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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

¨ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

TERRA INDUSTRIES INC.

(Exact name of registrant as specified in its charter)

Maryland

(State or other jurisdiction of incorporation or organization)

52-1145429

(I.R.S. Employer Identification No.)

Terra Centre 600 Fourth Street P.O. Box 6000 Sioux City, Iowa

(Address of principal executive offices)

51102-6000

(Zip Code)

Registrant’s telephone number, including area code: (712) 277-1340

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act.)    Yes  x    No  ¨

The aggregate market value of the voting and non-voting common shares held by non-affiliates computed by reference to the price at which the common shares were last sold, or the average bid and asked price of such common shares, as of the last business day of the registrant’s most recently completed second fiscal quarter was $218,011,931.28.

The number of shares of Common Shares, without par value, outstanding as of March 1, 2005 was 92,984,216.

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Documents Incorporated by Reference

Certain portions of the proxy statement for the Annual Meeting of Shareholders of Registrant to be held on May 3, 2005 are incorporated herein by reference into Part III hereof.

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ITEMS 1 AND 2. BUSINESS AND PROPERTIES

Terra Industries Inc., a Maryland corporation, is referred to as “Terra,” “we” or “our” throughout this report. References to Terra also include the direct and indirect subsidiaries of Terra Industries Inc. where required by the context, including the recently acquired Mississippi Chemical Corporation. Subsidiaries not wholly-owned by Terra include a limited partnership, Terra Nitrogen Company, L.P., (“TNCLP”), which, through its subsidiary, Terra Nitrogen, Limited Partnership, operates Terra’s manufacturing facility in Verdigris, Oklahoma. Terra is the sole general partner and the majority limited partner in TNCLP. Terra’s principal corporate office is located at Terra Centre, 600 Fourth Street, P.O. Box 6000, Sioux City, Iowa 51102-6000 and its telephone number is (712) 277-1340.

Terra makes available free of charge through its web site, www.terraindustries.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission. Terra’s internet web site and the information contained or incorporated therein are not intended to be incorporated into this Annual Report on Form 10-K.

MCC Acquisition

On December 21, 2004, Terra completed its acquisition of Mississippi Chemical Corporation (“MCC”), which we refer to herein as the “MCC Acquisition.” Through MCC, we acquired nitrogen products manufacturing facilities at Donaldsonville, Louisiana and Yazoo City, Mississippi; a 50% equity interest in Point Lisas Nitrogen Limited, a 50/50 ammonia production joint venture with KNC Trinidad Limited; FMCL Limited Liability Company, a 50/50 ammonia shipping joint venture with KNC Trinidad Limited; and Houston Ammonia Terminal, L.P., a 50/50 ammonia storage joint venture with Potash Corporation of Saskatchewan. Simultaneously with the MCC Acquisition, MCC emerged from bankruptcy proceedings administered under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to MCC’s second amended and restated Plan of Reorganization, and prior to the consummation of the MCC Acquisition, MCC’s phosphate business was separated and transferred to certain creditors. Unless the context requires otherwise, statements in Items 1 and 2 of this report give effect to the MCC Acquisition.

Business Overview

Terra is a leading North American and U.K. producer and marketer of nitrogen products serving both agricultural and industrial end-use markets. In addition, we own a 50% interest in an ammonia production joint venture in the Republic of Trinidad and Tobago. Terra is one of the largest North American producers of ammonia, the basic building block of nitrogen fertilizers. We upgrade a significant portion of the ammonia we produce into higher value products, which are easier for agricultural end-users to transport, store and apply to crops than ammonia. We own nine manufacturing facilities in North America and the U.K. capable of producing nitrogen products. Two of these nine facilities (Beaumont, Texas and Woodward, Oklahoma) can also produce methanol. Our Beaumont, Texas facility, which historically has been a significant producer of methanol and also has the capability to produce ammonia, was mothballed in December, 2004 and is out of production.

Nitrogen is both a global and local commodity: global because it is both produced and traded in almost all regions of the world, local because local fertilizer customers display preferences for nitrogen in one of four basic forms based upon local conditions. The principal forms of nitrogen fertilizer products that are

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traded globally are ammonia (82% nitrogen by weight) and urea (46% nitrogen by weight). Ammonium nitrate (AN) (34% nitrogen by weight) is traded to a lesser extent, primarily in international markets. Urea ammonium nitrate (UAN) has only recently been traded in international markets. It is less likely to be traded internationally because it carries a high transportation cost due to its high water content. Because transportation is a significant component of a customer’s total cost, a key to competitiveness in the nitrogen business is to have the lowest delivered cost for the customer’s product of choice, while providing a reliable source of supply.

The locations of Terra’s North American production facilities provide Terra a competitive advantage in serving agricultural customers in the Corn Belt and other major agricultural areas in the United States and Canada. Terra’s U.K. facilities are able to serve competitively the entire British agricultural market. Our Point Lisas ammonia production facility in Trinidad and Tobago serves the international nitrogen markets and benefits from access to low-cost natural gas supplies. Terra’s facilities have the following production capacities:

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The principal customers for Terra’s North American nitrogen products are national agricultural retail chains, farm cooperatives, independent dealers and industrial customers. Industrial customers use our products to manufacture chemicals and plastics such as acrylonitrile, polyurethanes, fibers, explosives and adhesives. Agricultural customers accounted for approximately 74% and industrial customers approximately 26% of Terra’s North American nitrogen product revenue in 2004 (excluding the plants acquired in the MCC Acquisition). In the U.K., revenues are evenly divided between agricultural and industrial customers.

During December 2003, Terra entered into contracts with the Methanex Corporation (“Methanex”), providing it exclusive rights to all methanol production at the Beaumont facility for five years. In December 2004, this facility was mothballed. As long as the Beaumont facility remains idle through the December 2008 termination of the Methanex contract, we will continue to realize revenues relating to the facility of up to $16.4 million per year due to $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin based on the plant’s methanol production capacity, reference prices and natural gas costs. Terra also entered into an agreement for Methanex to market, under a commission arrangement, all methanol produced at the Woodward facility. For more information on the methanol business, see the discussion under the caption “Methanol Business” below.

