Terra Nitrogen Co L P 10-Q 2007 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, 2007

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	73-1389684
(State or other jurisdiction of incorporation or organization)	(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.
þ Yeso No

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

o Large accelerated filer        þ Accelerated filer     o Non-accelerated filer

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

At the close of business on October 23, 2007 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	15
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	19
	Item 4.	Controls and Procedures	20
Part II – OTHER INFORMATION
	Item 1.	Legal Proceedings	21
	Item 1A.	Risk Factors	21
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
	Item 3.	Defaults upon Senior Securities	21
	Item 4.	Submission of Matters to a Vote of Security Holders	21
	Item 5.	Other Information	21
	Item 6.	Exhibits	22
Exhibit 10.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32

2

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,
	2007			2006			2006
ASSETS
Current assets:
Cash and cash equivalents	$	93,549		$	62,287		$	49,644
Demand deposits with affiliate		¾			2,457			¾
Accounts receivable		40,174			37,676			24,861
Inventory		30,487			22,709			25,841
Prepaid expenses and other current assets		3,747			3,334			2,688
Total current assets		167,957			128,463			103,034
Property, plant and equipment, net		72,413			74,096			75,748
Other assets		24,975			15,655			16,241
Total assets	$	265,345		$	218,214		$	195,023
LIABILITIES AND PARTNERS’ CAPITAL
Current liabilities:
Accounts payable and accrued liabilities	$	52,012		$	38,342		$	34,366
Customer prepayments		39,762			35,326			14,758
Total current liabilities		91,774			73,668			49,124
Other long-term liabilities		1,979			474			308
Total liabilities		93,753			74,142			49,432
Partners’ capital:
Limited partners’ interests, 18,502 Common Units and 184 Class B Common Units authorized and outstanding		193,869			160,795			162,120
General partner’s interest, 5 Master Limited Partner Units authorized and outstanding		(10,209	)		(10,544	)		(10,532	)
Accumulated other comprehensive loss		(12,068	)		(6,179	)		(5,997	)
Total partners’ capital		171,592			144,072			145,591
Total liabilities and partners’ capital	$	265,345		$	218,214		$	195,023

See Accompanying Notes to the Consolidated Financial Statements.

3

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,
	2007			2006			2007			2006
Revenues	$	133,009		$	91,839		$	438,019		$	306,426
Other		142			175			729			196
Total revenues		133,151			92,014			438,748			306,622
Cost of goods sold		86,490			76,592			291,371			272,806
Gross profit		46,661			15,422			147,377			33,816
Operating expenses		2,452			2,226			13,100			6,291
Operating income		44,209			13,196			134,277			27,525
Interest expense		(115	)		(110	)		(341	)		(329	)
Interest income		1,517			635			4,062			1,453
Net income	$	45,611		$	13,721		$	137,998		$	28,649
Net income allocable to limited partners’ interest	$	45,155		$	13,584		$	136,618		$	28,363
Net income per limited partnership unit	$	2.42		$	0.73		$	7.31		$	1.52

See Accompanying Notes to the Consolidated Financial Statements.

4

TERRA NITROGEN COMPANY, L.P.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended
	September 30,
	2007			2006
Operating activities:
Net income	$	137,998			28,649
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation and amortization		11,976			10,156
Gain on disposal of property, plant and equipment		¾			(1,311	)
Non-cash loss on derivative instruments		362			1,072
Changes in operating assets and liabilities:
Receivables		(2,498	)		7,902
Inventories		(7,778	)		891
Accounts payable, accrued liabilities and customer prepayments		12,116			(5,104	)
Other assets and liabilities		(259	)		5,638
Net cash flows from operating activities		151,917			47,893
Investing activities:
Capital expenditures		(5,379	)		(7,597	)
Plant turnaround expenditures		(13,144	)		(9,390	)
Proceeds from the sale of property, plant and equipment		¾			2,123
Change in demand deposits with affiliate		2,457			26,505
Net cash flows from investing activities		(16,066	)		11,641
Financing activities:
Partnership distributions paid		(104,589	)		(17,369	)
Repayment of long-term debt and capital lease obligations		¾			(12	)
Net cash flows used in financing activities		(104,589	)		(17,381	)
Net increase in cash and cash equivalents		31,262			42,153
Cash and cash equivalents at beginning of year		62,287			7,491
Cash and cash equivalents at end of period	$	93,549		$	49,644
Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	64		$	190

See Accompanying Notes to the Consolidated Financial Statements.

