 - Income and Other Taxes for
      information on the American Jobs Creation Act of 2004 (the “Jobs Act”).





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





**2.**  **NEW
      ACCOUNTING PRONOUNCEMENTS**





**Accounting
      changes and error corrections.** In
      May
      2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, *Accounting
      Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB
      Statement No. 3.*  ** The
      statement requires retrospective application of voluntary changes in accounting
      principle and error corrections. Retrospective application is also required
      for
      mandatory changes in accounting principle if the transition method is not
      prescribed. The statement is effective for the company beginning January 1,
      2006
      and will be adopted prospectively. The initial adoption of this standard is
      not
      expected to have any impact on the company’s cash flows, financial position or
      results of operations.





**Asset
      retirement obligations.** In
      March
      2005, the FASB issued Interpretation No. 47, *Accounting
      for Conditional Asset Retirement Obligations* (“FIN
      47”). FIN 47 is an interpretation of SFAS No. 143 that generally results in a
      broadened assessment of when assets contain measurable retirement obligations.
      Prior to adopting FIN 47, Nicor recorded AROs related primarily to the required
      removal and/or disposal of mercury regulators.





Nicor adopted
      FIN 47 in 2005. Upon adoption, Nicor:  recorded additional AROs
      associated with services, mains and other components of the distribution system
      and the buildings in its gas distribution segment and with certain equipment
      in
      its shipping segment of $160.6 million; increased the carrying value of the
      related assets by $60.1 million; increased accumulated depreciation by $26.4
      million; and reduced its regulatory liability for future retirement costs by
      $126.6 million. Nicor Gas has not recognized an ARO associated with gathering
      lines and storage wells because there is insufficient company or industry
      retirement history to reasonably estimate the fair value of the obligation.
      In
      connection with the adoption, $0.2 million was charged to net income. At
      December 31, 2005 a total ARO of $164.8 million is recorded, substantially
      all
      of which is classified as a noncurrent liability.





As
      provided for by FIN 47, the financial statements for the periods prior to
      December 31, 2005 have not been restated. If the company had applied the
      interpretations of FIN 47 to prior periods, it would have recorded AROs of
      $152.9 million, $147.0 million and $140.9 million at December 31, 2004, 2003
      and
      2002, respectively.





**Share-based
      payment.** In
      December 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based
      Payment* (“SFAS
      123R”). SFAS 123R requires entities to adopt the fair value method of accounting
      for stock-based compensation plans. The fair value method will require the
      amortization of the fair value of equity awards, as determined at the date
      of
      grant, over the related vesting period. SFAS 123R also requires certain
      share-based liabilities, such as stock appreciation rights, to be recorded
      at
      fair value, and





48





most
      employee stock purchase plans that offer a discount of greater than five percent
      will be considered  compensatory,
      which will require the entire discount to be charged to expense. Nicor’s primary
      stock-based compensation plans are described in Note 10 - Stock-Based
      Compensation.





The
      provisions of SFAS 123R are effective for Nicor beginning January 1, 2006 and
      will be adopted on a modified prospective basis for equity awards. In addition,
      share-based liabilities will be adjusted from intrinsic value to fair value
      on
      January 1, 2006, with a corresponding adjustment to pretax earnings. The company
      has substantially completed its evaluation of SFAS 123R and the implementation
      of this standard is not expected to have a material impact on the company’s cash
      flow, financial position or results of operations .





At
      December 31, 2005, Nicor continues to apply the intrinsic value method of
      Accounting Principles Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      for all
      awards granted under its stock-based compensation plans. The intrinsic value
      method does not require compensation expense to be recognized for Nicor’s equity
      awards. If compensation expense for stock options and other equity awards had
      been recognized based upon the fair value method, the impact on the company’s
      net income and earnings per share would have been as follows (in millions,
      except per share data):





**2005**
            
            
            2004
            
            
            2003**Net
                income**As
                reported
            
            **$**
            **136.3**
            
            $
            75.1
            
            $
            105.3Less:
                Total stock-based employee compensation expense determined under
                the fair
                value method for all awards, net of tax
            
            
            **1.2**
            
            
            1.2
            
            
            .7Pro
                forma
            
            **$**
            **135.1**
            
            $
            73.9
            
            $
            104.6**Earnings
                per share**Basic
                - As reported
            
            **$**
            **3.08**
            
            $
            1.71
            
            $
            2.39Basic
                - Pro forma
            
            
            **3.05**
            
            
            1.68
            
            
            2.38Diluted
                - As reported
            
            
            **3.07**
            
            
            1.70
            
            
            2.38Diluted
                - Pro forma
            
            
            **3.05**
            
            
            1.67
            
            
            2.37





**3.**  **INVESTMENTS**





The
      following is a summary of the carrying values, which approximate fair value,
      of
      marketable securities at December 31 (in millions):





**2005**
            
            
            2004**Available-for-sale**U.S.
                government agency securities
            
            **$**
            **-**
            
            $
            7.7U.S.
                Treasury securities
            
            
            **-**
            
            
            1.7Corporate
                bonds
            
            
            **-**
            
            
            4.8Other
            
            
            **.6**
            
            
            .9**.6**
            
            
            15.1**Held-to-maturity**Corporate
                bonds
            
            
            **6.9**
            
            
            7.3Certificates
                of deposit
            
            
            **.3**
            
            
            .3**7.2**
            
            
            7.6**$**
            **7.8**
            
            $
            22.7











49





At
      December 31, 2005 and 2004, short-term investments totaled $8.0 million and
      $41.2 million, respectively. These investments include $5.7 million and $35.6
      million of money market funds held by the company’s non-U.S. subsidiaries and
      $2.3 million and $5.6 million of available-for-sale and held-to-maturity
      securities at December 31, 2005 and 2004, respectively. The remaining marketable
      securities are included in long-term investments.





Securities
      of $1.3 million were sold during 2004 that had originally been classified as
      held-to-maturity. These sales occurred after the issuer’s creditworthiness
      declined thus becoming non-compliant with the company’s investment policy. There
      was no gain or loss realized on the 2004 sale of these securities.





Proceeds
      from the sale of available-for-sale securities were $15.1 million, $6.9 million
      and zero in 2005, 2004 and 2003, respectively. There were no significant
      realized gains or losses from the sale of available-for-sale securities in
      2005,
      2004 or 2003.





The
      contractual maturities of available-for-sale and held-to-maturity marketable
      securities at December 31, 2005 were as follows (in millions):





Years
      to maturity


Less
              than
                1
              year
            
            
            1-5
              years
            
            
            5-10
              years
            
            
            More
              than
                10
              years
            
            
            TotalAvailable-for-sale
            
            $
            .6
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            .6Held-to-maturity
            
            
            1.7
            
            
            5.5
            
            
            -
            
            
            -
            
            
            7.2$
            2.3
            
            $
            5.5
            
            $
            -
            
            $
            -
            
            $
            7.8





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





At
      December 31, 2004, Nicor had $29.1 million of restricted short-term investments
      held in an escrow fund and a corresponding $29.1 million current liability.
      The
      escrow fund was established through a $29.0 million deposit by one of Nicor’s
      Directors and Officers insurance carriers to be used to satisfy Nicor’s
      directors’ and officers’ liabilities and expenses associated with claims
      asserted against them, with any remaining balance to be paid to Nicor. On May
      17, 2005, the restriction on this fund ceased, and the funds were released
      to
      the company. As of December 31, 2005, no restricted short-term investments
      remained. (See also Note 19 - Contingencies.)





**5.**  **GAS
      IN STORAGE**





Gas
      in
      storage at December 31 included natural gas inventory of the following
      subsidiaries (in millions):





**2005**
            
            
            2004Nicor
                Gas
            
            **$**
            **221.0**
            
            $
            189.0Nicor
                Enerchange
            
            
            **40.3**
            
            
            31.7**$**
            **261.3**
            
            $
            220.7





Gas
      distribution segment inventory is carried at cost on a last-in, first-out
      (“LIFO”) basis. Nicor Enerchange inventory is carried at the lower of
      weighted-average cost or market.





Based
      on
      the average cost of gas purchased in December 2005 and 2004, the estimated
      replacement cost of Nicor Gas’ inventory at December 31, 2005 and 2004 exceeded
      the LIFO cost by $778.4 million and $434.2 million, respectively.





50





During
      2004, Nicor Gas partially liquidated a LIFO layer at a cost per thousand cubic
      feet (“Mcf”) of $5.81. For gas purchased in 2004, the company’s average cost per
      Mcf was $0.24 higher than the LIFO liquidation rate. Applying LIFO cost in
      valuing the liquidations, as opposed to using the average gas purchase cost,
      had
      the effect of decreasing the cost of gas in 2004 by $0.7 million. However,
      since
      the cost of gas, including inventory costs, is charged to customers without
      markup, these amounts had no impact on net income. There was no liquidation
      of
      any LIFO layers during 2005 and 2003.





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





In
      December 2005, Tropical Shipping obtained a $40 million two-year senior
      unsecured term loan used to fund a portion of the repatriation of its cumulative
      undistributed foreign earnings in connection with the Jobs Act. The term loan
      bears a floating interest rate based on the London Inter-bank Offered Rate
      (“LIBOR”) plus 0.50 percent per annum.





In
      September 2005, Nicor and Nicor Gas established two revolving credit facilities
      totaling $1 billion with major domestic and foreign banks, which replaced the
      $500 million, three-year revolver, which was to expire in September 2007 and
      the
      $400 million, 210-day seasonal revolver, which expired in April 2005. In
      connection with this replacement, the company charged to interest expense $0.8
      million of unamortized costs on the $500 million revolver.





The
      new
      replacement facilities, which serve as backup for the issuance of commercial
      paper, consist of a $600 million, 5-year revolver, expiring September 2010,
      available to Nicor Inc. and Nicor Gas, and a $400 million, 210-day seasonal
      revolver, expiring in April 2006, available to Nicor Gas. Commitment fees paid
      in advance are insignificant and are being amortized over the respective terms
      of the agreements as interest expense. The company believes it is in compliance
      with all debt covenants at December 31, 2005.





The
      company had $586 million and $490 million of commercial paper outstanding with
      a
      weighted-average interest rate of 4.1 percent and 2.3 percent at December 31,
      2005 and 2004, respectively.





The
      company incurred total interest expense of $47.9 million, $41.6 million, and
      $37.6 million in 2005, 2004 and 2003, respectively. Interest expense is reported
      net of amounts capitalized. Interest expense capitalized for the years ended
      December 31, 2005, 2004 and 2003 was $1.1 million, $0.4 million, and $0.3
      million, respectively.





**7.**  **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 discount
      and
      issuance costs. The principal balance of Nicor Gas’ First Mortgage Bonds
      outstanding at December 31, 2005 and 2004 was $500 million. Based on quoted
      market interest rates, the fair value of the company’s First Mortgage Bonds
      outstanding, including current maturities, was approximately $525 million and
      $530 million at December 31, 2005 and 2004, respectively.





Derivative
      financial instruments are recorded at fair value as determined primarily from
      actively quoted prices. The fair value of derivative financial instruments
      held
      at December 31, 2005 relates primarily to Nicor Gas. The majority of derivative
      financial instruments held by Nicor Gas are for the purpose of hedging natural
      gas purchases, 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 Consolidated Balance Sheets at
      December 31 as follows (in millions):











51





**2005**
            
            
            2004Current
                other assets
            
            **$**
            **29.2**
            
            $
            5.1Noncurrent
                other assets
            
            
            **2.3**
            
            
            .7**$**
            **31.5**
            
            $
            5.8Current
                other liabilities
            
            **$**
            **6.1**
            
            $
            1.8Noncurrent
                other liabilities
            
            
            **1.4**
            
            
            .5**$**
            **7.5**
            
            $
            2.3





Nicor
      maintains margin accounts related to financial derivative transactions. At
      December 31, 2005 and 2004, the balance of these accounts were $37.0 million
      and
      $24.5 million, respectively, and were reflected in the Consolidated Balance
      Sheets as Receivables.