Nitrogen Business Segment

Terra is a leading producer and marketer of nitrogen products, principally fertilizers. We upgrade a significant portion of the ammonia that we produce into other nitrogen products, such as urea, ammonium nitrate (AN) and urea ammonium nitrate (UAN). Ammonia, AN, urea and UAN are the principal nitrogen products we produce and sell in North America. Terra produces and sells primarily ammonia and AN in the U.K. Our Point Lisas production facility in Trinidad provides ammonia for sale into the international nitrogen markets. Other important products that we manufacture include nitric acid, dinitrogen tetroxide and carbon dioxide. These products, along with a portion of our ammonia and urea production, are used in non-agricultural applications.

Although the different nitrogen products are interchangeable to some extent, each has its own characteristics which make one product or another preferable to the end-user. Terra’s plants are designed to provide the products preferred by end-users in the regions in which they are located. These preferences

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vary according to the crop planted, soil and weather conditions, regional farming practices, relative prices, and the cost and availability of appropriate storage, handling and application equipment. Terra’s nitrogen products are described in greater detail below.

Ammonia

Ammonia is the simplest form of nitrogen fertilizer and is the feedstock for the production of other nitrogen fertilizers, including urea, AN and UAN. Ammonia is also widely used in industrial applications. With the MCC Acquisition, Terra is now the leading U.S. producer of ammonia. Ammonia is produced when natural gas reacts with steam and air at high temperatures and pressures in the presence of catalysts. Ammonia has a nitrogen content of 82% by weight and is generally the least expensive form of fertilizer on a per pound of contained nitrogen basis. Although generally the cheapest source of nitrogen available to agricultural customers, ammonia can be less desirable to end-users than UAN or urea because of the need for specialized application equipment and the lack of application flexibility.

Urea

Terra produces urea for both the fertilizer and animal feed markets by converting ammonia and carbon dioxide into liquid urea, which can be further processed into a solid, granular form. Urea is also used in industrial applications. Granular urea has a nitrogen content of 46% by weight, the highest level of any solid nitrogen product. Terra produces both a granulated form of urea, generally for the fertilizer market, and urea liquor (liquid) for animal feed supplements and industrial applications.

Ammonium Nitrate (AN)

Terra is the largest manufacturer and marketer of agricultural-grade AN fertilizer in the United States and produces AN at two facilities in the U.K. AN is produced by combining nitric acid and ammonia into a liquid form which is then converted to a solid, largely for fertilizer applications. The nitrogen content of AN is 34% by weight. AN is less subject to volatilization (evaporation) losses than other nitrogen products. Due to its stable nature, AN is the product of choice for such uses as pastures and no-till crops where fertilizer is spread upon the surface and is subject to volatilization losses.

Urea Ammonium Nitrate (UAN)

UAN is a liquid fertilizer and, unlike ammonia, is odorless and does not require refrigeration or pressurization for transportation or storage. UAN is produced by combining liquid urea, liquid ammonium nitrate and water. The nitrogen content of UAN ranges from 28% to 32% by weight. Because of its high water content, UAN is relatively expensive to transport, making it largely a regionally distributed product.

UAN can be applied to crops directly or mixed with crop protection products, permitting the application of several materials simultaneously, reducing energy and labor costs and accelerating field preparation for planting. In addition, UAN may be applied from ordinary tanks and trucks and can be sprayed or injected into the soil, or applied through irrigation systems. UAN may be applied throughout the growing season, providing significant application flexibility. Due to its stability, UAN may be used for no-till row crops where fertilizer is spread on the surface of the soil but may be subject to evaporation losses.

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Manufacturing Facilities

Terra’s fertilizer manufacturing facilities, as well as the Point Lisas manufacturing facility in which we own a 50% interest, are designed to operate continuously, except for planned shutdowns (usually biennial) for maintenance and efficiency improvements. Capacity utilization (gross tons produced divided by capacity tons at expected operating rates and on-stream factors) of our nitrogen products manufacturing facilities (excluding 2004 production at the Blytheville, Arkansas plant, which closed in May, 2004, and the plants acquired in the MCC Acquisition) was 99%, 96% and 97% in 2004, 2003 and 2002, respectively.

Terra owns all of its manufacturing facilities, unless otherwise indicated below. (See “Methanol Business—Manufacturing Facilities” for a description of our Beaumont, Texas facility.) Substantially all of our manufacturing facilities are mortgaged to secure indebtedness under our credit agreements and our notes due in the years 2008 and 2010.

The Verdigris, Oklahoma facility is one of the largest UAN production facilities in North America. Located at the Verdigris facility are two ammonia plants, two nitric acid plants, two UAN plants and a port terminal. Terra owns the plants, while the port terminal is leased from the Tulsa-Rogers County Port Authority. The leasehold interest on the port terminal was renewed in April 2004, and Terra has an option to renew the lease for an additional five-year term. We also have UAN upgrading capability at our facilities in Port Neal, Iowa; Courtright, Ontario and Woodward, Oklahoma.

We believe we have some of the most efficient UAN plants in North America, including three of the five lowest-cost plants in terms of delivered cost to end-users. The location of our Port Neal, Iowa and Courtright, Ontario plants, with low-cost access to nearby Corn Belt markets, allows these plants to be among the most efficient in North America as measured by delivered cost to the end-user. Because of UAN’s relatively high transportation costs due to its water content, there is less competition from importers than for ammonia or urea. Four of our facilities are able to provide UAN locally by truck, which can offer a competitive advantage.

In May, 2004, Terra discontinued production at its Blytheville, Arkansas nitrogen products manufacturing facility and prepared to permanently close the production plants. Terra expects to operate the facility’s storage and distribution assets as a terminal for ammonia produced at its Verdigris, Oklahoma facility or obtained from other sources.

The Yazoo City, Mississippi facility includes two ammonia plants, five nitric acid plants, an AN plant, two urea plants, a UAN plant and a dinitrogen tetroxide production and storage facility. The Yazoo City facility is under contract through August 2007 as the sole provider of dinitrogen tetroxide for the United States Defense Energy Support Center. The Yazoo City plant and port facility have direct access to barge, rail and truck transportation and the plant is strategically located for the purchase of competitively priced natural gas.

The Donaldsonville, Louisiana facility includes two ammonia plants, a urea plant and two melamine crystal production plants. All of these plants, except for one ammonia plant, have been mothballed. No decision has been made regarding the sale or demolition of these plants. The facility has ready access to rail, truck and ammonia pipeline transportation. The plant is also equipped with a deep-water port facility on the Mississippi River, allowing for barge transportation and making Donaldsonville one of the northernmost points on the river capable of receiving economical ocean-going vessels.

