Terra Nitrogen Co L P 10-Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2006

OR

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

For the transition period from                         to                    

Commission file number 1-10877

TERRA NITROGEN COMPANY, L.P.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)	73-1389684 (I.R.S. Employer Identification No.)
Terra Centre PO Box 6000, 600 Fourth Street Sioux City, Iowa (Address of principal executive office)	51102-6000 (Zip Code)

Registrant’s telephone number:
(712) 277-1340

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

þYesoNo

     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.

oLarge accelerated filer     þAccelerated filer     oNon-accelerated filer

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

At the close of business on September 30, 2006, there were 18,501,576 Common Units and 184,072 Class B Common Units outstanding.

TABLE OF CONTENTS

Part I — FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Consolidated Balance Sheets	3
		Consolidated Statements of Operations	4
		Consolidated Statements of Cash Flows	5
		Consolidated Statements of Partners’ Capital	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	14
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18
	Item 4.	Controls and Procedures	19
Part II — OTHER INFORMATION
	Item 1.	Legal Proceedings	20
	Item 1A.	Risk Factors	20
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20
	Item 3.	Defaults Upon Senior Securities	20
	Item 4.	Submission of Matters to a Vote of Security Holders	20
	Item 5.	Other Information	20
	Item 6.	Exhibits	21
302 Certification of Chief Executive Officer
302 Certification of Chief Financial Officer
Section 906 Certification

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TERRA NITROGEN COMPANY, L.P.

CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

	September 30,			December 31,			September 30,
	2006			2005			2005
ASSETS
Current assets:
Cash and cash equivalents	$	49,644		$	7,491		$	14,822
Demand deposits with affiliate		¾			26,505			23,805
Accounts receivable		24,861			32,088			36,131
Inventory		25,841			26,732			25,108
Prepaid insurance and other current assets		2,688			12,356			35,184
Total current assets		103,034			105,172			135,050
Property, plant and equipment, net		75,748			75,920			74,250
Other assets		16,241			10,200			11,258
Total assets	$	195,023		$	191,292		$	220,558
LIABILITIES AND PARTNERS’ CAPITAL
Current liabilities:
Accounts payable and accrued liabilities	$	34,366		$	25,113		$	43,123
Customer prepayments		14,758			31,673			17,370
Current portion of long-term debt and capital lease obligations		¾			12			28
Total current liabilities		49,124			56,798			60,521
Other long-term liabilities		308			135			174
Total liabilities		49,432			56,933			60,695
Partners’ capital:
Limited partners’ interests		162,120			150,952			164,888
General partner’s interest		(10,532	)		(10,644	)		(10,503	)
Accumulated other comprehensive income (loss)		(5,997	)		(5,949	)		5,478
Total partners’ capital		145,591			134,359			159,863
Total liabilities and partners’ capital	$	195,023		$	191,292		$	220,558

See Accompanying Notes to the Consolidated Financial Statements.

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TERRA NITROGEN COMPANY, L.P.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per unit amounts)
(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Revenues	$	91,839		$	111,462		$	306,426		$	337,175
Other		175			277			196			624
Total revenues		92,014			111,739			306,622			337,799
Cost of goods sold		76,592			92,387			272,806			267,943
Gross profit		15,422			19,352			33,816			69,856
Operating expenses		2,226			1,770			6,291			5,939
Operating income		13,196			17,582			27,525			63,917
Interest expense		(110	)		(184	)		(329	)		(598	)
Interest income		635			314			1,453			1,037
Net income	$	13,721		$	17,712		$	28,649		$	64,356
Net income allocable to limited partners’ interest	$	13,584		$	17,357		$	28,363		$	63,068
Net income per limited partnership unit	$	0.73		$	0.94		$	1.52		$	3.41

See Accompanying Notes to the Consolidated Financial Statements.

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TERRA NITROGEN COMPANY, L.P.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Nine Months Ended
	September 30,
	2006			2005
Operating activities:
Net income	$	28,649		$	64,356
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation and amortization		10,156			11,045
Gain on disposal of property, plant and equipment		(1,311	)		¾
Non-cash loss (gain) on derivative instruments		1,072			¾
Changes in operating assets and liabilities:
Receivables		7,902			(15,052	)
Inventories		891			(9,379	)
Accounts payable, accrued liabilities and customer prepayments		(5,104	)		(11,194	)
Other assets and liabilities		5,638			(19,813	)
Net cash flows from operating activities		47,893			19,963
Investing activities:
Capital expenditures		(7,597	)		(5,141	)
Plant turnaround expenditures		(9,390	)		(1,113	)
Proceeds from the sale of property, plant and equipment		2,123			4,991
Change in demand deposits with affiliate		26,505			13,272
Net cash flows from investing activities		11,641			12,009
Financing activities:
Repayment of long-term debt and capital lease obligations		(12	)		(8,235	)
Partnership distributions paid		(17,369	)		(50,030	)
Net cash flows used in financing activities		(17,381	)		(58,265	)
Net increase (decrease) in cash and cash equivalents		42,153			(26,293	)
Cash and cash equivalents at beginning of year		7,491			41,115
Cash and cash equivalents at end of period	$	49,644		$	14,822
Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	190		$	176

See Accompanying Notes to the Consolidated Financial Statements.