5

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, 2007	$	160,795		$	(10,544	)	$	(6,179	)	$	144,072
Net income		136,618			1,380			¾			137,998		$	137,998
Change in fair value of derivatives		¾			¾			(5,889	)		(5,889	)		(5,889	)
Comprehensive income													$	132,109
Distributions		(103,544	)		(1,045	)		¾			(104,589	)
Partners’ capital at September 30 ,2007	$	193,869		$	(10,209	)	$	(12,068	)	$	171,592
Limited partner units issued and outstanding at September 30, 2007:
Common Units								18,501,576
Class B Common Units								184,072
Total units outstanding at September 30, 2007								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, 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 September 30, 2006:
Common Units								18,501,576
Class B Common Units								184,072
Total units outstanding at September 30, 2006								18,685,648

See Accompanying Notes to the Consolidated Financial Statements.

6

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, 2006. 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 futures 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 losses associated with settled nitrogen derivative contracts are classified as revenue. The Partnership classifies amounts directly or indirectly billed to its customers for shipping and handling as revenue.

7

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 directly or indirectly billed for delivery of products to its customers or its terminals 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.

The Partnership estimates a reserve for obsolescence and excess of its materials and supplies inventory. Inventory is stated net of the reserve.

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.

8

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.

Demand Deposits with Affiliate

Partnership cash receipts are generally received by Terra Capital, Inc., (“Terra Capital”) the indirect parent of the General Partner. Cash receipts, net of cash payments made by Terra Capital, are transferred to the Partnership from Terra Capital on a weekly basis. As a result of this cash collection and distribution arrangement, Terra Capital is a creditor to the Partnership.

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

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 Agreement of Limited Partnership. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves that the General Partner reasonably determines necessary.

The Limited Partners receive 99% of the Available Cash and 1% is distributed to the General Partner, except when cumulative distributions of Available Cash exceed specified target levels above the Minimum Quarterly Distribution (“MQD”) of $0.605 per unit. Under such circumstances, the General Partner is entitled, as an incentive, to larger percentage interests. As of September 30, 2007, the cumulative shortfall on quarterly distributions to holders of Common Units that must be paid before the General Partner receives an incentive payment was $152.9 million, or $8.18 per unit.

When cumulative distributions of Available Cash exceed specified target levels above the MQD, the General Partner’s percentage interest in the Partnership’s distributions of Available Cash at various levels follows:

Incremental Distribution	Percentage of Incremental Distribution
per Common Unit	to General Partner
Less than $0.715	1%
$0.715-$0.825	15%
$0.825-$1.045	25%
Greater than $1.045	50%

9

On October 25, 2007, the Partnership announced a $2.10 per unit distribution to be paid during the 2007 fourth quarter. As a result of this distribution, the pro forma cumulative shortfall that must be paid before the General Partner affiliate receives an incentive payment as of December 31, 2007 is anticipated to be approximately $125.0 million, or $6.69 per unit.

The General Partner is required to remit the majority of cash distributions it receives from the Partnership in excess of its one percent Partnership equity interest to an affiliated company.

In the first nine months of 2007, the Partnership paid $104.6 million in cash distributions to its partners. In the first nine months of 2006 the Partnership paid $17.4 million in cash distributions to its partners.

At September 30, 2007, 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, 2007 and 2006:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands, except per-unit amounts)	2007		2006		2007		2006
Basic income (loss) per limited Partnership unit computation:
Net income allocable to limited Partners’ interest	$	45,155	$	13,584	$	136,618	$	28,363
Weighted average units outstanding		18,686		18,686		18,686		18,686
Net income per limited Partnership unit	$	2.42	$	0.73	$	7.31	$	1.52

There were no dilutive Partnership units outstanding for the three- and nine-month periods ended September 30, 2007 and 2006.

10

4.      Inventories

Inventories consisted of the following:

	September 30,		December 31,		September 30,
(in thousands)	2007		2006		2006
Materials and supplies	$	7,737	$	7,925	$	9,625
Finished goods		22,750		14,784		16,216
Total	$	30,487	$	22,709	$	25,841

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.

11

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, 2007, December 31, 2006 and September 30, 2006:

	Other		Accrued
	Current		Current			Net
(in thousands)	Assets		Liabilities			Asset (Liability)
September 30, 2007	$	2,867	$	(14,041	)	$	(11,174	)
December 31, 2006		1,529		(8,052	)		(6,523	)
September 30, 2006		1,868		(8,938	)		(7,070	)

Certain derivatives outstanding at September 30, 2007 and 2006, which settled during October 2007 and 2006, respectively, are included in the position of open natural gas derivatives in the table above. The October 2007 derivatives settled for an approximate $4.0 million loss. All open derivatives will settle during the next 12 months.

At September 30, 2007, the Partnership determined that certain derivative contracts were ineffective hedges for accounting purposes and recorded a credit of $0.2 million and $1.2 million to cost of sales for the three- and nine-month periods ending September 30, 2007, respectively. Derivatives outstanding at September 30, 2006 included a charge of $0.7 million and a credit of $0.2 million to cost of sales for the three- and nine-month periods ending September 30, 2006.