**8.**  **INCOME
      AND OTHER TAXES**





The
      components of income tax expense (benefit) are presented below (in
      millions):


**2005**
                
                2004
                
                2003CurrentFederal
                **$**
                **116.3**
                
                
                $
                9.3
                
                
                $
                (55.0
                )State
                
                **22.1**
                
                
                
                (5.0
                )
                
                
                (16.4
                )**138.4**
                
                
                
                4.3
                
                
                
                (71.4
                )DeferredFederal
                
                **(87.7**
                **)**
                
                
                17.0
                
                
                
                99.8State
                
                **(14.4**
                **)**
                
                
                10.3
                
                
                
                32.8**(102.1**
                **)**
                
                
                27.3
                
                
                
                132.6Amortization
                    of investment tax credits, net
                
                **(2.1**
                **)**
                
                
                (1.8
                )
                
                
                (2.0
                )Foreign
                    taxes
                
                **.5**
                
                
                
                .4
                
                
                
                .4Income
                    tax expense, net
                **$**
                **34.7**
                
                
                $
                30.2
                
                
                $
                59.6





The
      temporary differences which gave rise to the net deferred tax liability at
      December 31 were as follows (in millions):





**2005**
            
            
            2004Deferred
                tax liabilitiesProperty,
                plant and equipment
            **$**
            **354.7**
            
            
            $
            432.2Investment
                in partnerships
            
            **134.3**
            
            
            
            138.0Investment
                in foreign subsidiaries
            
            **12.0**
            
            
            
            47.1Other
            
            **31.2**
            
            
            
            37.4**532.2**
            
            
            
            654.7Deferred
                tax assetsAlternative
                minimum tax
            
            **32.0**
            
            
            
            41.8Other
            
            **74.2**
            
            
            
            91.8**106.2**
            
            
            
            133.6Net
                deferred tax liability
            **$**
            **426.0**
            
            
            $
            521.1




















52





Differences
      between the federal statutory rate and the effective combined federal and state
      income tax rate are shown below:





**2005**
            
            2004
            
            2003Federal
                statutory rate
            
            **35.0**
            **%**
            
            
            35.0
            %
            
            
            35.0
            %Foreign
                earnings repatriation
            
            **(9.9**
            **)**
            
            
            -
            
            
            
            -State
                income taxes, net
            
            **3.1**
            
            
            
            3.7
            
            
            
            3.9Tax
                credits
            
            **(3.1**
            **)**
            
            
            (5.3
            )
            
            
            (2.7
            )Amortization
                of regulatory tax liability
            
            **(1.1**
            **)**
            
            
            (1.8
            )
            
            
            (1.2
            )Undistributed
                foreign earnings
            
            **(3.3**
            **)**
            
            
            (3.0
            )
            
            
            (1.5
            )Other,
                net
            
            **(.4**
            **)**
            
            
            .1
            
            
            
            1.7Effective
                combined federal and state income tax rate
            
            **20.3**
            **%**
            
            
            28.7
            %
            
            
            35.2
            %





The
      overall effective income tax rate for 2005 decreased to 20.3 percent from the
      prior year rate of 28.7 percent, due primarily to the 2005 tax benefits recorded
      in connection with the Jobs Act (approximately $17 million). The decline in
      the
      company’s effective income tax rate to 28.7 percent in 2004 from 35.2 percent in
      2003 was primarily a result of lower pretax income (which typically causes
      a
      lower effective income tax rate since permanent differences and tax credits
      are
      a larger share of pretax income).


The
      company had available at December 31, 2005, federal alternative minimum tax
      (“AMT”) credit carryforwards of approximately $38.2 million, which may be used
      indefinitely to reduce federal income taxes. The company believes it is more
      likely than not that all of its AMT benefits will be realized and accordingly,
      no valuation allowance has been recorded.





The
      company accrues tax and interest related to tax uncertainties. Tax uncertainties
      arise due to actual or potential disagreements about the tax treatment of
      specific items between the company and the governmental agency reviewing the
      company’s tax returns. At December 31, 2005 and 2004, the company had accrued
      approximately $17.1 million and $6.3 million, respectively, for such
      uncertainties.





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





On
      October 22, 2004, the Jobs Act was enacted. Certain provisions of the Jobs
      Act
      impact income taxes related to the earnings of foreign subsidiaries of Nicor.
      One provision provides that a portion of a foreign subsidiary’s income is no
      longer subject to current federal taxation because of its status as shipping
      income, beginning in 2005, to the extent such earnings are retained by the
      foreign subsidiary. Another provision of the Jobs Act allowed a portion of
      cumulative undistributed earnings of a foreign subsidiary to be repatriated
      to
      the United States by the end of 2005, at an effective federal income tax rate
      of
      5.25 percent.





As
      of
      December 31, 2004, Nicor had recorded a $47 million deferred income tax
      liability, based on a 35 percent federal income tax rate, associated with
      approximately $134 million of earnings retained by its foreign subsidiaries.
      Nicor had not provided deferred income taxes of approximately $12 million
      on





53





approximately
      $35 million of cumulative undistributed earnings of foreign subsidiaries that
      were considered to be indefinitely invested in foreign operations.





During
      December 2005, Nicor repatriated $132 million of cumulative undistributed
      earnings. The repatriation was funded by cash available from foreign
      subsidiaries coupled with the proceeds received by Tropical Shipping in
      connection with the December 2005 issuance of a $40 million two-year senior
      unsecured term loan. The federal income tax benefit resulting from the
      repatriation is approximately $17 million and was recognized in the fourth
      quarter of 2005. In conjunction with the repatriation, Nicor reclassified
      approximately $7.6 million of deferred income tax liabilities to other income
      tax reserves.





After
      accounting for the repatriation, Nicor has remaining at December 31, 2005
      approximately $12 million deferred income tax liabilities related to
      approximately $34 million of cumulative undistributed earnings of its foreign
      subsidiaries. Nicor has not recorded deferred income taxes of approximately
      $18
      million on approximately $51 million of cumulative undistributed foreign
      earnings that are expected in management’s judgment to be indefinitely
      reinvested offshore.





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





**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 a limit 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.





The
      following table sets forth the changes in the plans’ benefit obligations and
      assets, and reconciles the October 1 funded status of the plans to the prepaid
      (accrued) benefit cost recorded on the balance sheet at December 31 (in
      millions):





Pension
                benefits
            
            Health
                care and
              other
                benefits**2005**
            
            2004
            
            **2005**
            
            2004**Change
                in benefit obligation**Benefit
                obligation at beginning of period
            **$**
            **282.6**
            
            
            $
            273.1
            
            
            **$**
            **184.7**
            
            
            $
            173.6Service
                cost
            
            **9.3**
            
            
            
            9.0
            
            
            
            **2.7**
            
            
            
            2.4Interest
                cost
            
            **15.6**
            
            
            
            15.7
            
            
            
            **10.3**
            
            
            
            10.1Actuarial
                loss
            
            **7.1**
            
            
            
            10.6
            
            
            
            **4.9**
            
            
            
            8.2Participant
                contributions
            
            **-**
            
            
            
            -
            
            
            
            **.8**
            
            
            
            .9Plan
                amendments
            
            **-**
            
            
            
            -
            
            
            
            **-**
            
            
            
            (1.9
            )Benefits
                paid
            
            **(30.2**
            **)**
            
            
            (25.8
            )
            
            
            **(10.9**
            **)**
            
            
            (8.6
            )Benefit
                obligation at end of period
            
            **284.4**
            
            
            
            282.6
            
            
            
            **192.5**
            
            
            
            184.7

















54





Pension
                benefits
            
            Health
                care and
              other
                benefits**2005**
            
            2004
            
            **2005**
            
            2004**Change
                in plan assets**Fair
                value of plan assets at beginning of period
            
            **402.0**
            
            
            
            383.6
            
            
            
            **10.6**
            
            
            
            11.7Actual
                return on plan assets
            
            **52.2**
            
            
            
            44.2
            
            
            
            **1.0**
            
            
            
            1.2Employer
                contributions
            
            **-**
            
            
            
            -
            
            
            
            **5.4**
            
            
            
            5.4Participant
                contributions
            
            **-**
            
            
            
            -
            
            
            
            **.8**
            
            
            
            .9Benefits
                paid
            
            **(30.2**
            **)**
            
            
            (25.8
            )
            
            
            **(10.9**
            **)**
            
            
            (8.6
            )Fair
                value of plan assets at end of period
            
            **424.0**
            
            
            
            402.0
            
            
            
            **6.9**
            
            
            
            10.6





Funded
                status
            
            **139.6**
            
            
            
            119.4
            
            
            
            **(185.6**
            **)**
            
            
            (174.1
            )Unrecognized
                net actuarial loss
            
            **44.9**
            
            
            
            58.4
            
            
            
            **88.5**
            
            
            
            88.6Unrecognized
                prior service cost
            
            **3.1**
            
            
            
            3.7
            
            
            
            **(.7**
            **)**
            
            
            (.8
            )Other
            
            **-**
            
            
            
            -
            
            
            
            **(3.8**
            **)**
            
            
            (2.7
            )Recognized
                prepaid (accrued) benefit cost
            **$**
            **187.6**
            
            
            $
            181.5
            
            
            **$**
            **(101.6**
            **)**
            
            $
            (89.0
            )





The
      accumulated benefit obligation for pension benefits, a measure which excludes
      the effect of salary and wage increases, was $246.1 million and $238.8 million
      at October 1, 2005 and 2004, respectively. The accrued benefit cost for health
      care and life insurance benefits is classified as a noncurrent other
      liability.





In
      2003,
      the company amended the retiree health care plan as it applies to non-unionized
      employees to improve consistency of benefits among participant groups and reduce
      the company’s share of plan costs effective January 1, 2004. In 2004, further
      cost-sharing amendments, effective January 1, 2006, were made to the plan for
      all employees.





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**2005**
            
            2004
            
            2003
            
            **2005**
            
            2004
            
            2003Service
                cost
            **$**
            **9.3**
            
            
            $
            9.0
            
            
            $
            7.4
            
            
            **$**
            **2.7**
            
            
            $
            2.4
            
            
            $
            2.0Interest
                cost
            
            **15.6**
            
            
            
            15.7
            
            
            
            16.3
            
            
            
            **10.3**
            
            
            
            10.1
            
            
            
            11.1Expected
                return on plan assets
            
            **(33.2**
            **)**
            
            
            (31.7
            )
            
            
            (28.7
            )
            
            
            **(.9**
            **)**
            
            
            (1.0
            )
            
            
            (1.2
            )Recognized
                net actuarial loss
            
            **1.6**
            
            
            
            2.0
            
            
            
            4.3
            
            
            
            **4.9**
            
            
            
            4.6
            
            
            
            2.9Amortization
                of unrecognized transition obligation
            
            **-**
            
            
            
            -
            
            
            
            -
            
            
            
            **-**
            
            
            
            .1
            
            
            
            3.1Amortization
                of prior service cost
            
            **.6**
            
            
            
            .6
            
            
            
            .7
            
            
            
            **(.1**
            **)**
            
            
            -
            
            
            
            -Net
                periodic benefit cost (credit)
            **$**
            **(6.1**
            **)**
            
            $
            (4.4
            )
            
            $
            -
            
            
            **$**
            **16.9**
            
            
            $
            16.2
            
            
            $
            17.9


























55





Assumptions
      used to determine benefit obligations at October 1 included the
      following:





Pension
                benefits
            
            Health
                care and
              other
                benefits**2005**
            
            2004
            
            **2005**
            
            2004Discount
                rate
            
            **5.50**
            **%**
            
            
            5.75
            %
            
            
            **5.50**
            **%**
            
            
            5.75
            %Rate
                of compensation increase
            
            **3.75**
            
            
            
            4.00
            
            
            
            **3.75**
            
            
            
            4.00





The
      5.50
      percent discount rate was determined independently for the pension and
      health-care plans based on bond matching models, using non-callable, high
      quality bonds (AA- or better), whose cash flows match the timing and amount
      of
      future benefit payments of the plans.