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TERRA NITROGEN COMPANY, L.P.

CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
(in thousands, except for units)
(unaudited)

							Accumulated
	Limited			General			Other			Total
	Partners’			Partner’s			Comprehensive			Partners’			Comprehensive
(in thousands, except for Units)	Interests			Interests			Income (Loss)			Capital			Income
Partners’ capital at January 1, 2006	$	150,952		$	(10,644	)	$	(5,949	)	$	134,359
Net income		28,363			286			¾			28,649		$	28,649
Change in fair value of derivatives		¾			¾			(48	)		(48	)		(48	)
Comprehensive income													$	28,601
Distributions		(17,195	)		(174	)		¾			(17,369	)
Partners’ capital at September 30, 2006	$	162,120		$	(10,532	)	$	(5,997	)	$	145,591
Limited partner units issued and outstanding at September 30, 2006:
Common Units								18,501,576
Class B Common Units								184,072
Total units outstanding at September 30, 2006								18,685,648

							Accumulated
	Limited			General			Other			Total
	Partners’			Partner’s			Comprehensive			Partners’			Comprehensive
(in thousands, except for Units)	Interests			Interest			Income (Loss)			Capital			Income
Partners’ capital at January 1, 2005	$	150,850		$	(10,791	)	$	(6,075	)	$	133,984
Net income		63,068			1,288			¾			64,356		$	64,356
Change in fair value of derivatives		¾			¾			11,553			11,553			11,553
Comprehensive income													$	75,909
Distributions		(49,030	)		(1,000	)		¾			(50,030	)
Partners’ capital at September 30, 2005	$	164,888		$	(10,503	)	$	5,478		$	159,863
Limited partner units issued and outstanding at September 30, 2005:
Common Units								18,501,576
Class B Common Units								184,072
Total units outstanding at September 30, 2005								18,685,648

See Accompanying Notes to the Consolidated Financial Statements.

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TERRA NITROGEN COMPANY, L.P.

Notes to Consolidated Financial Statements (Unaudited)

1.	Financial Statement Presentation
	Basis of Presentation
	The condensed consolidated financial statements contained herein should be read in conjunction with the consolidated financial statements and notes thereto contained in the Terra Nitrogen Company, L.P. (“TNCLP”) Annual Report on Form 10-K for the year ended December 31, 2005. TNCLP and its operating partnership subsidiary, Terra Nitrogen, Limited Partnership (the “Operating Partnership”), are referred to herein, collectively, as the “Partnership”.
	The accompanying unaudited condensed consolidated financial statements reflect all adjustments, which are, in the opinion of management, necessary for the fair statement of the results for the periods presented. All of these adjustments are of a normal and recurring nature. Results for the quarter are not necessarily indicative of future financial results of the Partnership.
	Derivatives and Financial Instruments
	The Partnership accounts for derivatives in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133,Accounting for Derivative Instruments and Hedging Activities,which requires that derivatives be reported on the balance sheet at fair value and, if the derivative is not designated as a hedging instrument, changes in fair value must be recognized in earnings in the period of change. If the derivative is designated as a hedge and to the extent such hedge is determined effective, changes in fair value are either (a) offset by the change in fair value of the hedged asset or liability or (b) reported as a component of accumulated other comprehensive income (loss) in the period of change, and subsequently recognized in the determination of net income in the period that the offsetting hedged transaction occurs.
	Terra Industries Inc. and its subsidiaries (“Terra”) enter into derivative instruments with counterparties for the Partnership’s operations. When Terra enters into a derivative instrument for the Partnership’s operations, the Partnership simultaneously enters into a derivative instrument with Terra as the counterparty. The terms of the derivative instruments between the Partnership and Terra are identical to the terms of the derivative instruments between Terra and Terra’s counterparty. The types of derivative instruments entered into include future contracts, swap agreements, put and call options to cap or fix prices for a portion of the Partnership’s natural gas production requirements. Terra may also enter into similar derivative instruments to fix or set floor prices for a portion of the Partnership’s nitrogen sales volumes.
	Revenue Recognition
	Revenue is recognized when persuasive evidence of a transaction exists, delivery has occurred, the price is fixed or determinable, no obligations remain and collectibility is probable. The Partnership classifies any discounts and trade allowances as a reduction in revenue. Gains or

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losses associated with settled nitrogen derivative contracts are classified as revenue. The Partnership classifies amounts paid by customers for shipping and handling as revenue.