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The Point Lisas Nitrogen facility, in the Republic of Trinidad and Tobago, is owned by a 50/50 joint venture with KNC Trinidad Limited. This facility has the capacity to produce annually 720,000 tons of ammonia from natural gas supplied under contract with the National Gas Company of Trinidad and Tobago. Terra is obligated to buy 50% of the joint venture’s ammonia output at market prices, which is mostly transported to the U.S. Gulf Coast and resold to Terra’s customers. The joint venture’s cost of natural gas has recently been significantly lower than U.S. natural gas costs, which has resulted in the joint venture being substantially more profitable than comparable North American facilities.

Marketing and Distribution

Terra’s customers are broadly segregated into two groups: (1) North American customers, which include those receiving shipments of imported product from the Point Lisas Nitrogen facility as well as purchases from other foreign producers, and (2) U.K. customers, which includes export sales to continental Europe.

The principal customers for Terra’s North American manufactured nitrogen products are independent dealers, national retail chains, cooperatives and industrial customers. Industrial customers accounted for approximately 26% of Terra’s North American nitrogen product revenues in 2004 (excluding the plants acquired in the MCC Acquisition).

Terra’s production facilities, combined with significant storage capacity at more than 50 locations throughout the major fertilizer consuming regions of the U.S. and Canada, position Terra to respond competitively to demand in our markets. Terra also owns and operates a storage and distribution terminal in Donaldsonville, Louisiana, one of the northernmost points on the Mississippi River capable of receiving ocean-going nitrogen vessels.

Terra’s U.K. sales are divided about equally between agricultural and industrial customers. Terra engages merchants and buying groups to sell its Nitram brand bagged AN fertilizer directly to British farmers. AN is also bagged for other U.K. suppliers and sold in bulk to suppliers who blend it with potash and phosphates, bag it and distribute it to farmers. A small quantity of AN is exported to continental Europe.

Terra’s U.K.’s industrial products include ammonia, nitric acid, and liquid carbon dioxide. Most industrial sales are to customers where Terra has a freight advantage.

Methanol Business

Recent Developments

During December 2003, we entered into contracts with Methanex Corporation (“Methanex”) providing it exclusive rights to all methanol production at our Beaumont, Texas facility for five years. Methanex paid $25 million for these rights and agreed to purchase production from us at amounts expected to approximate cash production costs. Methanex also agreed to pay us 50% of any gross profits earned from its sales of Beaumont product up to maximum payments of $12 million per year. Our agreement with Methanex gave Methanex the right to terminate Beaumont production during the term of the agreement, with Terra being responsible for the costs of shutting down the facility.

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On December 1, 2004, at the request of Methanex and under the terms of the agreement between the two companies, we ceased production at our Beaumont, Texas methanol manufacturing facility and began the process of mothballing the plant. Our agreement stipulates that, beginning two years from the date of the shutdown, Terra has the option to terminate the agreement by paying Methanex approximately $417,000 per month remaining on the contract. As long as the Beaumont facility remains idle through the December 2008 termination of the Methanex contract, we will continue to realize revenues relating to the facility of up to $16.4 million per year due to $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin attributable to idled methanol production based on reference prices and natural gas costs.

Approximately 40 Terra employees were terminated after the methanol plant was mothballed. Terra has retained some employees to operate the methanol storage and distribution terminal and potentially to operate the ammonia plant.

Manufacturing Facilities

Terra owns the plant and processing equipment at the Beaumont facility, which has annual production capacity of 225 million gallons of methanol. The facility also contains an “ammonia loop” which provides an annual production capacity of 255,000 tons of ammonia. The facility’s real estate is leased from E.I. DuPont de Nemours and Company (“DuPont”) for a nominal annual rate under a lease agreement which expires in 2090. Because the Beaumont facility is entirely contained within an industrial complex owned and operated by DuPont, Terra depends on DuPont for access to the facility as well as certain essential services.

The Woodward, Oklahoma facility produced 33.8 million, 33.8 million and 37.3 million gallons of methanol in 2002, 2003 and 2004, respectively, and has an annual methanol production capacity of 40 million gallons.

Marketing and Distribution

In addition to the Beaumont production agreement, we also entered into an agreement with Methanex to market, under a commission arrangement, all methanol produced at the Woodward, Oklahoma facility. The customers served under these arrangements are primarily large domestic chemical producers.

Nitrogen Industry Overview

Overview

The three major nutrients required for plant growth are phosphorous, mined as phosphate rock; potassium, mined as potash; and nitrogen, produced from natural gas. Phosphorus plays a key role in the photosynthesis process. Potassium is an important regulator of plants’ physiological functions. Nitrogen is an essential element for most organic compounds in plants as it promotes protein formation. Nitrogen is also a major component of chlorophyll, which helps to promote green healthy growth and high yields.

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There are no substitutes for nitrogen fertilizers in the cultivation of high-yield crops. These three nutrients occur naturally in the soil to a certain extent but must be replaced as crops remove them from the soil. Nitrogen, to a greater extent than phosphate and potash, must be reapplied each year in areas of intense agricultural usage because of absorption by crops and its tendency to escape from the soil by evaporation or leaching. Consequently, demand for nitrogen fertilizer tends to be more consistent on a year-by-year per-acre-planted basis than is demand for phosphate or potash fertilizer.

Demand

Global demand for fertilizers typically grows at predictable rates and tends to correspond to growth in grain production. Global fertilizer demand is driven in the long term primarily by population growth, increases in disposable income and associated improvements in diet. Short-term demand depends on world economic growth rates and factors creating temporary imbalances in supply and demand. These factors include weather patterns, the level of world grain stocks relative to consumption, agricultural commodity prices, energy prices, crop mix, fertilizer application rates, farm income and temporary disruptions in fertilizer trade from government intervention, such as changes in the buying patterns of China or India.

Supply

Increased ammonia prices in 1995 led to capacity expansion projects globally that resulted in capacity growth that was, in the short term, substantially greater than demand, causing a structural imbalance in ammonia supply and demand. In addition, foreign government support for domestic production in India, China and the former Soviet Union has kept uneconomical plants running, further increasing supply.

This new global capacity has been partially offset by permanent plant closings in the U.S. and Europe since 1998. Recent increases in natural gas costs in many regions of the world have forced temporary plant closures which, in addition to permanent plant closures, have provided support for nitrogen prices.