Assumptions
      used to determine net periodic benefit cost for the years ended December 31
      included the following:





Pension
                benefits
            
            Health
                care and other benefits**2005**
            
            2004
            
            2003
            
            **2005**
            
            2004
            
            2003Discount
                rate
            
            **5.75**
            **%**
            
            
            6.00
            %
            
            
            6.75
            %
            
            
            **5.75**
            **%**
            
            
            6.00
            %
            
            
            6.75
            %Expected
                return on assets
            
            **8.50**
            
            
            
            8.50
            
            
            
            8.75
            
            
            
            **8.50**
            
            
            
            8.50
            
            
            
            8.75Rate
                of compensation increase
            
            **4.00**
            
            
            
            4.00
            
            
            
            4.00
            
            
            
            **4.00**
            
            
            
            4.00
            
            
            
            4.00





Nicor
      Gas
      establishes its expected long-term return-on-asset assumption by considering
      historical and projected returns for each investment asset category. Projected
      returns are calculated with the assistance of independent firms via
      probability-based models. The company has elected to apply this assumption
      to
      the fair value of plan assets, rather than to a rolling-average fair value,
      in
      calculating the expected return on plan assets component of net periodic benefit
      cost. The assumed rate of return on assets can have a significant effect on
      the
      amounts reported for the pension benefits. A one-percentage-point change in
      the
      assumed rate of return on assets would impact the net periodic pension credit
      by
      approximately $4 million.





Other
      assumptions used to determine the health care benefit obligation at October
      1
      were as follows:





**2005**
            
            2004Health
                care cost trend rate
            
            **9.5**
            **%**
            
            
            9.5
            %Rate
                to which the cost trend rate is assumed to decline (the ultimate
                rate)
            
            **5.0**
            **%**
            
            
            5.0
            %Years
                to reach ultimate rate
            
            **5**
            
            
            
            4





Other
      assumptions used to determine the health care benefit cost for the years ended
      December 31 were as follows:





**2005**
            
            2004
            
            2003Health
                care cost trend rate
            
            **9.5**
            **%**
            
            
            9.5
            %
            
            
            11.0
            %Rate
                to which the cost trend rate is assumed to decline (the ultimate
                rate)
            
            **5.0**
            **%**
            
            
            5.0
            %
            
            
            5.0
            %Years
                to reach ultimate rate
            
            **4**
            
            
            
            4
            
            
            
            4





Assumed
      health care cost trend rates can have a significant effect on the amounts
      reported for the health care plans. A one-percentage-point change in the assumed
      health care cost trend rates would have the following effects (in
      millions):

















56





One-percentIncrease
            
            DecreaseEffect
                on total of service and interest cost components
            $
            1.3
            
            
            $
            (1.1
            )Effect
                on benefit obligation
            
            18.1
            
            
            
            (15.4
            )





In
      2004,
      the FASB issued FASB Staff Position No. FAS 106-2, *Accounting
      and Disclosure Requirements Related to the Medicare Prescription Drug,
      Improvement and Modernization Act of 2003* (“FSP
      SFAS 106-2”). The Medicare Prescription Drug, Improvement and Modernization Act
      of 2003 (the “Act”) provides a prescription drug benefit as well as a potential
      federal subsidy to sponsors of certain retiree health care benefit plans. FSP
      SFAS 106-2 provides guidance on accounting for the effects of the Act, including
      the potential subsidy, and required public companies to reflect the impact
      by
      the third quarter of 2004, if determinable and significant. The company’s 2004
      net periodic postretirement health care costs do not reflect the effects of
      the
      Act because the company’s actuaries estimated that the impact in 2004 would be
      minimal. The company has, as required, reflected its best estimate of the
      potential subsidy in the October 1, 2004 measurement of the benefit obligation.
      The potential subsidy reduced the October 1, 2004 benefit obligation by $19.4
      million, creating an actuarial gain that will be amortized over the remaining
      service lives of plan participants. Beginning in 2005, the company has also
      reflected its best estimate of the potential subsidy in its measurement of
      net
      periodic postretirement health care costs. The estimated subsidy reduced such
      costs by $2.4 million for the year ended December 31, 2005. This reduction
      was
      offset by general medical cost increases. As of the October 1, 2005 measurement
      date, the company refined its estimate of the potential subsidy to be ultimately
      collected. The refinement reduced the benefit obligation by an additional $19.7
      million, creating an actuarial gain which will also be amortized over the
      remaining service lives of plan participants beginning in 2006, and further
      reducing the projected 2006 periodic health care plan cost by $2.9 million.





The
      company’s investment objective relating to pension plan assets is to have a high
      probability of meeting its obligations without additional cash contributions.
      The company’s investment strategy is to maintain an asset mix near its target
      asset allocation and to rebalance the portfolio monthly if the actual allocation
      deviates from the target by two or more percentage points. The following table
      sets forth the target allocation and actual percentage of plan assets by asset
      category:





Target
            
            Percentage
                of plan assets
              at
                October 1Asset
                category
            
            allocation
            
            
            **2005**
            
            
            2004Equity
                securities
            
            69
            %
            
            **69**
            **%**
            
            69
            %Debt
                securities
            
            31
            
            
            **31**
            
            
            30Real
                estate and other
            
            -
            
            
            **-**
            
            
            1100
            %
            
            **100**
            **%**
            
            100
            %





The
      company does not expect to contribute to its pension plan in 2006 and expects
      to
      contribute about $11.9 million to its other postretirement benefit plan in
      2006.
      The following table sets forth the benefit payments from the plans expected
      over
      the next 10 years (in millions):





























57





Twelve
                months ending October 1
            
            
            Pension
                benefits
            
            
            Health
                care and other benefits
            
            
            Expected
                Medicare subsidy2006
            
            $
            27.4
            
            $
            11.9
            
            $
            (1.5
            )2007
            
            
            18.4
            
            
            12.6
            
            
            (1.6
            )2008
            
            
            17.5
            
            
            13.1
            
            
            (1.8
            )2009
            
            
            18.8
            
            
            13.7
            
            
            (1.9
            )2010
            
            
            20.0
            
            
            14.2
            
            
            (2.0
            )2011-2015
            
            
            129.7
            
            
            76.9
            
            
            (10.7
            )





Higher
      projected pension benefit payments for the 2006 plan year reflect an expected
      increase in retirements due to the health care cost-sharing amendments which
      become effective January 1, 2006.





Nicor
      also has a separate unfunded supplemental retirement plan and provides unfunded
      postretirement health care and life insurance benefits to employees of
      discontinued businesses. These plans are noncontributory with defined benefits.
      Plan expenses were $2.5 million, $1.9 million and $1.4 million in 2005, 2004
      and
      2003, respectively. The projected benefit obligation associated with these
      plans
      was $7.1 million and $12.7 million at December 31, 2005 and 2004, respectively.





The
      company also sponsors defined contribution plans covering substantially all
      domestic employees. These plans provide for employer matching contributions.
      The
      total cost of these plans was $6.5 million, $6.2 million and $6.0 million in
      2005, 2004 and 2003, respectively.





**10.**  **STOCK-BASED
      COMPENSATION**





Nicor
      has
      a long-term incentive compensation plan that permits the granting of stock
      options, restricted stock and alternate stock rights to key executives and
      managerial employees, as well as a stock deferral plan and an employee stock
      purchase plan.





**Long-term
      incentive compensation plan.** The
      company may grant options for up to 3.5 million common shares and at December
      31, 2005 had 0.4 million options available to be granted. The stock option
      exercise price equals the stock’s market price on the date of grant. Options
      vest after one year, generally become exercisable after three years, and expire
      after ten years.





Following
      is a summary of stock option activity:




Number
                of shares
            
            
            Weighted-average
                exercise price**Options
                outstanding at:**December
                31, 2002
            
            882,600
            
            
            $
            36.90Granted
            
            349,600
            
            
            
            27.17Exercised
            
            -
            
            
            
            -Cancelled
            
            (74,900
            )
            
            
            36.95December
                31, 2003
            
            1,157,300
            
            
            
            33.96Granted
            
            333,600
            
            
            
            36.35Exercised
            
            (19,400
            )
            
            
            31.37Cancelled
            
            (182,900
            )
            
            
            34.31December
                31, 2004
            
            1,288,600
            
            
            
            34.57Granted
            
            **261,000**
            
            
            
            **37.23**Exercised
            
            **(82,548**
            **)**
            
            
            **28.18**Cancelled
            
            **(22,600**
            **)**
            
            
            **34.64**December
                31, 2005
            
            **1,444,452**
            
            
            
            **35.41**





58





Number
                of shares
            
            
            Weighted-average
                exercise price**Options
                exercisable at:**December
                31, 2003
            
            513,000
            
            
            $
            34.47December
                31, 2004
            
            549,800
            
            
            
            35.23December
                31, 2005
            
            **634,400**
            
            
            
            **37.61**





Exercise
      price ranges for stock options outstanding at December 31, 2005 are as
      follows:


Range
                of exercise price
            
            Number
                of shares
            
            Weighted
                -average exercise price
            
            Weighted
                -average
              remaining
                contractual life
            
            Number
                of shares currently exercisable
            
            Weighted
                -average exercise price of options currently
                exercisable$26.97
                - $34.10
            
            461,652
            
            $
                29.30
            
            6.4
            
            200,200
            
            $
                32.0036.34
                - 45.05
            
            982,800
            
            38.28
            
            7.6
            
            434,200
            
            40.20





The
      weighted-average fair value of options granted in 2005, 2004 and 2003 was $7.22,
      $6.98 and $4.32, respectively. The fair value of each option was estimated
      as of
      the date of grant using the Black-Scholes option-pricing model with the
      following assumptions:





**2005**
            
            2004
            
            2003Expected
                volatility
            
            **32.6%**
            
            
            
            35.5%
            
            
            
            34.7%Dividend
                yield
            
            **5.0%**
            
            
            
            5.1%
            
            
            
            6.9%Risk-free
                interest rate
            
            **4.0%**
            
            
            
            2.4%
            
            
            
            2.7%Expected
                period outstanding (years)
            
            **4**
            
            
            
            4
            
            
            
            4





The
      computation of Nicor’s diluted earnings per share includes the potentially
      dilutive effect of issuing additional shares due to employees exercising stock
      options. However, when option exercise prices are above the stock prices, those
      options are not considered in the earnings per share computation, as to do
      so
      would be anti-dilutive. As a result, Nicor’s earnings per share computation
      excludes the potentially dilutive effect related to about 201,000 options,
      306,500 options and 508,800 options in 2005, 2004 and 2003, respectively.





**Stock
      deferral plan.** Officers
      may elect to defer up to 50 percent of their annual bonus or long-term incentive
      award in exchange for Nicor common stock to be received at a future date. No
      additional compensation expense is recorded since the number of shares to be
      provided is determined based upon market value on the deferral date. As of
      December 31, 2005 and 2004, Nicor had commitments to distribute about 115,200
      common shares and 94,900 common shares, respectively, to participants of the
      plan.





**Employee
      stock purchase plan.** Under
      the
      employee stock purchase plan, the company may sell up to 1.5 million shares
      of
      common stock to its employees and has sold about 1.1 million shares through
      December 31, 2005. Under the terms of this plan, eligible employees may purchase
      shares at 90 percent of the stock’s market price. The company sold about 24,900
      shares, 28,700 shares and 30,900 shares to employees in 2005, 2004 and 2003,
      respectively. The weighted-average market value of shares sold in 2005, 2004
      and
      2003 was $38.50, $34.65 and $32.30, respectively.