Cost of Sales

The cost of manufacturing fertilizer products is recorded when the fertilizer products are sold and revenue is recognized. The Partnership classifies amounts paid by customers for shipping and handling as cost of sales. Premiums paid for option contracts are deferred and recognized in cost of sales in the month to which the related derivative transactions are settled. Realized gains and losses on derivatives activities are recognized in cost of sales.

Inventories

Inventories are stated at the lower of average cost or estimated net realizable value. The Partnership performs a monthly analysis of its inventory balances to determine if the carrying amount of inventories exceeds its net realizable value. The analysis of estimated realizable value is based on customer orders, market trends and historical pricing. If the carrying amount exceeds the estimated net realizable value, the carrying amount is reduced to the estimated net realizable value.

Production costs include the cost of direct labor and materials, depreciation and amortization, and overhead costs related to manufacturing activities. The cost of inventories is determined using the first-in, first-out method.

Impairment of Long-Lived Assets

The Partnership reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the undiscounted future cash flows expected to result from the use of the asset is less than the carrying amount of the asset, an impairment loss is recognized based on the difference between the carrying amount and the fair value of the asset.

Natural Gas Futures, Swaps, Options and Basis Swaps

The estimated fair value of each class of derivatives is based on published referenced prices and quoted market prices from brokers.

Cash and Cash Equivalents

The Partnership classifies cash and short-term investments with an original maturity of three months or less as cash and cash equivalents. Demand deposits with affiliate are not classified in cash and cash equivalents.

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	Demand Deposits with Affiliate
	The Partnership has an arrangement for demand deposits with an affiliate to allow for excess Partnership cash to be deposited with Terra Capital, Inc. (“Terra Capital”), the indirect parent of the General Partner. Excess Partnership cash is received by Terra Capital and earns interest until the funds can be transferred to Partnership accounts for disbursements. Cash balances are transferred to the Partnership from Terra Capital on a weekly basis. Amounts on deposit with Terra Capital earn interest at the rate that Terra Capital receives on its pooled cash investments. The Partnership believes that Terra Capital and its parent, Terra Industries Inc., have sufficient credit available under its existing borrowing agreements combined with cash on hand to fully fund all obligations to the Partnership, upon request. However, the Partnership does have credit risks with deposits held by Terra Capital in the event of bankruptcy by Terra or its subsidiaries. The Partnership may be unable to obtain its funds on demand in such a situation.
	During the 2005 fourth quarter, the Partnership changed its accounting policy concerning classification of cash deposited with Terra Capital. The new policy results in the reclassification of deposits with Terra Capital from “cash and cash equivalents” to “demand deposits with affiliate” on the balance sheet and cash flows arising from deposits in and withdrawals from such demand deposits as a cash flows from investing activities. For the September 30, 2005 balance sheet, the Partnership has reclassified $23.8 million of demand deposits with affiliate that was presented as cash and cash equivalents in the original Form 10-Q filed on November 10, 2005. In connection with this balance sheet reclassification, the Partnership reclassified the cash and cash equivalent balance and included the $13.3 million investing activity effect of such reclassification in its September 30, 2005 statement of cash flows. There was no impact to Partners’ capital or net income as a result of this change.
	The Partnership believes that presenting the related party deposits in a separate balance sheet caption and presenting related party deposits and withdrawals as an investing activity in the statement of cash flows is preferable because the separate presentation (1) is more consistent with the nature of the deposit, which is subject to credit risk and is not a deposit in a financial institution and (2) more clearly presents the related party nature of the cash management arrangement with Terra Capital.
	Although none of the agreements or conditions governing these deposits has changed, the Partnership has elected to change the presentation of such deposits to show them as a separate current asset and not as a cash equivalent. The Partnership continues to have the contractual right to withdraw these funds on demand and continues to have the ability to access funds deposited in these accounts on a daily basis. The Partnership may terminate such cash management arrangement at any time.
	Use of Estimates in Preparation of the Financial Statements
	The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2.	Agreement of Limited Partnership