Imports account for a significant portion of U.S. nitrogen product supply. Producers from the former Soviet Union, Canada, the Middle East, Trinidad and Venezuela are major exporters to the U.S. These export producers are often competitive in regions of close proximity to the point of entry for imports, primarily the Gulf Coast and East Coast of North America. Due to higher freight costs and limited distribution infrastructure, importers are less competitive in serving the main corn-growing regions of the U.S., which are more distant from these ports.

Methanol Industry Overview

Overview

Methanol is a liquid made primarily from natural gas that is used as a feedstock in the production of formaldehyde, acetic acid, MTBE, and a variety of other chemical intermediates which form the foundation of a large number of secondary derivatives. Formaldehyde is used to produce urea-formaldehyde and phenol-formaldehyde resins, which are used as wood adhesives for plywood, particleboard, oriented strand board, medium-density fiberboard and other engineered wood products. In addition, formaldehyde is used in the manufacture of elastomers, paints, foams, polyurethane and

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automotive products. Acetic acid is used as a chemical intermediate to produce adhesives, paper, paints, plastics, resins, solvents, and textiles. MTBE, an oxygenate and octane enhancer, is used to reduce hydrocarbon and carbon monoxide emissions from motor vehicles. Chemical intermediates are used to manufacture de-icer and windshield fluid, antifreeze, herbicides, pesticides, and poultry feed products.

Methanol is a typical commodity chemical and the methanol industry is characterized by cycles of oversupply resulting in lower prices and idled capacity, followed by periods of shortage and rapidly rising prices until increased prices justify new plant investments or the re-start of idled capacity. However, the expanding number of different uses for methanol and its derivatives over the last several years has resulted in the methanol industry becoming more complex and subject to increasingly diverse influences on supply and demand.

Demand

Due to an increasing range of end uses for methanol, demand has tended to move with the general level of economic activity in methanol’s major markets. The significant use of methanol for the production of chemicals used in the building products industry means that building and construction cycles are important factors in determining demand for methanol-based chemicals.

MTBE accounts for approximately 22% of global demand for methanol. MTBE is considered the preferred oxygenate by the refining industry and its production had grown rapidly until 2003 when initiatives in California and other states resulted in regulations that prohibit the addition of MTBE to gasoline.

Supply

Over the past several years significant industry restructuring has taken place with most North American methanol capacity shut down. New methanol production facilities have generally been constructed in locations with access to low-cost natural gas, although this advantage is partially offset by higher distribution costs due to distance from major markets.

Credit

Our credit terms are generally 15-30 days in the U.S. and 30 days in the U.K., but may be extended for longer periods during certain sales seasons consistent with industry practices.

Seasonality and Volatility

The fertilizer business is seasonal, based upon the planting, growing and harvesting cycles. Nitrogen fertilizer inventories must be accumulated to permit uninterrupted customer deliveries, and require significant storage capacity. This seasonality generally results in higher fertilizer prices during peak periods, with prices normally reaching their highest point in the spring, decreasing in the summer, and increasing again in the fall as depleted inventories are restored.

Nitrogen fertilizer prices can also be volatile as a result of a number of other factors. The most important of these factors are:

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Governmental policies may directly or indirectly influence the number of acres planted, the level of grain inventories, the mix of crops planted and crop prices.

While most U.S. methanol is sold pursuant to long-term contracts based on market index pricing and fixed volumes, the spot market price of methanol can be volatile. The industry has experienced cycles of oversupply, resulting in depressed prices and idled capacity, followed by periods of shortages and rapidly rising prices. Future demand for methanol will depend in part on the emerging regulatory environment with respect to reformulated gasoline.

Raw Materials

The principal raw material used to produce manufactured nitrogen products and methanol is natural gas. Natural gas costs in 2004 accounted for approximately 60% of our total costs and expenses (excluding the plants acquired in the MCC Acquisition). We believe there is a sufficient supply of natural gas for the foreseeable future and will, as opportunities present themselves, enter into firm transportation contracts to minimize the risk of interruption or curtailment of natural gas supplies during the peak-demand winter season.

As a result of the MCC Acquisition, we now own a 50% interest in Point Lisas Nitrogen Limited, a 50/50 ammonia production joint venture with KNC Trinidad Limited. Point Lisas Nitrogen Limited has a contract to purchase natural gas from the National Gas Company of Trinidad and Tobago. The joint venture’s cost of natural gas has recently been significantly lower than U.S. natural gas costs, which has resulted in the joint venture being substantially more profitable than comparable North American facilities.

Terra’s natural gas hedging policy is to fix or cap the price of 20% to 80% of our natural gas requirements for a rolling 12-month period, and up to 50% of our natural gas requirements for the subsequent 24-month period, provided that such arrangements would not result in costs greater than expected selling prices for our finished products. The Board of Directors is advised of any departures from this policy. We cap natural gas prices through various supply contracts, financial derivatives and other instruments. A significant portion of the global nitrogen products production occurs at facilities with access to fixed-priced natural gas supplies, such as at our Point Lisas Nitrogen Limited facility. These facilities’ natural gas costs have been and likely will continue to be substantially lower than those of our North American and U.K. facilities.

If natural gas prices rise, we may benefit from our use of forward-pricing techniques. Conversely, if natural gas prices fall, we may incur costs above the then-available spot market price. The settlement dates of forward-pricing contracts coincide with gas purchase dates. Forward-pricing contracts are based on a specified price referenced to spot market prices or appropriate NYMEX futures contract prices.

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Transportation

Terra uses several modes of transportation to distribute products to customers, including railroad cars, common carrier trucks, barges and common carrier pipelines. We use 53 liquid, dry and anhydrous ammonia fertilizer terminal storage facilities in 18 U.S. states and one Canadian province.

Railcars are the major mode of transportation at our North American manufacturing facilities. Terra leases approximately 2,100 railcars. Terra also owns 10 nitric acid railcars. In the U.K., Terra’s AN production is transported primarily by contract carrier trucks, and ammonia production is transported primarily by pipelines that we own.