59





**11.**  **COMMON
      STOCK**





**Changes
      in common shares.** Changes
      in common shares outstanding are below (in millions):





**2005**
            
            2004
            
            2003Beginning
                of year
            
            **44.1**
            
            
            
            44.0
            
            
            
            44.0Issued
            
            **.1**
            
            
            
            .1
            
            
            
            -End
                of year
            
            **44.2**
            
            
            
            44.1
            
            
            
            44.0





There
      were no repurchases of common stock in 2005, 2004 and 2003 under the common
      stock repurchase program announced in 2001.





**Dividend
      and other restrictions.** Nicor
      has no contractual or regulatory restrictions on the payment of dividends.
      Nicor
      Gas is restricted by regulation in the amount it can dividend or loan to
      affiliates. Dividends are allowed only to the extent of Nicor Gas’ retained
      earnings balance. In addition, Nicor Gas may not extend cash advances to an
      affiliate if Nicor Gas has any outstanding short-term borrowings. Nicor Gas’
practice also provides that the balance of cash deposits or advances from Nicor
      Gas to an affiliate at any time shall not exceed the unused balance of funds
      actually available to that affiliate under its existing bank credit agreements
      or its commercial paper facilities with unaffiliated third parties. Nicor Gas’
positive cash deposits, if any, may be applied by Nicor to offset negative
      balances of other Nicor subsidiaries and vice versa.





**12.
      MANDATORILY REDEEMABLE PREFERRED STOCK**





**Voting.** Each
      share of preferred stock, regardless of class, entitles the holder to one vote
      as to matters considered at the company’s annual meeting of shareholders.





**Mandatorily
      redeemable preferred stock.** On
      November 3, 2005 Nicor redeemed 20,062 shares of 5% Mandatorily Redeemable
      Preferred Stock, $50 par value, at a per share redemption price of $51 plus
      accrued and unpaid dividends. There were 11,681 shares of the 4.48% Series
      Mandatorily Redeemable Preferred Stock, $50 par value, outstanding at December
      31, 2005.





**13.**  **BUSINESS
      SEGMENT AND GEOGRAPHIC INFORMATION**





Nicor
      is
      a holding company that operates primarily in two separately managed reportable
      business segments: gas distribution and shipping. The gas distribution segment,
      Nicor’s principal business, serves over 2.1 million customers in a service
      territory that encompasses most of the northern third of Illinois, excluding
      the
      city of Chicago. The shipping segment transports containerized freight between
      Florida, the eastern coast of Canada, the Bahamas and the Caribbean region.
      The
      shipping segment also includes amounts related to cargo insurance coverages
      sold
      to its customers and other third parties.





Gas
      distribution revenues are comprised principally of natural gas sales bundled
      with delivery, delivery-only (transportation) services and revenue taxes, as
      follows (in millions):





**2005**
            
            2004
            
            2003Bundled
                sales
            **$
                2,546.7**
            
            $
                2,024.7
            
            $
                2,014.8Transportation
            **151.9**
            
            147.4
            
            148.0Revenue
                taxes
            **156.4**
            
            143.5
            
            134.0Other
            **54.6**
            
            46.5
            
            54.8**$
                2,909.6**
            
            $
                2,362.1
            
            $
                2,351.6








60





The
      Gas
      distribution 2005 revenues and operating income reflect $12.8 million and $9.0
      million, respectively, for amounts recorded in connection with the rate relief
      which became effective during the fourth quarter of 2005.





Tropical
      Shipping’s vessels are under foreign registry, and its containers are considered
      instruments of international trade. Although the majority of its long-lived
      assets are foreign owned and its revenues are derived from foreign operations,
      the functional currency is generally the U.S. dollar. The 2005 income tax
      benefit for the shipping segment includes the impact of the tax benefit recorded
      in connection with the Jobs Act (approximately $17 million).





Nicor’s
      other business segments operate primarily in northern Illinois and include
      businesses that market energy-related products and services at retail to
      residential and small business consumers through Nicor Services and Nicor
      Solutions, and natural gas at the wholesale level through Nicor Enerchange.
      They
      also include a 50-percent-owned natural gas pipeline joint venture with Natural
      Gas Pipeline Company of America (Horizon Pipeline), and a 50-percent-owned
      retail energy marketing joint venture (Nicor Energy) whose operations were
      terminated in 2003. Financial information about these other business segments
      is
      combined under the heading “Other energy ventures” on the chart that follows.
      Intersegment revenues on the chart are presented prior to
      elimination.





Nicor
      management evaluates segment performance based on operating income. Intercompany
      billing for goods and services exchanged between segments is based generally
      upon direct and indirect costs incurred, but in some instances is based upon
      the
      prevailing tariffed or market-based price of the provider.





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 consolidated financial statements.





The
      $30.3
      million operating income in the “Corporate and eliminations” column for 2005
      includes $29.9 million of net insurance recoveries and earnings thereon of
      securities class action and derivative lawsuit settlements in the first and
      second quarters of 2005. The $44.0 million operating loss in the “Corporate and
      eliminations” column for 2004 includes a $38.5 million securities class action
      settlement charge recorded in the first quarter of 2004. See Note 19 -
      Contingencies - Securities Class Actions, Shareholder Derivative Lawsuits and
      Other. Corporate operating expenses also include unallocated legal and business
      development costs.





Financial
      data by business segment is as follows (in millions):


















































61










**Nicor
                Inc.**Other
            
            
            CorporateGas
            
            
            
            
            
            energy
            
            
            anddistribution
            
            
            Shipping
            
            
            ventures
            
            
            eliminations
            
            
            Consolidated**Operating
                revenues****2005****External
                customers**
            
            
            
            
            **$**
            **2,824.5**
            
            **$**
            **378.5**
            
            **$**
            **154.8**
            
            **$**
            -
            
            **$**
            **3,357.8****Intersegment**
            
            
            
            
            
            **85.1**
            
            
            -
            
            
            **2.2**
            
            
            **(87.3**
            **)**
            
            -**2,909.6**
            
            
            **378.5**
            
            
            **157.0**
            
            
            **(87.3**
            **)**
            
            **3,357.8**2004External
                customers
            
            
            
            
            
            2,282.2
            
            
            310.7
            
            
            146.8
            
            
            -
            
            
            2,739.7Intersegment
            
            
            
            
            
            79.9
            
            
            -
            
            
            8.5
            
            
            (88.4
            )
            
            -2,362.1
            
            
            310.7
            
            
            155.3
            
            
            (88.4
            )
            
            2,739.72003External
                customers
            
            
            
            
            
            2,300.7
            
            
            272.2
            
            
            89.8
            
            
            -
            
            
            2,662.7Intersegment
            
            
            
            
            
            50.9
            
            
            -
            
            
            6.7
            
            
            (57.6
            )
            
            -2,351.6
            
            
            272.2
            
            
            96.5
            
            
            (57.6
            )
            
            2,662.7**Operating
                income (loss)****2005**
            
            
            
            
            **$**
            **116.9**
            
            **$**
            **40.4**
            
            **$**
            **14.1**
            
            **$**
            **30.3**
            
            **$**
            **201.7**2004
            
            
            
            
            
            130.8
            
            
            31.6
            
            
            19.3
            
            
            (44.0
            )
            
            137.72003
            
            
            
            
            
            166.2
            
            
            22.7
            
            
            7.9
            
            
            (7.4
            )
            
            189.4**Equity
                investment income (loss), net****2005**
            
            
            
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **3.3**
            
            **$**
            **6.0**
            
            **$**
            **9.3**2004
            
            
            
            
            
            (.1
            )
            
            -
            
            
            2.2
            
            
            4.2
            
            
            6.32003
            
            
            
            
            
            (.1
            )
            
            -
            
            
            11.5
            
            
            3.9
            
            
            15.3**Interest
                income****2005**
            
            
            
            
            **$**
            **4.3**
            
            **$**
            **2.9**
            
            **$**
            **.8**
            
            **$**
            **(2.0**
            **)**
            **$**
            **6.0**2004
            
            
            
            
            
            1.0
            
            
            1.1
            
            
            .3
            
            
            (.1
            )
            
            2.32003
            
            
            
            
            
            1.6
            
            
            .9
            
            
            .6
            
            
            (1.2
            )
            
            1.9**Other
                income (expense), net****2005**
            
            
            
            
            **$**
            **(.5**
            **)**
            **$**
            **.3**
            
            **$**
            **-**
            
            **$**
            **1.0**
            
            **$**
            **0.8**2004
            
            
            
            
            
            (2.4
            )
            
            (.4
            )
            
            .1
            
            
            2.9
            
            
            0.22003
            
            
            
            
            
            .2
            
            
            (.1
            )
            
            -
            
            
            -
            
            
            0.1**Interest
                expense, net of****amounts
                capitalized****2005**
            
            
            
            
            **$**
            **42.1**
            
            **$**
            **1.2**
            
            **$**
            **1.2**
            
            **$**
            **2.3**
            
            **$**
            **46.8**2004
            
            
            
            
            
            37.2
            
            
            .7
            
            
            .5
            
            
            2.8
            
            
            41.22003
            
            
            
            
            
            36.8
            
            
            .5
            
            
            .4
            
            
            (.4
            )
            
            37.3**Income
                tax expense (benefit), net****2005**
            
            
            
            
            **$**
            **26.1**
            
            **$**
            **(7.5**
            **)**
            **$**
            **6.8**
            
            **$**
            **9.3**
            
            **$**
            **34.7**2004
            
            
            
            
            
            33.1
            
            
            8.1
            
            
            8.7
            
            
            (19.7
            )
            
            30.22003
            
            
            
            
            
            48.0
            
            
            6.0
            
            
            7.9
            
            
            (2.3
            )
            
            59.6**Cumulative
                effect of accounting****change,
                net of tax****2005**
            
            
            
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **-**
            
            **$**
            **-**2004
            
            
            
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -2003
            
            
            
            
            
            -
            
            
            -
            
            
            (4.5
            )
            
            -
            
            
            (4.5
            )**Property,
                plant and****equipment,
                net****2005**
            
            
            
            
            **$**
            **2,530.1**
            
            **$**
            **119.9**
            
            **$**
            **9.3**
            
            **$**
            **(.2**
            **)**
            **$**
            **2,659.1**2004
            
            
            
            
            
            2,416.4
            
            
            125.9
            
            
            7.6
            
            
            (.1
            )
            
            2,549.82003
            
            
            
            
            
            2,345.2
            
            
            133.3
            
            
            5.7
            
            
            -
            
            
            2,484.2**Capital
                expenditures****2005**
            
            
            
            
            **$**
            **186.4**
            
            **$**
            **10.7**
            
            **$**
            **3.4**
            
            **$**
            **(.1**
            **)**
            **$**
            **200.4**2004
            
            
            
            
            
            175.1
            
            
            9.0
            
            
            3.2
            
            
            -
            
            
            187.32003
            
            
            
            
            
            172.9
            
            
            5.9
            
            
            2.5
            
            
            -
            
            
            181.3**Depreciation****2005**
            
            
            
            
            **$**
            **154.5**
            
            **$**
            **16.2**
            
            **$**
            **1.7**
            
            **$**
            **-**
            
            **$**
            **172.4**2004
            
            
            
            
            
            148.8
            
            
            16.4
            
            
            1.4
            
            
            -
            
            
            166.62003
            
            
            
            
            
            143.5
            
            
            16.9
            
            
            1.3
            
            
            -
            
            
            161.7




62










**14.
      EQUITY INVESTMENT INCOME, NET**





Equity
      investment income, net included the following (in millions):





**2005**
            
            2004
            
            2003Triton
            **$**
            **7.4**
            
            
            $
            6.5
            
            
            $
            5.5Nicor
                Energy
            
            **.1**
            
            
            
            -
            
            
            
            9.6Affordable
                housing investments
            
            **(1.3**
            **)**
            
            
            (2.4
            )
            
            
            (1.6
            )Horizon
                Pipeline
            
            **1.7**
            
            
            
            1.6
            
            
            
            1.5All
                other
            
            **1.4**
            
            
            
            .6
            
            
            
            .3**$**
            **9.3**
            
            
            $
            6.3
            
            
            $
            15.3





In
      2005,
      2004 and 2003, Nicor received dividends from equity investees of $5.5 million,
      $5.6 million and $2.3 million, respectively.