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	The Partnership makes quarterly cash distributions to Unitholders and the General Partner in an amount equal to 100% of its “Available Cash” as defined in the Partnership Agreement.
	In the first nine months of 2006, the Partnership paid $17.4 million in cash distributions to its partners. In the first nine months of 2005 the Partnership paid $50.0 million in cash distributions to its partners.
	At September 30, 2006, the General Partner and its affiliates owned 75.3% of the Partnership’s outstanding units. When less than 25% of the issued and outstanding units are held by non-affiliates of the General Partner, the Partnership, at the General Partner’s sole discretion, may call, or assign to the General Partner or its affiliates, its right to acquire all such outstanding units held by non-affiliated persons. If the General Partner elects to acquire all outstanding units, the Partnership is required to give at least 30 but not more than 60 days’ notice of its decision to purchase the outstanding units. The purchase price per unit will be the greater of 1) the average of the previous 20 trading days’ closing prices as of the date five days before the purchase is announced and 2) the highest price paid by the General Partner or any of its affiliates for any unit within the 90 days preceding the date the purchase is announced. Additional purchases of common units by the General Partner may be restricted under the terms of Terra’s bank credit agreement as described therein.
3.	Net Income per Limited Partnership Unit
	Basic income per unit data is based on the weighted-average number of Partnership Units outstanding during the period. Diluted income per unit data is based on the weighted-average number of Partnership Units outstanding and the effect of all dilutive potential common units.
	The following table provides the components of basic income per unit for the three- and nine-month periods ended September 30, 2006 and 2005:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands, except per-share amounts)	2006		2005		2006		2005
Basic income per limited Partnership unit computation:
Net income allocable to limited Partners’ interest	$	13,584	$	17,357	$	28,363	$	63,068
Weighted average units outstanding		18,686		18,562		18,686		18,502
Net income per limited Partnership unit	$	0.73	$	0.94	$	1.52	$	3.41

	There were no dilutive Partnership units outstanding for the three- and nine-month periods ended September 30, 2006 and 2005.
4.	Inventories
	Inventories consisted of the following:

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	September 30,		December 31,		September 30,
(in thousands)	2006		2005		2005
Materials and supplies	$	9,625	$	7,287	$	6,361
Finished goods		16,216		19,445		18,747
Total	$	25,841	$	26,732	$	25,108

	Inventory is valued at actual first in, first out cost. Costs include raw material, labor and overhead.
5.	Derivative Financial Instruments
	The Partnership manages risk using derivative financial instruments for changes in natural gas supply prices and changes in nitrogen prices. Derivative financial instruments have credit risk and market risk.
	Terra enters into derivative instruments with counterparties for the Partnership’s operations. When Terra enters into a derivative instrument for the Partnership’s operations, the Partnership simultaneously enters into a derivative instrument with Terra as the counterparty. The terms of the derivative instruments between the Partnership and Terra are identical to the terms of the derivative instruments between Terra and Terra’s counterparty. Terra will not enter into transactions with a counterparty if the additional transaction will result in credit exposure exceeding $20 million. The credit rating of counterparties may be modified through guarantees, letters of credit or other credit enhancement vehicles.
	The Partnership classifies a derivative financial instrument as a hedge if all of the following conditions are met:

1.	The item to be hedged must expose the Partnership to currency or price risk.
2.	It must be probable that the results of the hedge position substantially offset the effects of currency or price changes on the hedged item (e.g., there is a high correlation between the hedge position and changes in market value of the hedge item).
3.	The derivative financial instrument must be designated as a hedge of the item at the inception of the hedge.

Natural gas supplies to meet production requirements at the Partnership’s production facilities are purchased at market prices. Natural gas market prices are volatile and the Partnership effectively hedges a portion of its natural gas production requirements and inventory through the use of futures contracts, swaps and options. These contracts reference physical natural gas prices or approximate NYMEX futures contract prices. Contract physical prices are frequently based on prices at the Henry Hub in Louisiana, the most common and financially liquid location of reference for financial derivatives related to natural gas. However, natural gas supplies for the Partnership’s production facilities are purchased at locations other than Henry Hub, which often creates a location basis differential between the contract price and the physical price of natural gas. Accordingly, the use of financial derivatives may not exactly offset the changes in the price of physical gas. The contracts are traded in months forward and settlement dates are scheduled to coincide with gas purchases during that future period.

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A swap is a contract between the Partnership and a third party to exchange cash based on a designated price. Option contracts give the holder the right to either own or sell a futures or swap contract. The futures contracts require maintenance of cash balances generally 10% to 20% of the contract value and option contracts require initial premium payments ranging from 2% to 5% of contract value. Basis swap contracts require payments to or from the Partnership for the amount, if any, that monthly published gas prices from the source specified in the contract differ from the prices of a NYMEX natural gas futures during a specified period. There are no initial cash requirements related to the swap and basis swap agreements.