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.

12

The activity related to accumulated other comprehensive income (loss) for the nine month periods ended September 30, 2007 and 2006 is:

(in thousands)	2007			2006
Beginning accumulated (loss)	$	(6,179	)	$	(5,949	)
Reclassification into earnings		13,160			22,235
Net change associated with current period hedging transactions		(19,049	)		(22,283	)
Ending accumulated loss	$	(12,068	)	$	(5,997	)

All of the accumulated loss recorded above will be reclassified into earnings during the next twelve-month period ending September 30, 2008.

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, 2007, the Partnership had 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, 2007, the Partnership recognized a loss of $0.7 million and $2.6 million, respectively, on nitrogen forward derivative instruments. For the three-and nine-month periods ending September 30, 2006, there were no gains or losses on nitrogen forward derivative instruments.

6.      Revolving Credit Facility

In the first quarter of 2007, the Partnership amended the $50.0 million revolving credit facility to extend the expiration date to January 31, 2012. The revolving credit facility bears interest at a variable rate plus a margin (London Interbank Offer Rate (LIBOR) plus 175 basis points, or 6.88% at September 30, 2007). 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, 2007, 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 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 input 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 Partnership in 2008 first quarter and the Partnership expects no significant impact from adopting the Standard.

13

In February 2007 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 159,The Fair Value Option for Financial Assets and Financial Liabilities(SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. SFAS 159 is effective for the Partnership beginning in the first quarter of 2008. The Partnership is currently assessing the impact SFAS 159 may have on its financial statements.

14

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. Natural gas is the most significant raw material in the production of nitrogen products. 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.

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 Verdigris plant. 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.

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.

15

Three months ended September 30, 2007 compared with
three months ended September 30, 2006

Volumes and prices for the three-month periods ended September 30, 2007 and 2006 are:

	2007				2006
	Volumes		Unit Price		Volumes		Unit Price
	(000 tons)		($/ton)*		(000 tons)		($/ton)*
Ammonia		57	$	367		49	$	301
UAN		493	$	204		522	$	125

*After deducting outbound freight costs

Revenues for the 2007 third quarter were $133.0 million, compared to $91.8 million for the 2006 third quarter. The $41.2 million, or 45%, increase in revenues was primarily due to an increase in ammonia sales volumes and price of 16% and 22%, respectively, and a 63% increase in UAN prices. The higher prices and ammonia volumes result from increased and earlier demand for nitrogen products for corn and wheat plantings.

The 2007 third quarter gross profit was $46.7 million, which was $31.2 million more than the 2006 third quarter. As compared to the 2006 third quarter, 2007 gross profits increased approximately $42.3 million due to higher prices, offset by higher natural gas costs of $9.1 million. Natural gas costs purchased by the Partnership, including the effects of forward price contracts, during the 2007 and 2006 third quarters were $7.02 per MMBtu and $5.96 per MMBtu, respectively.

Nine months ended September 30, 2007 compared with
nine months ended September 30, 2006

Volumes and prices for the nine-month periods ended September 30, 2007 and 2006 are:

	2007				2006
	Volumes		Unit Price		Volumes		Unit Price
	(000 tons)		($/ton)*		(000 tons)		($/ton)*
Ammonia		221	$	370		168	$	367
UAN		1,698	$	188		1,521	$	139

*After deducting outbound freight costs

Revenues for the nine months ended September 30, 2007 increased $131.6 million, or 43%, compared with the same 2006 period primarily due to increased sales volumes and higher prices. The higher volumes and prices were due to stronger demand for nitrogen products primarily as a result of increased planted corn acreage as compared to 2006.

The 2007 first nine months gross profit was $147.4 million, which was $113.6 million more than the 2006 first nine months. Increased sales volumes and sales prices raised 2007 first nine months gross profit by approximately $18.5 million and $74.8 million, respectively, as compared to the 2006 first nine months. The 2007 first nine months natural gas costs decreased $23.5 million from the 2006 first nine months. Natural gas costs purchased by the Partnership, including the effects of forward price contracts, during the 2007 and 2006 first nine months, were $6.70 per MMBtu and $7.32 per MMBtu, respectively.

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Operating expenses for the first nine months of 2007 increased $6.8 million primarily due to annual and long-term incentive plans as compared to the first nine months of 2006.

Capital resources and liquidity

Operating activities for the first nine months of 2007 generated $151.9 million of cash, comprised of $150.3 million of cash from operating activities, $1.6 million used to fund working capital increases. The primary working capital needs were to fund $7.8 million related to increased inventory levels, offset by $4.4 million of customer prepayment reductions for seasonal customer shipments.