Terra transports purchased natural gas to our Woodward, Oklahoma facility via both intrastate and interstate pipelines and to Terra’s Verdigris, Oklahoma facility via intrastate pipeline. The intrastate pipelines serving Woodward and Verdigris are not open-access carriers, but are nonetheless part of a widespread regional system through which Woodward and Verdigris can receive natural gas from any major Oklahoma source. Terra also has limited access to out-of-state natural gas supplies for these facilities. Terra’s Beaumont, Texas facility sources natural gas via four intrastate pipelines. The Courtright, Ontario facility sources natural gas at delivery points at Parkway and Dawn, Ontario and a local utility. We transport purchased natural gas for our Port Neal, Iowa facility via interstate, open-access pipelines. At the Billingham and Severnside, England locations, purchased natural gas is transported to the facilities via a nationwide, open-access pipeline system. Terra’s Donaldsonville facility sources purchased natural gas from two intrastate pipelines. Terra’s Yazoo City facility is served by three interstate pipelines and one intrastate pipeline.

FMCL Limited Liability Company, Terra’s 50/50 ammonia shipping joint venture with KNC Trinidad Limited, leases a vessel for the transportation of ammonia. Use of this vessel is shared between the joint venture partners.

Research and Development

We are currently not undertaking any significant, ongoing research and development efforts.

Competition

The markets in which Terra operates are highly competitive. Competition in agricultural input markets takes place largely on the basis of price, reliability of supply, delivery time and quality of service. Feedstock availability to production facilities and the cost and efficiency of production, transportation and storage facilities are also important competitive factors. Government intervention in international trade can distort the competitive environment. The relative cost and availability of natural gas are also important competitive factors. Significant determinants of a plant’s competitive position are the natural gas acquisition and transportation contracts negotiated with its major suppliers as well as proximity to natural gas sources and/or end-users.

Terra’s domestic competitors in the nitrogen fertilizer markets include a large production cooperative and other independent fertilizer companies. In addition, nitrogen fertilizers imported into the United States compete with domestically produced nitrogen fertilizers, including those produced by Terra. Countries with inexpensive sources of natural gas (whether as a result of government regulation or otherwise) can

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produce nitrogen fertilizers at a low cost. A substantial amount of new ammonia capacity is expected to be added abroad in the foreseeable future. Importers of this new supply will face higher transportation costs, which will reduce their advantage of inexpensive natural gas.

In the methanol segment, production and trade have become increasingly globalized and a number of foreign competitors produce methanol primarily for the export market. Many of these foreign competitors have access to favorably priced sources of natural gas and are relatively insensitive to raw material price fluctuations. However, because of low domestic demand, foreign competitors aggressively pursue the U.S. and other export markets.

Nitrogen sales are made through independent retailers, resellers, farmer co-operatives affiliated dealer organizations and brokers. Terra sells methanol through Methanex as described in the preceding Business Overview section.

Environmental and Other Regulatory Matters

Terra’s operations are subject to various federal, state and local environmental, health and safety laws and regulations, including laws relating to air quality, hazardous and solid wastes and water quality. Terra’s operations in Canada are subject to various federal and provincial regulations regarding such matters, including the Canadian Environmental Protection Act administered by Environment Canada, and the Ontario Environmental Protection Act administered by the Ontario Ministry of the Environment. Terra’s U.K. operations are subject to similar regulations under a variety of acts governing hazardous chemicals, transportation and worker health and safety. Terra’s facilities require operating permits that are subject to review by governmental agencies. We are also involved in the manufacture, handling, transportation, storage and disposal of materials that are or may be classified as hazardous or toxic by federal, state, provincial or other regulatory agencies. We take precautions to reduce the likelihood of accidents involving these materials. If such materials have been or are disposed of at sites that are targeted for investigation and/or remediation by federal or state regulatory agencies, Terra may be responsible under CERCLA or analogous laws for all or part of the costs of such investigation and remediation, and damages to natural resources.

The State of Arizona designated Inspiration Consolidated Copper Company (“Inspiration”), a Terra subsidiary that disposed of its assets in 1988 and no longer operates a business, as a potentially responsible party (“PRP”) under the state Superfund law at the Pinal Creek Drainage Basin Site (“Pinal Site”) in Globe/Miami, Arizona, based upon Inspiration’s prior ownership and operation of copper mining and production facilities. Under state and federal Superfund laws, all PRPs may be jointly and severally liable for the costs of investigation and/or remediation of an environmentally impaired site regardless of fault or the legality of original disposals. The Pinal Site is the subject of ongoing investigation and cleanup to address releases of acidic metal-bearing solutions from past copper mining and production facilities. The remedial actions are governed by a 1997 consent decree between the Arizona Department of Environmental Quality and the two current owners/operators of the copper mining and production facilities (one of whom is the successor to Inspiration’s buyer) and Inspiration (collectively with Terra, the “Group”). The Group’s members are jointly and severally financing and performing the work, but Inspiration no longer owns assets at the Pinal Site. Also, the Group has filed an action for cost-recovery against other former owners and operators at the Pinal Site. In a related matter, residents in an area of the Pinal Site brought a class action against the Group seeking property damages and medical monitoring for

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potential personal injuries allegedly related to the acidic metal-bearing groundwater. All claims have been settled, although plaintiffs reserved the right to assert personal injury claims individually. After consideration of such factors as the number of PRPs and levels of financial responsibility, including the ongoing litigation, claims against historic insurance carriers, and contractual indemnities, we believe that our liability with respect to these matters will not be material. Existing contractual indemnities may be subject to legal challenge, however, and there can be no guarantee that they will be upheld or sufficient to cover all costs, or that material expenditures will not be incurred for these matters.

Terra retained a small number (less than 10%) of its retail locations after the sale of its distribution business in 1999. Some of these locations are now, or are expected in the future to be, the subject of environmental clean-up activities for which we have retained liability. We do not believe that such environmental costs and liabilities will have a material effect on our results of operations, financial position or net cash flows.

With respect to our Verdigris facility, Freeport-McMoRan Resource Partners, Limited Partnership (a former owner and operator of these facilities) retained liability for certain environmental matters. With respect to our Beaumont facility, DuPont retains responsibility for certain environmental costs and liabilities stemming from conditions or operations to the extent such conditions or operations existed or occurred prior to its sale of the facility in 1991. Likewise, with respect to our Billingham and Severnside, England facilities, the seller, ICI, indemnified us, subject to certain conditions, for pre-December 31, 1997 environmental contamination associated with the purchased assets. Known conditions are not expected to result in material expenditures but discovery of unknown conditions or the failure of prior owners and operators and indemnitors to meet their obligations could require significant expenditures.