The following summarizes the position of open natural gas derivative contracts at September 30, 2006, December 31, 2005 and September 30, 2005:

	Other		Accrued
	Current		Current			Net
(in thousands)	Assets		Liabilities			Asset (Liability)
September 30, 2006	$	1,868	$	(8,938	)	$	(7,070	)
December 31, 2005		6,809		(13,801	)		(6,992	)
September 30, 2005		31,451		(25,504	)		5,947

Certain derivatives outstanding at September 30, 2006 and 2005, which settled during October 2006 and 2005, respectively, are included in the position of open natural gas derivatives in the table above. The October 2006 derivatives settled for an approximate $6.1 million loss. All open derivatives will settle during the next 12 months.

At September 30, 2006, the Partnership determined that certain derivative contracts were ineffective hedges for accounting purposes and recorded a charge of $0.8 million and $1.1 million to cost of sales for the three- and nine-month periods ending September 30, 2006, respectively. Derivatives outstanding at September 30, 2005 included gains of $0.2 million and $0.5 million that were recorded as an ineffective position and credited to cost of sales for the three- and nine-month periods ending September 30, 2005, respectively.

The effective portion of gains and losses on settlement of these contracts that qualify for hedge treatment are carried as accumulated other comprehensive income (loss) and are credited or charged to cost of sales in the month in which the hedged transaction settles. Gains and losses on the contracts that do not qualify for hedge treatment are credited or charged to cost of sales based on the positions’ fair value. The risk and reward of outstanding natural gas positions are directly related to increases or decreases in natural gas prices in relation to the underlying NYMEX natural gas contract prices.

The activity related to accumulated other comprehensive income (loss) for the nine month periods ended September 30, 2006 and 2005 is:

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(in thousands)	2006			2005
Beginning accumulated (loss)	$	(5,949	)	$	(6,075	)
Reclassification into earnings		22,402			(2,888	)
Net change associated with current period hedging transactions		(22,450	)		14,441
Ending accumulated gain (loss)	$	(5,997	)	$	5,478

	Approximately $6.0 million of the accumulated other comprehensive loss at September 30, 2006 will be reclassified into earning during the next twelve-month period ending September 30, 2007.
	At times, the Partnership also uses forward derivative instruments to fix or set floor prices for a portion of its nitrogen sales volumes. At September 30, 2006, the Partnership had no open contracts covering nitrogen solutions. When outstanding, the nitrogen solution contracts do not qualify for hedge treatment due to inadequate trading history to demonstrate effectiveness. Consequently, these contracts are marked-to-market and unrealized gains or losses are reflected in revenue in the statement of operations. For the three- and nine-month periods ending September 30, 2006, there were no gains or losses on nitrogen forward derivative instruments. For the three- and nine-month periods ending September 30, 2005, approximately $0.2 million and $1.7 million of losses, respectively, were recognized on nitrogen forward derivative instruments.
6.	Long-Term Debt
	On December 21, 2004, the Partnership entered into a $50.0 million revolving bank credit facility that expires in June 2008 and bears interest at a variable rate plus a margin (London Interbank Offer Rate (LIBOR) plus 175 basis points, or 7.07% at September 30, 2006). Under the credit facility, the Partnership may borrow an amount generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible finished goods inventory, less outstanding letters of credit. The Partnership’s borrowings under the credit facility are secured by substantially all of its working capital. The agreement also requires the Partnership to adhere to certain limitations on additional debt, capital expenditures, acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changes in lines of business and transactions with affiliates. At September 30, 2006, the Partnership had $50.0 million of borrowing availability, and, there were no outstanding borrowings or letters of credit under the facility.
7.	New Accounting Pronouncements
	In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) 157,“Fair Value Measurements”(SFAS 157). SFAS 157 is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by generally accepted accounting principles (GAAP); it does not create or modify any current GAAP requirements to apply fair value accounting. SFAS 157 provides a single definition for fair value that is to be applied consistently for all accounting applications, and also generally describes and prioritizes according to reliability the methods and inputs used in valuations. SFAS 157 prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are not already specified elsewhere in GAAP. The new measurement and disclosure requirements of SFAS 157 are effective for the Company in the first quarter of 2008. The Company expects no significant impact from adopting the Standard.