Nicor’s
      investment in Nicor Energy was written off during 2002. In 2003, Nicor Energy
      ceased operations and Nicor recorded gains of $9.6 million upon the receipt
      of
      cash from Nicor Energy.





**15.**  **RELATED
      PARTY TRANSACTIONS**





Horizon
      Pipeline charged Nicor Gas $10.4 million in each year ended December 31, 2005,
      2004 and 2003 for natural gas transportation under rates that have been accepted
      by the Federal Energy Regulatory Commission.





EN
      Engineering, a 50-percent-owned joint venture of Nicor, charged Nicor Gas $4.4
      million for engineering and corrosion services rendered for 2005. In 2004 and
      2003, EN Engineering charged Nicor Technologies, a wholly owned subsidiary
      of
      Nicor, $4.0 million and $4.4 million, respectively for these
      services.





In
      addition, certain related parties may acquire regulated utility services at
      rates approved by the ICC.





**16.**  **COMMITMENTS**





As
      of
      December 31, 2005, Nicor had purchase commitments with payments due as follows
      (in millions):




Purchase
                obligations
            
            Operating
                leases
            
            Other
                long-term obligations2006
            
            $
            23.8
            
            $
            36.5
            
            $
            2.62007
            
            
            10.4
            
            
            28.2
            
            
            1.72008
            
            
            10.4
            
            
            23.2
            
            
            1.32009
            
            
            10.4
            
            
            11.1
            
            
            .42010
            
            
            10.4
            
            
            4.0
            
            
            .2After
                2010
            
            
            14.0
            
            
            16.6
            
            
            .6$
            79.4
            
            $
            119.6
            
            $
            6.8





Purchase
      obligations consist of a natural gas transportation agreement and property,
      plant and equipment purchases. Operating leases are primarily for vessels,
      containers and equipment in the shipping segment, office space and equipment
      in
      the gas distribution segment and office space for the other energy
      ventures.








63





Tropical
      Shipping has certain equipment operating leases which include purchase and/or
      renewal options, at fair market amounts at the time of purchase or renewal.
      Rental expense under operating leases was $37.2 million, $27.5 million and
      $23.7
      million in 2005, 2004 and 2003, respectively. Other long-term obligations
      consist primarily of equity fund commitments.





**17.**  **RATE
      PROCEEDING**





Nicor
      Gas
      filed a request with the ICC for an overall increase in base rates on November
      4, 2004.  In late 2005, Nicor Gas received approval from the ICC for a
      $54.2 million base rate increase which reflected an allowed rate of return
      on
      original-cost rate base of 8.85 percent, including a 10.51 percent cost of
      common equity. The order also included the authorization to pass all Chicago
      Hub
      revenues directly through to customers as a credit to Nicor Gas’ Purchased Gas
      Adjustment (“PGA”) rider and the shifting of certain storage-related costs from
      the PGA rider to base rates.  In addition, rates were established using a
      10-year average for weather as opposed to the previous use of a 30-year average.
      The new rates were implemented in the fourth quarter of 2005.





In
      October 2005, Nicor Gas and six other parties filed applications for rehearing
      of the final order of the rate case.  The ICC granted rehearing on seven
      issues, only two of which relate to the amount of the approved annual net
      revenue increase, and denied rehearing on all other issues raised in the
      applications.




The
      ICC
      is expected to issue its decision on rehearing in March 2006. As a result of
      the
      rehearing process, the actual annual net revenue increase approved by the ICC
      could change. Based on the positions of the parties on the rehearing issues,
      the
      outcome could range from an approximate $7.1 million reduction to the annual
      net
      revenue increase to an approximate $0.9 million additional annual increase.
      Rate
      changes, if any, resulting from the outcome of the rehearing process would
      be
      prospective.





As
      a
      result of the rate order which became effective in the fourth quarter of 2005,
      certain storage-related costs are now recorded in operating and maintenance
      expense. In aggregate, the fourth quarter storage-related gas costs in operating
      and maintenance expense totaled $6.5 million. Such costs incurred prior to
      the
      effective date of the rate order were recorded as cost of gas.





**18.**  **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 repay the obligations should its affiliates
      default. The obligations of the company’s wholly owned subsidiaries are
      reflected in Nicor’s Consolidated Balance Sheet, while the obligations of its
      unconsolidated equity investments are not. As of December 31, 2005 Nicor had
      guaranteed the payment of $0.6 million of lease obligations extending through
      February 2007 in support of one of its unconsolidated equity investee’s
      operations, and no liability has been recorded for this guarantee. Nicor
      believes the likelihood of payment under this guarantee is remote.





Tropic
      Equipment Leasing Inc. (“TEL”), an indirectly wholly owned subsidiary of Nicor,
      holds the company’s interests in Triton. 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
      $7
      million at December 31, 2005. Nicor believes the likelihood of any such payment
      by TEL is remote and has recorded no liability for this
      contingency.














64





**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 $5.0 million,
      $2.9
      million and $3.4 million were incurred in 2005, 2004 and 2003, respectively.




**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 cleanup,
      as
      discussed in Note
      19 -
      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.





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. The company recorded expense
      of $2.2 million for 2003 in connection with this indemnification. No significant
      additional expense was recorded in 2004 and 2005. As of December 31, 2005,
      the
      company had a remaining estimated liability of $0.2 million in connection with
      this indemnification. While the company does not expect to incur significant
      additional costs under these indemnifications, it is not possible to estimate
      the maximum potential payments.





**19.**  **CONTINGENCIES**





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





**Performance-Based
      Rate (“PBR”) Plan.** Nicor
      Gas’ PBR plan for natural gas costs went into effect in 2000 and was terminated
      by the company effective January 1, 2003. Under the PBR plan, Nicor Gas’ total
      gas supply costs were compared to a market-sensitive benchmark. Savings and
      losses relative to the benchmark were determined annually and shared equally
      with sales customers. The PBR 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. Parties
      who were plaintiffs in a dismissed class action proceeding against the company
      could potentially intervene in these proceedings. The company has committed
      to
      cooperate fully in the reviews of the PBR plan.





In
      response to these allegations, on July 18, 2002, the Nicor Board of Directors
      appointed a special committee of independent, non-management directors to
      conduct an inquiry into issues surrounding natural gas purchases, sales,
      transportation, storage and such other matters as may come to the attention
      of





65





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





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





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





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





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











66





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





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





**Nicor
      Energy.** Nicor
      Energy was a retail energy marketing joint venture owned 50 percent by Nicor
      and
      50 percent by Dynegy Marketing and Trade, that was dissolved in 2005, having
      liquidated all its assets and resolved all its liabilities.





As
      a
      result of an audit and review process in 2002, accounting irregularities were
      identified at Nicor Energy. Appropriate accounting adjustments were made by
      Nicor in restated financial statements previously filed with the
      SEC.





Nicor’s
      investment in Nicor Energy was written off in the third quarter of 2002 due
      to
      the belief at that time that Nicor ultimately would not recover its investment
      balance. During 2003, Nicor recorded gains upon the receipt of cash from Nicor
      Energy. No recoveries occurred during 2004 and recoveries received in 2005
      have
      been immaterial, and any future gains or losses are not expected to be
      material.





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





**SEC
      and U.S. Attorney Inquiries.** In 2002,
      the staff of the SEC informed Nicor and Nicor Energy that the SEC is conducting
      a formal inquiry regarding both the PBR plan and Nicor Energy. A representative
      of the Office of the United States Attorney for the Northern District of
      Illinois has notified Nicor that that office is conducting an inquiry on the
      same matters that the SEC is investigating, and a grand jury is also reviewing
      these matters. In April 2004, Nicor was advised by the SEC Division of
      Enforcement that it intended to recommend to the SEC that it bring a civil
      injunctive action against Nicor, alleging that Nicor violated Sections 17(a)
      of
      the Securities Act of 1933 and Sections 10(b) and 13(a) of the Securities
      Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder.
      The
      SEC may also seek injunctive relief, disgorgement and civil penalties. The
      SEC
      staff invited Nicor to make a formal response (known as a Wells Submission)
      with
      respect to the proposed recommendation. In June 2004, Nicor filed its Wells
      Submission with the SEC. In addition, in connection with the SEC’s invitation to
      the company to make a Wells Submission, the SEC informed the company of
      additional sources of





67





information
      relating to activities affecting the PBR plan, the status of which is addressed
      in detail in the **** PBR
      plan
      section set forth above. In August 2004, Nicor withdrew its Wells Submission
      in
      light of its continuing review of the newly available additional sources of
      information referenced above. Nicor continues in its efforts to resolve this
      matter with the SEC and has requested that the SEC allow Nicor to file an
      updated Wells Submission if necessary. Nicor is unable to predict the outcome
      of
      these inquiries or Nicor’s potential exposure related thereto and has not
      recorded a liability associated with the outcome of these
      contingencies.





**Securities
      Class Actions.** Following a July 18, 2002 Nicor press release concerning Nicor Energy and the
      PBR plan, several purported class actions were brought against Nicor, certain
      current and former officers of Nicor and Arthur Andersen LLP, the company’s
      former independent auditor. The actions were brought in the United States
      District Court for the Northern District of Illinois, Eastern Division, and
      were
      consolidated. The plaintiffs alleged that the defendants violated Section 10(b)
      and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5
      thereunder. On April 16, 2004 Nicor announced that its board of directors had
      approved an agreement to settle the above referenced action. Under the terms
      of
      the settlement, all claims against Nicor and Nicor-related defendants have
      been
      dismissed without any finding or admission of wrongdoing or liability, for
      a
      payment of $38.5 million. In the first quarter of 2004, the company recorded
      a
      litigation charge of $38.5 million related to this agreement. On July 13, 2004
      the court granted final approval of the settlement. All appeal rights expired
      on
      August 12, 2004.





**Shareholder
      Derivative Lawsuits.** Also
      following Nicor’s issuance of the press release concerning Nicor Energy and the
      PBR plan, three purported derivative lawsuits were brought against Thomas Fisher
      (former Chairman and former CEO), Kathleen Halloran (former Executive Vice
      President Finance and Administration and former Executive Vice President and
      Chief Risk Officer) and all of the then members of Nicor’s Board of Directors
      (the “individual defendants”). Nicor was named as a nominal defendant in all
      three suits, which were consolidated in an amended complaint. The actions were
      brought in the Circuit Court of Cook County, Illinois, Chancery Division. The
      plaintiffs alleged that the individual defendants breached their fiduciary
      duties to Nicor by allegedly causing or allowing Nicor to disseminate to the
      market materially misleading and inaccurate information, failing to establish
      and maintain adequate accounting controls and approving the PBR plan despite
      allegedly knowing that the plan was unlawful or that ICC approval would be
      improperly obtained. Plaintiffs also contended that two of the defendants (Mr.
      Fisher and Mr. Birdsall) engaged in improper insider selling of Nicor stock
      at
      inflated prices. The plaintiffs sought compensatory and punitive damages,
      attorneys’ fees and costs, and other relief against the individual defendants on
      behalf of Nicor but did not seek any damages against the company. On January
      25,
      2005, Nicor announced that its Board of Directors had approved a preliminary
      agreement to settle the above referenced action. Under the terms of the
      settlement, all claims against the defendants would be dismissed without any
      finding or admission of wrongdoing or liability. The settlement obligated Nicor
      to adopt certain new corporate governance policies and required the payment
      of
      $3.5 million in attorneys’ fees and expenses to plaintiffs’ counsel out of the
      Directors and Officers (“D&O”) insurance proceeds described below. The court
      granted final approval of the settlement and entered an Order of Dismissal
      on
      March 29, 2005. The settlement became final in the second quarter of 2005,
      when
      all appeal rights expired. In connection with the derivative settlement, in
      the
      first quarter of 2005, Nicor’s excess insurance carrier paid $4 million to Nicor
      to settle certain claims Nicor had asserted against it arising out of the
      derivative action and related class action securities litigation. Pursuant
      to
      the terms of the derivative settlement, Nicor paid $3.5 million of that $4
      million to plaintiffs’ attorneys to reimburse them for the fees and costs
      expended in pursuing the derivative action. The $0.5 million net of these
      payments was reflected as “Litigation charges (recoveries), net” in the
      Consolidated Statement of Operations in the first quarter of 2005.