Capital expenditures of $5.4 million during the first nine months of 2007 were primarily to fund replacement and stay-in-business additions to plant and equipment. Plant turnaround costs represent cash used for the periodic scheduled maintenance of the Partnership’s continuous process production facilities. The Partnership funded $13.1 million of plant turnaround during the first nine months of 2007.

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 $50.0 million revolving bank credit facility.

In the first quarter of 2007, the Partnership amended the $50.0 million revolving credit facility to extend the expiration date to January 31, 2012. 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, 2007, the Partnership had borrowing availability of $50.0 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.

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 $10.0 million, it is required to have generated $25.0 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 $5.0 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.

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Quarterly distributions to the partners are based on Available Cash for the quarter as defined in the Agreement of Limited Partnership. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner reasonably determines necessary.

The Limited Partner receives 99% of the Available Cash and 1% is distributed to the General Partner, except when cumulative distributions of Available Cash exceed specified target levels above the Minimum Quarterly Distribution (“MQD”) of $0.605 per unit. Under such circumstances, the General Partner is entitled, as an incentive, to larger percentage interests. As of September 30, 2007, the cumulative shortfall on quarterly distributions to holders of Common Units that must be paid before the General Partner receives an incentive payment was $152.9 million, or $8.18 per unit.

The General Partner’s percentage interest in the Partnership’s distributions of Available Cash at various levels follows:

Incremental Distribution	Percentage of Incremental Distribution
per Common Unit	to General Partner
Less than $0.715	1%
$0.715-$0.825	15%
$0.825-$1.045	25%
Greater than $1.045	50%

On October 25, 2007, the Partnership announced a $2.10 per unit distribution to be paid during the 2007 fourth quarter. As a result of this distribution, the pro forma cumulative shortfall that must be paid before the General Partner affiliate receives an incentive payment as of December 31, 2007 is anticipated to be approximately $125.0 million, or $6.69 per unit.

The General Partner is required to remit the majority of cash distributions it receives from the Partnership in excess of its one percent Partnership equity interest to an affiliated company.

Distributions paid to the partners for the nine-month period ended September 30, 2007 were $104.6 million. Distributions paid to the partners for the period ended September 30, 2006 were $17.4 million.

At September 30, 2007, 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.

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Partnership cash receipts are generally received by Terra Capital, Inc., (“Terra Capital”) the indirect parent of the General Partner. Cash receipts, net of cash payments made by Terra Capital, are transferred to the Partnership from Terra Capital on a weekly basis. As a result of this cash collection and distribution arrangement, Terra Capital is a creditor to the Partnership.

There were no material changes outside the ordinary course of business to the Company’s contractual obligations or off-balance sheet arrangements presented in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Annual Report on Form 10-K for the period ended December 31, 2006.

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 of the Partnership’s 2006 form 10-K. There were no material changes in the Company’s use of financial instruments during the quarter ended September 30, 2007.

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. Management also considers the Partnership’s position related to forward fixed price sales contracts in determining the level of derivatives necessary. Contracts were in place at September 30, 2007 to cover approximately 38% 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.

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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, 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.

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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. 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.

ITEM 1A. RISK FACTORS

There were no significant changes in the Partnership’s risk factors during the third quarter of 2007 as compared to the risk factors identified in the Partnership’s 2006 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

General, administrative and selling services have been provided to or for the benefit of Terra Nitrogen Company, L.P. (TNCLP or the Partnership) by Terra Industries Inc. (Terra) or its affiliates pursuant to two agreements, each dated as of January 1, 1995, by and between Terra and Terra Nitrogen Corporation (TNC), the prior general partner of TNCLP. Each agreement was amended on September 1, 2005 in conjunction with an internal reorganization whereby TNC transferred its general partner interest to Terra Nitrogen GP Inc. (TNGP) and TNGP became the new general partner of TNCLP and a party to both services agreements.

On October 23, 2007, the parties to the services agreements entered into an Amended and Restated General and Administrative Services Agreement in order to update the terms of the services agreements in a single agreement. Under the amended agreement, Terra or its affiliates will continue to provide certain general, administrative and selling services to the Partnership. In exchange, Terra will be reimbursed for reasonable and documented direct expenses incurred in providing such services, as well as a proportionate amount of indirect costs and expenses relating to the provision of such services.

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ITEM 6. EXHIBITS

(a) Exhibits:

Exhibits 10.1	Amended and Restated General and Administrative Services Agreement Regarding Services by Terra Industries Inc. among Terra Industries Inc., Terra Nitrogen Corporation and Terra Nitrogen GP Inc. dated October 23, 2007.
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 Vice President and Chief Accounting 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

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/ DANIEL D. GREENWELL
	Daniel D. Greenwell
	Vice President and Chief Accounting Officer (Principal Financial Officer)

Date: October 25, 2007

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