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In September 2006, the SEC issued Staff Accounting Bulletin 108,“Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both an income statement and balance sheet approach and then evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior year’s financial statements are not restated, the cumulative effect adjustment is recorded in opening Partners’ Capital as of the beginning of fiscal year of adoption. SAB 108 is effective for the Partnership at the end of 2006. The Partnership is currently assessing the impact the adoption of SAB 108 will have on its Consolidated Financial Statements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The Partnership produces and markets nitrogen products for use in agricultural and industrial markets. Nitrogen is a commodity chemical and prices are established based on global supply and demand conditions. The nitrogen products industry has cycles of oversupply, resulting in lower prices and idled capacity, followed by supply shortages, resulting in high selling prices and higher industry-wide production rates. To be viable under these market conditions, a producer must be among the low-cost producers to markets it serves and have a financial position that can sustain it during periods of oversupply.

Natural gas is the most significant raw material in the production of nitrogen products. During the third quarter of 2005, the cost of natural gas had increased to unprecedented levels due to supply disruptions caused by Hurricanes Katrina and Rita. During 2006, the cost of natural gas has declined.

Imports, most of which are produced at facilities with access to fixed-price natural gas supplies, account for a significant portion of U.S. nitrogen product supply. Imported products’ natural gas costs have been and could continue to be substantially lower than the delivered cost of natural gas to the Partnership’s facilities. Offshore producers are most competitive in regions close to the point of entry for imports, including the Gulf Coast and East Coast.

The Partnership’s sales volumes are primarily dependent upon the operating rates for its plants. The Partnership may purchase product from other manufacturers or importers for resale, however, historic gross margins on those volumes are rarely significant. Profitability and cash flows from the operations are affected by the ability to manage costs and expenses (other than natural gas), most of which do not materially change for different levels of production or sales. Other factors affecting operating results include the level of planted acres, transportation costs, weather conditions (particularly during the planting season), grain prices and other variables described in Item 1 “Business” and Item 2 “Properties” sections of the Partnership’s most recent Form 10-K filing with the Securities and Exchange Commission.

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Dependence on Terra Industries

The Partnership is dependent on Terra Industries Inc. (“Terra”) in a number of respects. Terra provides all of the Partnership’s management, natural gas purchasing and hedging, selling and administrative services and operates its facilities through its wholly-owned subsidiary Terra Nitrogen GP Inc., the Partnership’s General Partner. Terra and its wholly-owned subsidiaries have more debt and debt service requirements than the Partnership. Although Terra is affected by most of the factors that affect the Partnership, its higher level of debt could put a greater risk on Terra in the event of adverse business conditions. The Partnership’s results of operations and financial condition might be materially adversely affected by financial difficulties at Terra, default by it or its subsidiaries on their debt or their bankruptcy. For additional information concerning Terra, refer to Terra’s filings with the Securities and Exchange Commission on Form 10-K, Forms 10-Q and current reports on Form 8-K.

Three months ended September 30, 2006 compared with
three months ended September 30, 2005

Volumes and prices for the three-month periods ended September 30, 2006 and 2005 are:

	2006				2005
	Volumes		Unit Price		Volumes		Unit Price
	(000 tons)		($/ton)*		(000 tons)		($/ton)*
Ammonia		49	$	301		45	$	329
UAN		522	$	125		578	$	150

* After deducting outbound freight costs

Revenues for the 2006 third quarter were $91.8 million, compared to $111.5 million for the 2005 third quarter. The $19.6 million, or 18%, decrease in revenues was primarily due to a 10% decrease in UAN sales volumes, a 9% decrease in ammonia prices and a 17% decrease in UAN prices. The UAN sales volumes decreased 10% due to lower market demand. The decrease in ammonia and UAN prices is due to the current market demand, which is affected by the decrease in the primary raw material cost of natural gas in the 2006 third quarter as compared to the 2005 third quarter.

The 2006 third quarter gross profit was $15.4 million, which was $3.9 million less than the 2005 third quarter. Approximately $14.4 million of the gross profit decline was due to lower average selling prices. Decreased sales volumes reduced 2006 third quarter gross profit by approximately $1.6 million as compared to the 2005 third quarter. The 2006 third quarter natural gas costs decreased $10.8 million from the 2005 third quarter. The $10.8 million decrease in natural gas costs includes the effects of forward price contracts that increased 2006 third quarter natural gas costs $0.9 million. The 2006 third quarter gross profit includes a $1.3 million gain on disposal of the Blytheville urea plant.