Terra may be required to install additional air and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors, at certain facilities in order to maintain compliance with applicable environmental requirements. We estimate that the total cost of additional equipment to comply with these requirements in 2005 and the next two years will be less than $15 million.

Terra endeavors to comply in all material respects with applicable environmental, health and safety regulations and has incurred substantial costs in connection with such compliance. Because these regulations are expected to continue to change and generally to be more restrictive than current requirements, the costs of compliance will likely increase. We do not expect our compliance with such regulations to have a material adverse effect on our results of operations, financial position or net cash flows. However, there can be no guarantee that new regulations will not result in material costs.

Terra’s capital expenditures related to environmental control in 2004, 2003 and 2002 were approximately $2.4 million, $1.3 million and $3.6 million, respectively. Projected environmental capital expenditures are $5 million for 2005 and $6.1 million for 2006.

Terra believes that its policies and procedures now in effect are in compliance with applicable environmental laws and with the permits relating to the facilities in all material respects. However, in the normal course of its business, Terra is exposed to risks relating to possible releases of hazardous substances into the environment. Such releases could cause substantial damages or injuries. Although environmental expenditures have not been material during the past year, it is impossible to predict or quantify the impact of future environmental liabilities associated with releases of hazardous substances from Terra’s facilities.

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Revenues and Assets

Terra’s revenues from external customers, measure of profit and loss, total assets and revenues and assets according to geography for the years 2002-2004 is set forth in Item 8 of this Annual Report on Form 10-K under the caption “Note 23 – Industry Segment Data” contained in the “Notes to Consolidated Financial Statements.”

Employees

We had 1,323 full-time employees at December 31, 2004, with all 400 U.K. employees covered by a wage and working conditions arrangement similar to a collective bargaining agreement. In the 2005 first quarter, we will terminate the employment of approximately 80 employees who were assigned to acquired MCC locations or our Beaumont facility.

ITEM 3. LEGAL MATTERS

Appeals of a Federal court decision ordering our insurer to pay all of our past and future judgments, settlements and other associated costs arising from a 1998 recall of carbonated beverages containing carbon dioxide tainted with benzene were exhausted in our favor during 2004. Accordingly, we recorded the recovery of product claim costs totaling $17.9 million through the elimination of remaining reserves originally established for these claims and the receipt of additional amounts from the insurer for claims previously paid by us.

During 2003, $11.2 million in damages were awarded to a former Terra employee whose distribution and crop consulting business was acquired by Terra in 1997. The plaintiff alleged bad faith and fraud against Terra in connection with the sale of his business to Terra. During 2004, the Arizona Court of Appeals affirmed the trial court decision and the judgment was paid. Terra recorded the charge for the original verdict in its December 31, 2002 financial statements.

We are involved in various other legal actions and claims, including environmental matters, arising from the normal course of business. While it is not possible to predict with certainty the final outcome of these proceedings, we do not believe that these matters will have a material adverse effect on our results of operations, financial position or net cash flows.

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

No matters were submitted to a vote of security holders of Terra during the fourth quarter of 2004.

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Executive Officers of Terra

The following paragraphs set forth the name, age and offices of each present executive officer of Terra, the period during which each executive officer has served as such and each executive officer’s business experience during the past five years:

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There are no family relationships among the executive officers and directors of Terra or arrangements or understandings between any executive officer and any other person pursuant to which any executive officer was selected as such. Officers of Terra are elected annually to serve until their respective successors are elected and qualified.

PART II

ITEM 5. MARKET FOR TERRA’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF SECURITIES

The main market in which Terra’s common shares are traded is the NYSE. Set forth below are the high and low sales prices of Terra’s common shares during each quarter specified as reported on the NYSE.

As of March 1, 2005 there were 9,328 record holders of Terra’s common stock.

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ITEM 6. SELECTED FINANCIAL DATA

Financial Summary

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

Terra Industries Inc. produces and markets nitrogen products for agricultural and industrial markets with production facilities located in North America and the United Kingdom. In addition, we own a 50% interest in an ammonia production joint venture in the Republic of Trinidad and Tobago. Nitrogen products are commodity chemicals that are sold at prices reflecting 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 in this industry, a producer must be among the low-cost suppliers in the markets it serves and have a financial position that can sustain it during periods of oversupply.

On December 21, 2004, we acquired Mississippi Chemical Corporation. In order to achieve the full benefits of this acquisition, our management will emphasize the successful integration of MCC’s business with ours in a timely manner.

Natural gas is the most significant raw material in the production of nitrogen products. North American natural gas costs have increased substantially since 1999. Since some of our products compete with nitrogen products imported from regions with lower natural gas costs, we and other North American producers have not been able to increase selling prices to levels necessary to cover the natural gas cost increases. This has resulted in curtailments of North American nitrogen production. These curtailments contributed to reductions in global nitrogen product supplies.

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 our facilities. Off-shore producers are most competitive in regions close to North American points of entry for imports, including the Gulf Coast and East Coast.

Our sales volumes depend primarily on our plants’ operating rates. We may purchase product from other manufacturers or importers for resale, but gross margins on those volumes are rarely significant. Profitability and cash flows from our nitrogen products business are affected by our ability to manage our costs and expenses (other than natural gas), most of which do not materially change for different levels of production or sales. Other factors affecting our nitrogen products results include the number of planted acres, transportation costs, weather conditions (particularly during planting season), grain prices and other variables described in Items 1 and 2 “Business and Properties” of this Annual Report on Form 10-K.

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We also produce methanol in the U.S. Similar to nitrogen products, methanol is a commodity chemical manufactured from natural gas. Consequently, natural gas costs and the supply/demand balance for methanol significantly affect methanol earnings and cash flows. A significant portion of U.S. methanol demand is met by imports from regions with natural gas costs lower than those available to U.S. producers. U.S. methanol demand has declined over the past year and is expected to continue to decline due to reduced U.S. consumption of MTBE, a gasoline oxygenate and octane enhancer that uses methanol as a feedstock. In December 2003, we entered into contracts with the Methanex Corporation (“Methanex”) assigning it our sales contracts and providing it exclusive rights to all methanol production at the Beaumont facility for five years as more fully described in Items 1 and 2 “Business and Properties” of this report. As permitted under these contracts, Methanex elected to shut down the Beaumont facility as of December 1, 2004. As long as the Beaumont facility remains idle through the December 2008 termination of the Methanex contract, we will continue to realize revenues relating to the facility of up to $16.4 million per year due to $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin based on the plant’s methanol production capacity, methanol reference prices and natural gas costs.