**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





68





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. As a result, if the case proceeds in
      the
      Circuit Court, it will be as an individual action on behalf of the named
      plaintiff alone. The class certification decision remains subject to appeal.
      Nicor is unable to predict the outcome of this litigation or to reasonably
      estimate its potential exposure related thereto and has not recorded a liability
      associated with this contingency.





**Gas
      Line ComfortGuard Service.** On
      May 5,
      2005, a consumer class action was filed in the Circuit Court of Cook County,
      Illinois entitled *Rivera
      v. Nicor Inc., Nicor Gas and Nicor Services* .  Nicor,
      Nicor Gas and Nicor Services were defendants in the case.  The plaintiff
      alleged deceptive practices relating to the marketing and sale of the Gas Line
      ComfortGuard service offered by Nicor Services. The plaintiff also alleged
      violations of the Illinois Consumer Fraud and Deceptive Business Practices
      Act
      and unjust enrichment. The plaintiff sought damages in an amount equal to the
      total Gas Line ComfortGuard charges paid by the plaintiff and the putative
      class
      members, punitive damages, and attorney’s fees and costs. In the third quarter
      of 2005, the case was transferred to the Circuit Court of DuPage County,
      Illinois. In the first quarter of 2006, Nicor, Nicor Gas and Nicor Services
      settled the action on an individual basis with the named plaintiff without
      any
      admission of wrongdoing or liability. The plaintiff’s case has been dismissed
      with prejudice and no motion to certify a class was ever filed.





**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.





Nicor
      Gas
      is a defendant in several private lawsuits, all in the Circuit Court of Cook
      County, Illinois, seeking a variety of unquantified damages (including bodily
      injury, property and punitive damages) allegedly caused by mercury spillage
      resulting from the removal of mercury-containing regulators. Under the terms
      of
      a class action settlement agreement, Nicor Gas will continue, until 2007, to
      provide medical screening to persons exposed to mercury from its equipment,
      and
      will use reasonable efforts to remove any remaining inside residential mercury
      regulators by March of 2006. Nicor Gas believes it is in compliance with its
      obligations under the settlement agreement. The class action settlement
      permitted class members to “opt out” of the settlement and pursue their claims
      individually. Nicor Gas is currently defending claims brought by 27
      households.





As
      of
      December 31, 2005, Nicor Gas had remaining an estimated liability of $17.5
      million, representing management’s best estimate of future costs, including
      potential liabilities relating to remaining lawsuits, based on an evaluation
      of
      currently available information. Actual costs may vary from this estimate.
      The
      company will continue to reassess its estimated obligation and will record
      any
      necessary adjustment, which could be material to operating results in the period
      recorded.





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 recovered
      approximately $18 million of pretax mercury-related costs, net of legal fees,
      from insurers and independent contractors in 2003. Amounts recovered during
      2004
      and 2005 were immaterial. On October 25, 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 appeal of the
      judgment. On November 29, 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. On January 3, 2006, Nicor and Nicor Gas filed a petition for leave
      to
      appeal to the Illinois Supreme Court.





69





The
      final
      disposition of these mercury-related matters is not expected to have a material
      adverse impact on the company’s 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 cleanup of coal tar at certain former
      manufactured gas plant sites.





To
      date,
      Nicor Gas has identified about 40 properties for which it may, in part, be
      responsible. Most of these properties are not presently owned by the company.
      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
      determine the extent additional remediation is necessary and provide a basis
      for
      estimating additional future costs. As of December 31, 2005 the company had
      recorded a liability of $19.5 million. In accordance with ICC authorization,
      the
      company is and has been recovering these costs from its customers, subject
      to
      annual prudence reviews.





In
      December 2001, a purported class action lawsuit was filed against Exelon
      Corporation, Commonwealth Edison Company and Nicor Gas in the Circuit Court
      of
      Cook County alleging, among other things, that the ongoing cleanup of a former
      manufactured gas plant site in Oak Park, Illinois was inadequate. Since then,
      additional lawsuits have been filed related to this same former manufactured
      gas
      plant site. These lawsuits seek, in part, unspecified damages for property
      damage, nuisance, and various personal injuries that allegedly resulted from
      exposure to contaminants allegedly emanating from the site, and punitive
      damages. Management cannot predict the outcome of this litigation or the
      company’s potential exposure thereto and has not recorded a liability associated
      with this contingency.





In
      April
      2002, Nicor Gas was named as a defendant, together with Commonwealth Edison
      Company, in a lawsuit brought by the Metropolitan Water Reclamation District
      of
      Greater Chicago (the “MWRDGC”) under the Federal Comprehensive Environmental
      Response, Compensation and Liability Act seeking recovery of past and future
      remediation costs and a declaration of the level of appropriate cleanup 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 and
      has not recorded a liability associated with this contingency.





Since
      costs and recoveries relating to the cleanup 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.





**Other.** On
      April
      27, 2004 one of Nicor’s D&O insurance carriers agreed to pay $29.0 million
      to a third party escrow agent on behalf of Nicor and its insured directors
      and
      officers to be used to satisfy Nicor directors’ and officers’ liabilities and
      expenses associated with claims asserted against them in a securities class
      action, the related shareholder derivative lawsuit described above and related
      matters, with any remaining balance to be paid to Nicor. Under the terms of
      the
      derivative settlement, once the settlement became final (because all appeal
      rights had expired), the escrow was terminated and the $29.0 million, plus
      earnings of approximately $0.4 million, held by the escrow agent was paid to
      Nicor in the second quarter of 2005. These recoveries have been recorded in
      “Litigation charges (recoveries), net” in the Consolidated Statement of
      Operations for the year ended December 31, 2005. In the second half of 2005,
      Nicor received $2.8 million of additional insurance proceeds related to legal
      defense costs. These additional proceeds have been recorded in “Other corporate
      expenses and eliminations” in the Consolidated Statement of Operations for the
      year ended December 31, 2005. Nicor also continues to seek reimbursement for
      other expenses from its excess insurance carrier in connection with the
      same





70





matters
      but is unable to predict the outcome of this matter and therefore no additional
      potential insurance recoveries have been reflected in the financial
      statements.





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, rates, 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.





**20.**  **QUARTERLY
      RESULTS (UNAUDITED)**





Summarized
      quarterly financial data is presented below (in millions, except per share
      data).





Quarter
                endedMar.
                31
            
            June
                30
            
            Sept.
                30
            
            Dec.
                312005Operating
                revenues
            **$**
            **1,179.8**
            
            
            **$**
            **484.4**
            
            
            **$**
            **336.0**
            
            
            **$**
            **1,357.5**Operating
                income
            
            **69.8**
            
            
            
            **58.0**
            
            
            
            **.6**
            
            
            
            **73.3**Net
                income (loss)
            
            **43.7**
            
            
            
            **33.4**
            
            
            
            **(2.7**
            **)**
            
            
            **62.0**Earnings
                (loss) per common shareBasic
            
            **.99**
            
            
            
            **.76**
            
            
            
            **(.06**
            **)**
            
            
            **1.40**Diluted
            
            **.99**
            
            
            
            **.75**
            
            
            
            **(.06**
            **)**
            
            
            **1.40**2004Operating
                revenues
            $
            1,115.7
            
            
            $
            429.5
            
            
            $
            299.9
            
            
            $
            894.6Operating
                income (loss)
            
            34.3
            
            
            
            33.1
            
            
            
            (9.6
            )
            
            
            79.9Net
                income (loss)
            
            19.6
            
            
            
            19.5
            
            
            
            (11.6
            )
            
            
            47.7Earnings
                (loss) per common shareBasic
            
            .44
            
            
            
            .44
            
            
            
            (.26
            )
            
            
            1.08Diluted
            
            .44
            
            
            
            .44
            
            
            
            (.26
            )
            
            
            1.08





The
      second quarter of 2005 included $29.4 million of operating income related to
      insurance recoveries and earnings thereon related to the securities class action
      and derivative lawsuit settlements. The fourth quarter of 2005 included revenues
      of $12.8 million and operating income of $9.0 million recorded in connection
      with the rate relief that became effective during the quarter. Net income in
      the
      fourth quarter of 2005 includes the impact of the tax benefit recorded in
      connection with the Jobs Act of approximately $17 million. The first quarter
      of
      2004 included a $38.5 million pretax litigation charge to operating expenses
      related to an agreement to settle securities class lawsuits.





**Item
      9.** ****  **Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure**





None.





**Item
      9A.**  **Controls
      and Procedures**





**Evaluation
      of Disclosure 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








71





design
      and operation of the company’s disclosure controls and procedures as of the end
      of the most recent fiscal quarter of the period covered by this Annual Report
      on
      Form 10-K (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 most recent fiscal quarter covered by this
      Annual Report on Form 10-K, 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.





**Management’s
      Report on Internal Control Over Financial Reporting**





Internal
      control over financial reporting refers to the process designed by, or under
      the
      supervision of, the company’s Chief Executive Officer and Chief Financial
      Officer, and effected by the company’s board of directors, management and other
      personnel, to provide reasonable assurance regarding the reliability of
      financial reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting principles, and
      includes those policies and procedures that:





1.
            Pertain
                to the maintenance of records that in reasonable detail accurately
                and
                fairly reflect the transactions and dispositions of the assets of
                the
                company;





2.
            Provide
                reasonable assurance that transactions are recorded as necessary
                to permit
                preparation of financial statements in accordance with generally
                accepted
                accounting principles, and that receipts and expenditures of the
                company
                are being made only in accordance with authorizations of management
                and
                directors of the company, and;





3.
            Provide
                reasonable assurance regarding prevention or timely detection of
                unauthorized acquisition, use or disposition of the company’s assets that
                could have a material effect on the financial
                statements.





Internal
      control over financial reporting cannot provide absolute assurance of achieving
      financial reporting objectives because of its inherent limitations. Internal
      control over financial reporting is a process that involves human diligence
      and
      compliance and is subject to lapses in judgment and breakdowns resulting from
      human failures. Internal control over financial reporting also can be
      circumvented by collusion or improper management override. Because of such
      limitations, there is a risk that material misstatements may not be prevented
      or
      detected on a timely basis by internal control over financial reporting.
      However, these inherent limitations are known features of the financial
      reporting process. Therefore, it is possible to design into the process
      safeguards to reduce, though not eliminate, this risk. Management is responsible
      for establishing and maintaining adequate internal control over financial
      reporting for the company.





Management
      has used the framework set forth in the report entitled “Internal
      Control—Integrated Framework” published by the Committee of Sponsoring
      Organizations of the Treadway Commission to evaluate the effectiveness of the
      company’s internal control over financial reporting. Management has concluded
      that the company’s internal control over financial reporting was effective as of
      December 31, 2005. Deloitte & Touche LLP, an independent registered public
      accounting firm, has issued an attestation report on management’s assessment of
      the company’s internal control over financial reporting.