Nine months ended September 30, 2006 compared with
nine months ended September 30, 2005

Volumes and prices for the nine-month periods ended September 30, 2006 and 2005 follow:

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	2006				2005
	Volumes		Unit Price		Volumes		Unit Price
	(000 tons)		($/ton)*		(000 tons)		($/ton)*
Ammonia		168	$	367		207	$	310
UAN		1,521	$	139		1,655	$	148

* After deducting outbound freight costs

Revenues for the nine months ended September 30, 2006 declined $30.7 million, or 9%, compared with the same 2005 period primarily due to lower sales volumes, offset by increased ammonia prices. Price increases reflected increased manufacturing costs, primarily related to natural gas, and higher imported product costs as the result of increased international freight rates. However, the price increases and decrease in acres of corn planted have caused the Partnership’s customers to reduce 2006 ammonia and UAN demand from prior years.

The gross profit for the first nine months of 2006 was $33.8 million and was $36.0 million less than the gross profit of $69.9 million in the 2005 first nine months. The $36.0 million decrease in gross profit in 2006, as compared to 2005, was primarily due to higher natural gas costs of $22.9 million, lower sales volumes of $7.0 million and lower unit prices of $3.2 million, partially offset by a $1.3 million gain on the disposal of the Blytheville urea plant. The $22.9 million increase in natural gas costs includes the effects of forward price contracts that increased the 2006 natural gas costs by $22.4 million higher than natural gas spot prices.

Capital resources and liquidity

Operating activities for the first nine months of 2006 generated $47.9 million of cash, comprised of $38.6 million of cash from operations and $9.3 million from changes in current assets and liabilities. Cash from changes in current assets and liabilities represent seasonal fluctuations to working capital balances and included $7.2 reduction to accounts receivable balances during the period.

Capital expenditures of $7.6 million during the first nine months of 2006 were primarily to fund replacement and stay-in-business additions to plant and equipment. Plant turnaround expenditures of $9.4 million were primarily to fund the 2006 third quarter turnaround. During the 2006 third quarter, the Partnership sold the Blytheville urea plant for $2.8 million; proceeds of $2.1 million have been collected and $0.7 million has been recorded as a receivable.

The Partnership’s principal funding needs are to support its working capital and capital expenditures. The Partnership intends to fund its needs primarily from cash provided by operating activities and, to the extent required, from funds borrowed under the Partnership’s $50 million revolving bank credit facility.

Under the credit facility, the Partnership may borrow an amount generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible finished goods inventory, less outstanding letters of credit. The Partnership’s borrowings under the credit facility are secured by substantially all of its working capital. At September 30, 2006, the Partnership had borrowing availability of $50 million and had no outstanding borrowings or letters of credit under the facility. Management expects the facility to be adequate to meet the Partnership’s operating cash needs.

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Under the credit facility, the Partnership is subject to the covenants which impose certain limitations on additional debt, capital expenditures, acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changes in lines of business and transactions with affiliates. In addition, if the Partnership’s aggregate borrowing availability falls below $10 million, it is required to have generated $25 million of operating cash flows or earnings before interest, income taxes, depreciation, amortization and other non-cash items as defined in the credit facility for the preceding four quarters. The Partnership is also required to maintain a minimum aggregate unused borrowing availability of $5 million at all times.

The Partnership’s ability to continue to meet the covenants under the credit facility in the future will depend on market conditions, operating cash flows, working capital needs, receipt of customer prepayments and trade credit terms. Failure to meet these covenants, or to obtain a waiver from the lenders, would result in a default by the Partnership such that all outstanding amounts could become immediately due and payable and the Partnership would be unable to borrow additional amounts under the credit facility. Because access to adequate bank facilities may be critical to funding the Partnership’s operating cash needs and purchase of financial derivatives to manage the Partnership’s exposure to natural gas commodity price risk, any default or termination of the revolving bank credit facility could have a material adverse effect on the Partnership.

Quarterly distributions to the partners are based on Available Cash for the quarter as defined in the Partnership Agreement. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. Distributions paid to the partners for the nine-month periods ended September 30, 2006 and 2005 were $17.4 million and $50.0 million, respectively.

The Partnership has an arrangement for demand deposits with an affiliate to allow for excess Partnership cash to be deposited with Terra Capital, Inc. (“Terra Capital”), the indirect parent of the General Partner. Excess Partnership cash is received by Terra Capital and earns interest until the funds can be transferred to Partnership accounts for disbursements. Cash balances are transferred to the Partnership from Terra Capital on a weekly basis. Amounts on deposit with Terra Capital earn interest at the rate that Terra Capital receives on its pooled cash investments. The Partnership believes that Terra Capital and its parent, Terra Industries Inc., have sufficient credit available under its existing borrowing agreements combined with cash on hand to fully fund all obligations to the Partnership, upon request. However, the Partnership does have credit risks with deposits held by Terra Capital in the event of bankruptcy by Terra or its subsidiaries. The Partnership may be unable to obtain its funds on demand in such a situation.