Overview of Consolidated Results

Terra reported net income (loss) of $68 million in 2004, $(12) million in 2003 and $(258) million in 2002 with diluted earnings (loss) per share of $0.85, $(0.16) and $(3.43), respectively. Revenues from continuing operations totaled $1,509 million in 2004, $1,351 million in 2003 and $1,044 million in 2002.

Our 2002 net loss included a $206 million charge for the cumulative effect of a change in accounting for goodwill ($2.73 per share) and a $16 million loss from discontinued operations ($0.22 per share). At the beginning of 2002, we implemented Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” and determined that $206 million of assets classified as “excess of cost over net assets of acquired businesses” suffered impairment and had no value.

Income (loss) from continuing operations was $68 million in 2004, $(12) million in 2003 and $(36) million in 2002. The 2004 net income was increased by $27.9 million of income tax benefits due to a favorable settlement with a foreign taxing authority. The 2004 net income also included $11.6 million attributable to an insurance recovery of product claim costs (representing $17.9 million of operating income less $6.3 million of related income taxes) and an $11.1 million loss from the early retirement of long-term debt (there were no tax benefits associated with this loss).

During 2003, we recorded a $27.0 million net charge for the impairment of our Blytheville facility (representing a $53.1 million impairment charge to operating income less $9.9 million allocated to minority interest and $16.2 million of income tax benefit). The 2003 net loss was reduced by $36.4 million of income tax benefits for a reduced assessment by a foreign taxing authority and reversals of tax reserves that had been provided in prior years.

Other fluctuations to our income (loss) from continuing operations for 2002 through 2004 are primarily related to changes in the selling prices of nitrogen products and methanol and changes in the cost of natural gas, our primary raw material.

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Factors That Affect Operating Results

Factors that may affect our operating results include: the relative balance of supply and demand for nitrogen fertilizers, industrial nitrogen and methanol, the availability and cost of natural gas, the number of planted acres (which is affected by both worldwide demand and government policies), the types of crops planted, the effect of general weather patterns on the timing and duration of field work for crop planting and harvesting, the effect of environmental legislation on supply and demand for our products, the availability of financing sources to fund seasonal working capital needs, and the potential for interruption to operations due to accidents or natural disasters.

The principal raw material used to produce nitrogen products and methanol is natural gas. Natural gas costs in 2004 accounted for approximately 60% of our total costs and expenses (excluding the plants acquired in the MCC acquisition). A significant increase in the price of natural gas that is not hedged or recovered through an increase in the price of our nitrogen and methanol products would have an adverse effect on our business, financial condition and results. A portion of global nitrogen products and methanol production is at facilities with access to fixed-price natural gas supplies that have been, and could continue to be, substantially lower priced than natural gas costs at our North American and U.K. facilities. Our Point Lisas Nitrogen Limited facility is located in Trinidad with access to such lower-cost natural gas.

We enter into forward pricing contracts for some of our natural gas requirements when such arrangements would not result in costs greater than expected North American and U.K. selling prices for our finished products. Our current natural gas forward pricing policy is to fix or cap the price of between 20% and 80% of our natural gas requirements for a rolling 12-month period and up to 50% of our natural gas requirements for the subsequent 24-month period through supply contracts, financial derivatives and other instruments. We notify the Board of Directors when we deviate from the policy. Our December 31, 2004 forward positions covered 26% of our expected 2005 natural gas requirements and none beyond (excluding the natural gas requirements of Point Lisas Nitrogen Limited which purchases its gas under contract with the Natural Gas Company of Trinidad and Tobago).

Prices for nitrogen products are influenced by the world supply and demand balance for ammonia and other nitrogen-based products. Long-term demand is affected by population growth and rising living standards that determine food consumption. Short-term demand is affected by world economic conditions, international trade decisions and grain prices. Supply is affected by increasing worldwide capacity and the availability of nitrogen product exports from major producing regions such as the former Soviet Union, the Middle East and South America.

Methanol is used as a raw material in the production of formaldehyde, methyl tertiary-butyl ether (MTBE), acetic acid and numerous other chemical derivatives. The price of methanol is influenced by the supply and demand for each of these products. Environmental initiatives to ban or reduce the use of MTBE as a fuel additive, such as those currently underway in the United States, will affect demand for methanol.

Weather can have a significant effect on demand for our nitrogen products. Weather conditions that delay or intermittently disrupt field work during the planting and growing seasons may cause agricultural customers to use forms of nitrogen fertilizer that are more or less favorable to our sales. Weather conditions following harvest may delay or eliminate opportunities to apply fertilizer in the fall. Weather can also have an adverse effect on crop yields, which lowers the income of growers and could impair their ability to pay for crop inputs purchased from our dealer customers.

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Our nitrogen business segment is seasonal, with the majority of nitrogen products consumed during the second quarter in conjunction with spring planting activity. Due to the business’ seasonality and the relatively brief periods during which customers consume nitrogen products, our customers and we generally build inventories during the second half of the year in order to ensure product availability during the peak sales season. For our current level of sales, we require lines of credit to fund inventory increases and to support customer credit terms. We believe that our credit facilities are adequate for expected 2005 sales levels.

Our manufacturing operations may be subject to significant interruption if one or more of our facilities were to experience a major accident or were damaged by severe weather or other natural disaster. We currently maintain insurance, including business interruption insurance, which we believe is sufficient to allow us to cover major damage to any of our facilities.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America for reporting purposes. The preparation of these financial statements requires us to make estimates and judgments that affect the amount of assets, liabilities, revenues and expenses at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that reflect significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our critical accounting policies are described below.

Impairment of Long-Lived Assets

We will record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amount of these items. Our cash flow estimates are based on historical results adjusted to reflect our best estimate of future market and operating conditions. The net carrying value of assets not recoverable is reduced to fair value. Our estimates of fair value represent our best estimate based on industry trends and reference to market rates and transactions.

Estimates of future cash flows are subject to significant uncertainties and assumptions. Accordingly, actual results could vary significantly from such estimates. During 2004, events occurred that necessitated an evaluation of recoverability of assets at our Beaumont facility. At December 31, 2004, the Beaumont facility had a carrying value, net of $18 million of deferred revenues, of approximately $105 million. We estimated the remaining useful life of this facility at 14 years assuming normal investment in maintenance and replacement capital throughout this period. Our estimated cash flows over this period, based on our best estimate of future market and operating conditions at December 31, 2004, exceeded the carrying value of these assets and consequently, no impairment charge was recorded for the Beaumont facility.