72





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.





**Item
      9B.**  **Other
      Information**





None.





**PART
      III**





**Item
      10.**  **Directors
      and Executive Officers of the Registrant**





Information
      on directors is contained under the Election of Directors and Section 16(a)
      Beneficial Ownership Reporting Compliance sections in Nicor’s Definitive Proxy
      Statement to be filed on or about March 10, 2006, and is incorporated herein
      by
      reference.





Information
      about the audit committee financial expert is contained under the Audit
      Committee Report section in Nicor’s Definitive Proxy Statement to be filed on or
      about March 10, 2006, and is incorporated herein by reference.





Information
      about executive officers is included in Part I of this Form 10-K, Executive
      Officers of the Registrant, and is incorporated herein by reference. Executive
      officers of the company are elected annually by the Board of
      Directors.





In
      addition, information about executive officers is contained under the Section
      16(a) Beneficial Ownership Reporting Compliance section in Nicor’s Definitive
      Proxy Statement to be filed on or about March 10, 2006, and is incorporated
      herein by reference.





The
      company has adopted a Code of Ethics that applies to the company’s directors,
      officers and employees, including its principal executive officer, principal
      financial officer, principal accounting officer or controller or persons
      performing similar functions. We intend to satisfy the disclosure requirements
      under Item 5.05 of Form 8-K regarding an amendment to or waiver from a provision
      of such Code of Ethics as it applies to our principal executive officer,
      principal financial officer, principal accounting officer or controller or
      persons performing similar functions and that relates to certain topics, by
      posting such information on the company’s investor relations section of its
      internet site at www.nicor.com.





The
      company has disclosed its Code of Ethics, Audit Committee Charter, Corporate
      Governance Committee Charter, Compensation Committee Charter, and Corporate
      Governance Guidelines on the company’s investor relations section of its
      internet site at www.nicor.com. Any shareholder may also request this
      information in print form from the company’s Investor Relations
      department.





**Item
      11.**  **Executive
      Compensation**





Information
      on executive compensation is contained under the Compensation Committee Report
      and Executive Compensation sections in Nicor’s Definitive Proxy Statement to be
      filed on or about March 10, 2006, and is incorporated herein by
      reference.























73





**Item
      12.**  **Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters**





Information
      on security ownership of certain beneficial owners and management is contained
      under the Security Ownership of Management and Beneficial Ownership of Common
      Stock sections in Nicor’s Definitive Proxy Statement to be filed on or about
      March 10, 2006, and is incorporated herein by reference.





**EQUITY
      COMPENSATION PLAN INFORMATION**


Plan
                category
            (a)
              
              
              Number
                of securities to be issued upon exercise of outstanding options,
                warrants,
                and rights
            (b)
              
              
              Weighted-average
                exercise price of outstanding options, warrants, and
                rights
            (c)
              
              Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
                (a))Equity
                compensation plans approved by security holders
            1,559,658
            $
                35.41****
            889,465**(1)**Equity
                compensation plans not approved by security holders
            **-**
            **-**
            **-**Total
            1,559,658
            $
                35.41
            889,465





**(1)**
            This
                number includes 431,184 shares issuable under the 1997 Long-Term
                Incentive
                Plan, as amended. These shares can be used for stock options, alternate
                stock rights, restricted stock and performance award units, including
                awards under the Stock Deferral Plan, which allows eligible key executives
                and managerial employees to convert up to 50 percent of their cash
                awards
                from annual and long-term incentive plans into Nicor common stock,
                the
                receipt of which is deferred. The remaining 458,281 shares are issuable
                under the Employee Stock Purchase
                Plan.





**Item
      13.**  **Certain
      Relationships and Related Transactions**





Information
      about certain relationships and related transactions is contained under the
      Certain Relationships and Related Transactions section in Nicor’s Definitive
      Proxy Statement to be filed on or about March 10, 2006, and is incorporated
      herein by reference.





**Item
      14.**  **Principal
      Accountant Fees and Services**





Information
      on principal accountant fees and services is contained under the Principal
      Accountant Fees and Services section in Nicor’s Definitive Proxy Statement to be
      filed on or about March 10, 2006, and is incorporated herein by
      reference.






































74











**PART
      IV**





**Item
      15.**  **Exhibits
      and Financial Statement Schedules**





a)





1)  Financial
      Statements:





See
      Item
      8, Financial Statements and Supplementary Data, filed herewith, for a list
      of
      financial statements.





2)  Financial
      Statement Schedules:





ScheduleNumber
            
            PageReport
                of Independent Registered Public Accounting Firm
            36II
            Valuation
                and Qualifying Accounts
            76





Schedules
                other than those listed are omitted because they are not
                applicable.





3)  Exhibits
      Filed:





See
      Exhibit Index filed herewith.































































































75









**Nicor
                Inc.****Schedule
                II**VALUATION
                AND QUALIFYING ACCOUNTS(millions)AdditionsBalanceat
            
            
            Charged
                to
            
            
            Charged
                to
            
            
            
            
            
            
            
            
            
            Balancebeginning
            
            
            costs
                and
            
            
            other
            
            
            
            
            
            
            
            
            
            at
                endDescription
            
            of
                period
            
            
            expenses
            
            
            accounts
            
            
            
            
            Deductions
            
            
            
            
            of
                period2005Allowance
                for doubtfulaccounts
                receivable
            **$**
            **21.9**
            
            **$**
            **44.1**
            
            **$**
            **-**
            
            
            
            **$**
            **34.5**
            
            **(a**
            **)**
            **$**
            **31.5**Accrued
                mercury-related costs
            
            **20.2**
            
            
            **-**
            
            
            -
            
            
            
            
            **2.7**
            
            **(b**
            **)**
            
            **17.5**Accrued
                manufactured gas plantenvironmental
                costs
            
            **36.8**
            
            
            **-**
            
            
            **0.6**
            
            **(c**
            **)**
            
            **17.9**
            
            **(b**
            **)**
            
            **19.5**2004Allowance
                for doubtfulaccounts
                receivable
            $
            21.2
            
            $
            36.0
            
            $
            -
            
            
            
            $
            35.3
            
            (a
            )
            $
            21.9Accrued
                mercury-related costs
            
            21.9
            
            
            -
            
            
            -
            
            
            
            
            1.7
            
            (b
            )
            
            20.2Accrued
                manufactured gas plantenvironmental
                costs
            
            33.2
            
            
            -
            
            
            18.8
            
            (c
            )
            
            15.2
            
            (b
            )
            
            36.82003Allowance
                for doubtfulaccounts
                receivable
            $
            16.9
            
            $
            30.9
            
            $
            -
            
            
            
            $
            26.6
            
            (a
            )
            $
            21.2Accrued
                mercury-related costs
            
            23.4
            
            
            -
            
            
            -
            
            
            
            
            1.5
            
            (b
            )
            
            21.9Accrued
                manufactured gas plantenvironmental
                costs
            
            61.9
            
            
            -
            
            
            14.2
            
            (c
            )
            
            42.9
            
            (b
            )
            
            33.2(a)
                Accounts receivable written off, net of recoveries.(b)
                Expenditures, other adjustments.(c)
                Accrual of estimated future remediation costs that are deferred as
                regulatory assets.




76









**Signatures**





Pursuant
      to the requirements of Section 13 or 15(d) 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.DateFebruary
                24, 2006
            
            /s/
                RICHARD L. HAWLEYRichard
                L. HawleyExecutive
                Vice President andChief
                Financial OfficerPursuant
                to the requirements of the Securities Exchange Act of 1934, this
                report
                has been signed belowby
                the following persons on behalf of the registrant and in the capacities
                indicated on February 24, 2006.Signature
            
            Title/s/
                RUSS M. STROBELRuss
                M. Strobel
            
            Chairman,
                President and*(Principal
                Executive Officer)*
            
            Chief
                Executive Officer/s/
                RICHARD L. HAWLEYRichard
                L. Hawley
            
            Executive
                Vice President and*(Principal
                Financial Officer*
            
            Chief
                Financial Officer*and
                Principal Accounting Officer)*ROBERT
                M. BEAVERS, JR.*
            
            DirectorBRUCE
                P. BICKNER*
            
            DirectorJOHN
                H. BIRDSALL, III*
            
            DirectorTHOMAS
                A. DONAHOE*
            
            DirectorRAYMOND
                A. JEAN*
            
            DirectorJOHN
                E. JONES*
            
            DirectorDENNIS
                J. KELLER*
            
            DirectorR.
                EDEN MARTIN*
            
            DirectorGEORGIA
                R. NELSON*
            
            DirectorWILLIAM
                A. OSBORN*
            
            DirectorJOHN
                RAU*
            
            DirectorJOHN
                F. RIORDAN*
            
            Director*
            By/s/
                RICHARD L. HAWLEYRichard
                L. Hawley(Attorney-in-fact)








77











**Exhibit
      Index**





ExhibitNumber
            
            Description
                of Document3.01
            *
            Articles
                of Incorporation of the company. (File No. 2-55451, Form S-14, Nicor
                Inc.,
                Exhibit 1-03 and Exhibit B of Amendment No. 1 thereto.)3.02
            *
            Amendment
                to Articles of Incorporation of the company. (Proxy Statement dated
                April
                20, 1979, Nicor Inc., Item 3 thereto.)3.03
            *
            Amendment
                to Articles of Incorporation of the company. (File No. 2-68777, Form
                S-16,
                Nicor Inc., Exhibit 2-01.)3.04
            *
            Amendment
                to Articles of Incorporation of the company. (File No. 1-7297, Form
                10-K
                for 1985, Nicor Inc., Exhibit 3-03.)3.05
            *
            Amendment
                to Articles of Incorporation of the company. (Proxy Statement dated
                March
                12, 1987, Nicor Inc., Exhibit A and Exhibit B thereto.)3.06
            *
            Amendment
                to Articles of Incorporation of the company. (File No. 1-7297, Form
                10-K
                for 1992, Nicor Inc., Exhibit 3-06.)3.07
            *
            Amendments
                to Articles of Incorporation of the company. (Proxy Statement dated
                March
                9, 1994, Nicor Inc., Exhibit A-1 and Exhibit B
                thereto.)3.08
            *
            Amendment
                to Articles of Incorporation of the company. (Proxy Statement dated
                March
                6, 1998, Nicor Inc., Item 2 thereto.)3.09
            *
            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.)4.01
            *
            Indenture
                of Commonwealth Edison Company to Continental Illinois National Bank
                and
                Trust Company of Chicago, Trustee, dated as of January 1, 1954. (File
                No.
                1-7296, Form 10-K for 1995, Nicor Gas, Exhibit 4.01.)4.02
            *
            Indenture
                of Adoption of Nicor Gas to Continental Illinois National Bank and
                Trust
                Company of Chicago, Trustee, dated February 9, 1954. (File No. 1-7296,
                Form 10-K for 1995, Nicor Gas, Exhibit 4.02.)4.03
            *
            Supplemental
                Indenture, dated February 15, 1998, of Nicor Gas to Harris Trust
                and
                Savings Bank, Trustee, under Indenture dated as of January 1, 1954.
                (File
                No. 1-7296, Form 10-K for 1997, Nicor Gas, Exhibit
                4.19.)4.04
            *
            Supplemental
                Indenture, dated February 1, 1999, of Nicor Gas to Harris Trust and
                Savings Bank, Trustee, under Indenture dated as of January 1, 1954.
                (File
                No. 1-7296, Form 10-K for 1998, Nicor Gas, Exhibit
                4.19.)




