During the 2005 fourth quarter, the Partnership changed its accounting policy concerning classification of cash deposited with Terra Capital. The new policy results in the reclassification of deposits with Terra Capital from “cash and cash equivalents” to “demand deposits with affiliate” on the balance sheet and cash flows arising from deposits in and withdrawals from such demand deposits as a cash flows from investing activities. For the September 30, 2005 balance sheet, the Partnership has reclassified $23.8 million of demand deposits with affiliate that was presented as cash and cash equivalents in the original Form 10-Q filed on November 10, 2005. In connection with this balance sheet reclassification, the Partnership reclassified the cash and cash equivalent balance and included the $13.3 million investing activity effect of such reclassification in its September 30, 2005 statement of cash flows. There was no impact to Partners’ capital or net income as a result of this change.

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The Partnership believes that presenting the related party deposits in a separate balance sheet caption and presenting related party deposits and withdrawals as an investing activity in the statement of cash flows is preferable because the separate presentation (1) is more consistent with the nature of the deposit, which is subject to credit risk and is not a deposit in a financial institution and (2) more clearly presents the related party nature of the cash management arrangement with Terra Capital.

Although none of the agreements or conditions governing these deposits has changed, the Partnership has elected to change the presentation of such deposits to show them as a separate current asset and not as a cash equivalent. The Partnership continues to have the contractual right to withdraw these funds on demand and continues to have the ability to access funds deposited in these accounts on a daily basis. The Partnership may terminate such cash management arrangement at any time.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Partnership’s operations are significantly affected by the price of natural gas. It employs derivative commodity instruments related to a portion of its natural gas requirements (primarily futures, swaps and options) for the purpose of managing exposure to commodity price risk in the purchase of natural gas. Changes in the market value of these derivative instruments are expected to have a high correlation to changes in the spot price of natural gas. For more information about how the Partnership manages specific risk exposures, refer to its most recent Annual Report on Form 10-K (which is on file with the Securities and Exchange Commission), Item 7A “Quantitative and Qualitative Disclosures about Market Risk” and Note 6 – Derivative Financial Instruments contained in Item 8.

The volume of natural gas hedged varies from time to time based on management’s judgment of market conditions, particularly natural gas prices and prices for nitrogen products. Contracts were in place at September 30, 2006 to cover approximately 18% of its natural gas requirements for the succeeding twelve months. The General Partner’s ability to manage the Partnership’s exposure to commodity price risk in the purchase of natural gas through the use of financial derivatives may be affected by limitations imposed by its bank agreement covenants.

ITEM 4. CONTROLS AND PROCEDURES

The Partnership’s Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this report, that the Partnership’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Partnership files or submits under the Securities Exchange Act of 1934 is recorded, processed,

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summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There were no significant changes in the Partnerships’ internal control over financial reporting that occurred during the most recent quarter that have materially affected, or are reasonably likely to materially affect, the Partnerships’ internal control over financial reporting.

FORWARD LOOKING PRECAUTIONS

Information contained in this report, other than historical information, may be considered forward looking. Forward-looking information reflects management’s current views of future events and financial performance that involve a number of risks and uncertainties. The factors that could cause actual results to differ materially include, but are not limited to the following: changes in the financial markets, general economic conditions within the agricultural industry, competitive factors and price changes (principally, sales prices of nitrogen products and natural gas costs), changes in product mix, changes in the seasonality of demand patterns, changes in weather conditions, changes in agricultural regulations, and other risks detailed in the Partnership’s Securities and Exchange Commission filings, in particular Item 1A “Risk Factors” and the “Factors that Affect Operating Results” section of its most recent Form 10-K.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Partnership is involved in various claims and legal actions arising in the ordinary course of business, including employee injury claims. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Partnership’s consolidated financial position, results of operations or liquidity and the likelihood that a loss contingency will occur in connection with these claims is remote.

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ITEM 1A. RISK FACTORS

There were no significant changes in the Partnership’s risk factors during 2006 as compared to the risk factors identified in the Partnership’s 2005 Form 10-K.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

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ITEM 6. EXHIBITS

     (a) Exhibits:

Exhibits *31.1	Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibits *31.2	Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit *32	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* filed herewith

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SIGNATURE

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

TERRA NITROGEN COMPANY, L.P.
By:	TERRA NITROGEN GP INC. as General Partner
By:	/s/ Francis G. MeyerFrancis G. Meyer
	Vice President (Principal Accounting Officer)

Date: November 1, 2006

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