78








ExhibitNumber
            
            Description
                of Document4.05
            *
            Supplemental
                Indenture, dated February 1, 2001, of Nicor Gas to BNY Midwest Trust
                Company, Trustee, under Indenture dated as of January 1, 1954. (File
                No.
                1-7296, Form 10-K for 2000, Nicor Gas, Exhibit 4.17.)4.06
            *
            Supplemental
                Indenture, dated May 15, 2001, of Nicor Gas to BNY Midwest Trust
                Company,
                Trustee, under Indenture dated as of January 1, 1954. (File No. 1-7296,
                Form 10-Q for June 2001, Nicor Gas, Exhibit 4.01.)4.07
            *
            Supplemental
                Indenture, dated August 15, 2001, of Nicor Gas to BNY Midwest Trust
                Company, Trustee, under Indenture dated as of January 1, 1954. (File
                No.
                1-7296, Form 10-Q for September 2001, Nicor Gas, Exhibit
                4.01.)4.08
            *
            Supplemental
                Indenture, dated December 15, 2001, of Nicor Gas to BNY Midwest Trust
                Company, Trustee, under Indenture dated as of January 1, 1954. (File
                No.
                1-7296, Form 10-K for 2001, Nicor Gas, Exhibit 4.20.)4.09
            *
            Supplemental
                Indenture, dated December 1, 2003, of Nicor Gas to BNY Midwest Trust
                Company, Trustee, under Indenture dated as of January 1, 1954. (File
                No.
                1-7297, Form 10-K for 2003, Nicor Inc., Exhibit 4.10.)4.10
            *
            Supplemental
                Indenture, dated December 1, 2003, of Nicor Gas to BNY Midwest Trust
                Company, Trustee, under Indenture dated as of January 1, 1954. (File
                No.
                1-7297, Form 10-K for 2003, Nicor Inc., Exhibit 4.11.)4.11
            *
            Supplemental
                Indenture, dated December 1, 2003, of Nicor Gas to BNY Midwest Trust
                Company, Trustee, under Indenture dated as of January 1, 1954. (File
                No.
                1-7297, Form 10-K for 2003, Nicor Inc., Exhibit 4.12.)10.01
            *
            1984
                Nicor Officers’ Capital Accumulation Plan Participation Agreement. (File
                No. 1-7297, Form 10-K for 1988, Nicor Inc., Exhibit
                10-10.)10.01(a)
            *
            1985
                Nicor Officers’ Capital Accumulation Plan Participation Agreement. (File
                No. 1-7297, Form 10-K for 1988, Nicor Inc., Exhibit
                10-10(a).)10.02
            *
            1984
                Nicor Directors’ Capital Accumulation Plan Participation Agreement. (File
                No. 1-7297, Form 10-K for 1983, Nicor Inc., Exhibit
                10-13.)10.02(a)
            *
            1985
                Nicor Directors’ Capital Accumulation Plan Participation Agreement. (File
                No. 1-7297, Form 10-K for 1984, Nicor Inc., Exhibit
                10-13(a).)10.03
            *
            Directors’
                Deferred Compensation Plan. (File No. 1-7297, Form 10-K for 1983,
                Nicor
                Inc., Exhibit 10-16.)10.04
            *
            Directors’
                Pension Plan. (File No. 1-7297, Form 10-K for 1985, Nicor Inc., Exhibit
                10-18.)10.05
            *
            Flexible
                Spending Account for Executives. (File No. 1-7297, Form 10-K for
                1986,
                Nicor Inc., Exhibit 10-20.)








79





ExhibitNumber
            
            Description
                of Document10.06
            *
            Amendment
                and Restatement of the Nicor Gas Incentive Compensation Plan. (File
                No.
                1-7297, Form 10-K for 1986, Nicor Inc., Exhibit 10-21.)10.07
            *
            Nicor
                Inc. 1989 Long-Term Incentive Plan. (Filed with Nicor Inc. Proxy
                Statement, dated April 20, 1989, Exhibit A.)10.08
            *
            Nicor
                Inc. Stock Deferral Plan. (File No. 1-7297, Form 10-Q for September
                1996,
                Nicor Inc., Exhibit 10.01.)10.09
            *
            Amendment
                to Nicor Inc. Stock Deferral Plan. (File No. 1-7297, Form 10-K for
                1997,
                Nicor Inc., Exhibit 10.22.)10.10
            *
            Nicor
                Inc. 1995 Directors’ Stock Plan. (File No. 1-7297, Form 10-Q for September
                1996, Nicor Inc., Exhibit 10.02.)10.11
            *
            Nicor
                Inc. 1997 Long-Term Incentive Plan. (Filed as appendix to the Nicor
                Inc.
                Proxy Statement, dated March 6, 1997.)10.12
            *
            Security
                Payment Plan. (File No. 1-7297, Form 10-K for 1999, Nicor Inc., Exhibit
                10.24.)10.13
            *
            Amendment
                and Restatement of Nicor Gas Supplementary Retirement Plan. (File
                No.
                1-7297, Form 10-Q for March 2000, Nicor Inc., Exhibit
                10.01.)10.14
            *
            Amendment
                and Restatement of Nicor Gas Supplementary Savings Plan. (File No.
                1-7297,
                Form 10-Q for March 2000, Nicor Inc., Exhibit 10.02.)10.15
            *
            First
                Amendment to Agreements Restating 1984 and 1985 Nicor Capital Accumulation
                Plan Participation Agreements for Officers and Directors. (File No.
                1-7297, Form 10-Q for March 2000, Nicor Inc., Exhibit
                10.04.)10.16
            *
            First
                Amendment to Nicor 1989 Long-Term Incentive Plan. (File No. 1-7297,
                Form
                10-Q for March 2000, Nicor Inc., Exhibit 10.05.)10.17
            *
            First
                Amendment to Nicor 1997 Long-Term Incentive Plan. (File No. 1-7297,
                Form
                10-Q for March 2000, Nicor Inc., Exhibit 10.06.)10.18
            *
            Second
                Amendment to Nicor Stock Deferral Plan. (File No. 1-7297, Form 10-Q
                for
                March 2000, Nicor Inc., Exhibit 10.07.)10.19
            *
            Change-in-Control
                Agreement, dated December 20, 2000, between Nicor Inc. and Mr. Strobel.
                (File No. 1-7297, Form 10-K for 2001, Nicor Inc., Exhibit
                10.31.)10.20
            *
            Second
                Amendment and Restatement to Nicor Salary Deferral Plan. (File No.
                1-7297,
                Form 10-Q for September 30, 2002, Nicor Inc., Exhibit
                10.01.)10.21
            *
            First
                Amendment to the Change-in-Control Agreement, dated November 22,
                2002,
                between Nicor Inc. and Mr. Strobel. (File No. 1-7297, Form 10-K for
                2002,
                Nicor Inc., Exhibit 10.26.)








80







ExhibitNumber
            
            Description
                of Document10.22
            *
            Supplemental
                Retirement Benefit Agreement between Nicor Inc. and Mr. Strobel.
                (File No.
                1-7297, Form 10-K for 2001, Nicor Inc., Exhibit 10.32.)10.23
            *
            Nicor
                Inc. Supplemental Senior Officer Retirement Plan. (File No. 1-7297,
                Form
                10-K for 2002, Nicor Inc., Exhibit 10.28.)10.24
            *
            2003
                Long-Term Incentive Program. (File No. 1-7297, Form 10-Q for March
                2003,
                Nicor Inc., Exhibit 10.01.)10.25
            *
            Change-in-Control
                Agreement, dated November 22, 2002, between Nicor Inc. and Mr. Dodge.
                (File No. 1-7297, Form 10-K for 2003, Nicor Inc., Exhibit
                10.30.)10.26
            *
            Change-in-Control
                Agreement, dated November 25, 2002, between Nicor Inc. and Mr. Gracey.
                (File No. 1-7297, Form 10-K for 2003, Nicor Inc., Exhibit
                10.31.)10.27
            *
            Change-in-Control
                Agreement, dated December 8, 2003, between Nicor Inc. and Mr. Hawley.
                (File No. 1-7297, Form 10-K for 2003, Nicor Inc., Exhibit
                10.32.)10.28
            *
            2004
                Long-Term Incentive Program. (File No. 1-7297, Form 10-Q for March
                2004,
                Nicor Inc., Exhibit 10.01.)10.29
            *
            2004
                Incentive Compensation Plan. (File No. 1-7297, Form 10-Q for March
                2004,
                Nicor Inc., Exhibit 10.02.)10.30
            *
            First
                Amendment to Nicor Inc. 1995 Directors’ Stock Plan. (File No. 1-7297, Form
                10-Q for March 2004, Nicor Inc., Exhibit 10.03.)10.31
            *
            Agreement,
                dated July 30, 2004, between Nicor Inc. and Ms. Halloran. (File No.
                1-7297, Form 10-Q for September 30, 2004, Nicor Inc., Exhibit 10.03.)10.32
            *
            Nicor
                Inc. Stock Deferral Plan Election Form. (File No. 1-7297, Form 8-K
                for
                December 17, 2004, Nicor Inc., Exhibit 99.1.)10.33
            *
            Nicor
                Inc. Salary Deferral Plan Election Form. (File No. 1-7297, Form 8-K
                for
                December 17, 2004, Nicor Inc., Exhibit 99.2.)10.34
            *
            Nicor
                Inc. Directors’ Deferred Compensation Plan Election Form. (File No.
                1-7297, Form 8-K for December 17, 2004, Nicor Inc., Exhibit
                99.3.)10.35
            *
            Nicor
                Gas Supplementary Savings Plan Enrollment Form. (File No. 1-7297,
                Form 8-K
                for December 27, 2004, Nicor Inc., Exhibit 99.1.)10.36
            *
            Stock
                Payment Election Stock Deferral Plan Form. (File No. 1-7297, Form
                8-K for
                February 15, 2005, Nicor Inc., Exhibit 99.1.)10.37
            *
            Non-Qualified
                Stock Option Agreement Form. (File No. 1-7297, Form 8-K for March
                17,
                2005, Nicor Inc., Exhibit 10.01.)














81







ExhibitNumber
            
            Description
                of Document10.38
            *
            Performance
                Cash Unit Agreement Form. (File No. 1-7297, Form 8-K for March 17,
                2005,
                Nicor Inc., Exhibit 10.02.)10.39
            *
            2005
                Long-Term Incentive Program. (File No. 1-7297, Form 8-K for March
                17,
                2005, Nicor Inc., Exhibit 10.03.)10.40
            *
            2005
                Incentive Compensation Plan. (File No. 1-7297, Form 10-Q for March
                31,
                2005, Nicor Inc., Exhibit 10.05.)10.41
            *
            Stipulation
                and Agreement of Settlement of Shareholder Derivative Litigation
                dated as
                of February 16, 2005. (File No. 1-7297, Form 10-Q for March 31, 2005,
                Nicor Inc., Exhibit 10.06.)10.42
            *
            Final
                Judgment and Order of Dismissal dated as of March 29, 2005. (File
                No.
                1-7297 Form 10-Q for March 31, 2005, Nicor Inc., Exhibit
                10.07.)10.43
            *
            Directors
                Compensation. (File No. 1-7297, Form 8-K for September 21, 2005,
                Nicor
                Inc.)10.44
            *
            210-Day
                Credit Agreement dated as of September 13, 2005. (File No. 1-7297,
                Form
                10-Q for September 30, 2005, Nicor Inc., Exhibit
                10.02.)10.45
            *
            5-Year
                Credit Agreement dated as of September 13, 2005. (File No. 1-7297,
                Form
                10-Q for September 30, 2005, Nicor Inc., Exhibit
                10.03.)10.46
            
            First
                Amendment to the Nicor Inc. Salary Deferral Plan.10.47
            
            Change-in-Control
                Agreement, dated July 20, 2004 between Nicor Inc. and Mr. O’Connor.21.01
            
            Subsidiaries.23.01
            
            Consent
                of Independent Registered Public Accounting Firm.24.01
            
            Powers
                of Attorney.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 Securities and Exchange
                Commission as exhibits to registration statements or to other filings
                with
                the Commission 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.











82