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These cash flow estimates assume Beaumont will remain idle through the 2008 term of our contract with Methanex and, that once restarted, it will produce at historical rates and selling prices will be adequate to realize historical margins over natural gas. Actual results for the Beaumont facility could vary substantially from such estimates.

Equity Investments

Terra’s investments in companies that are accounted for on the equity method of accounting consist of the following: (1) 50% ownership interest in Point Lisas Nitrogen Limited, which operates an ammonia production plant in Trinidad (2) 50% interest in an ammonia storage joint venture located in Houston, Texas and (3) 50% interest in a joint venture in Oklahoma CO₂ Partnership, located in Verdigris, Oklahoma which produces CO₂ at Terra’s plant.

Equity investments are carried at original cost adjusted for our proportionate share of the investees’ income, losses and distributions. We periodically assess the carrying value of our equity investment and will record a loss on equity investments when management concludes a decline in the fair value of the investment is other than temporary.

Pension Assets and Liabilities

Pension assets and liabilities are affected by the estimated market value of plan assets, estimates of the expected return on plan assets and discount rates. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets and the expected return on plan assets will affect the amount of pension expense ultimately recognized. Our pension liabilities were $428 million at December 31, 2004, which was $139 million higher than pension plan assets. The December 31, 2004 liability was computed based on an average 5.7% discount rate, which was based on yields for high-quality corporate bonds with a maturity approximating the duration of our pension liability. In addition, the pension liability for our U.K. pension plan, which includes provisions to adjust benefit payments for general inflation rates, was estimated based on an average 3.0% annual inflation rate. Declines in comparable bond yields or higher U.K. inflation rates would increase our pension liability. Our net pension liability, after deduction of plan assets, could increase or decrease depending on the extent to which returns on pension plan assets are lower or higher than the discount rate.

Post-Retirement Benefits

Post-retirement benefits are determined on an actuarial basis and are affected by assumptions including the discount rate and expected trends in health care costs. Changes in the discount rate and differences between actual and expected health care costs will affect the recorded amount of post-retirement benefits expense ultimately recognized.

Accounting for Acquisitions

On December 21, 2004, we acquired Mississippi Chemical Corporation (“MCC”) for a purchase price valued at $210.6 million consisting of 15 million common shares, 172,690 Series B preferred shares and cash of $54.2 million, including costs directly related to the acquisition. The acquisition has been accounted for using the purchase method of accounting with the purchase price allocated to the net assets acquired based upon their estimated fair market values. This allocation was based on preliminary estimates and may be revised at a later date.

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Revenue Recognition

Revenue is recognized when title to finished product passes to the customer. Revenue is recognized as the net amount to be received after deducting estimated amounts for discounts and trade allowances. Revenue includes amounts paid by customers for shipping and handling. Revenues include gains or losses associated with the settlement of nitrogen derivative contracts.

Deferred Income Taxes

Deferred income tax assets and liabilities reflect (a) differences between financial statement carrying amounts and corresponding tax bases and (b) temporary differences resulting from differing treatment of items for tax and accounting purposes. Deferred tax assets also include the expected benefits of carrying forward our net operating losses. We regularly review deferred tax assets for recoverability and reduce them if we can not sufficiently determine that they will be realized. We base this determination on projected future taxable income and the expected timing of the reversals of existing temporary differences.

At December 31, 2004, deferred tax assets representing future benefits for our U.S. net operating loss carryforwards totaled $213 million. Since we have not generated U.S. taxable income since 1997, we do not have a basis to conclude that future taxable earnings are likely to be available to utilize benefits associated with loss carryforwards. Accordingly, through December 31, 2004, we have reduced our deferred tax assets for U.S. operations by $56 million. Further, we do not expect to recognize additional U.S. tax benefits for future losses until we realize taxable income or generate additional deferred tax liabilities for temporary differences. If there is a material change in the effective tax rates or time period when temporary difference become taxable or deductible, we may have to additionally reduce all or a significant portion of our deferred tax assets.

Inventory Valuation

Inventories are stated at the lower of cost and estimated net realizable value. The average cost of inventories is determined by using the first-in, first-out method. The nitrogen and methanol industries are characterized by rapid change in both demand and pricing. Rapid declines in demand could result in temporary or permanent curtailment of production, while rapid declines in price could result in a lower cost or market adjustment.

Intangible Assets

Intangible assets are amortized using the straight-line method over their estimated period of benefit, ranging from two to fourteen years. We evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. All of our intangible assets are subject to amortization. No impairments of intangible assets have been identified during any of the periods presented.

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Derivative and Financial Instruments

Terra accounts for derivatives in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133 “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 133 requires the recognition of derivatives in the balance sheet and the measurement of these instruments at fair value. Changes in the fair value of derivatives are recorded in earnings unless the normal purchase or sale exception applies or hedge accounting is elected.

Terra enters into derivative instruments including future contracts, swap agreements, and purchased options to cap or fix prices for a portion of natural gas production requirements. Terra uses similar derivative instruments to fix or set floor prices for a portion of its nitrogen sales volumes. Terra has designated, documented and assessed accounting hedge relationships, which mostly resulted in cash flow hedges that require the recording of the derivative assets or liabilities at their fair value on the balance sheet with an offset in other comprehensive income. Amounts are removed from other comprehensive income as the underlying transactions occur and realized gains or losses are recorded.

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RESULTS OF CONTINUING OPERATIONS—2004 COMPARED WITH 2003

Consolidated Results

We reported 2004 net income of $67.6 million on revenues of $1,509 million compared with a 2003 net loss of $12.5 million on revenues of $1,351 million. Diluted income (loss) per share for 2004 was $0.85 compared with $(0.16) for 2003. Results for 2004 and 2003 were favorably affected by income tax benefits of $27.9 million and $36.4 million, respectively, for reduced assessments by a foreign taxing authority and reversals of tax reserves established in prior years.

The 2004 net income also included $11.6 million attributable to an insurance recovery of product claim costs (representing $17.9 million of operating income less $6.3 million of related income taxes) and a $11.1 million loss from the early retirement of long-term debt primarily related to our redemption of $70.7 million in Second Priority Senior Secured Notes due 2010 (there were no tax benefits associated with this loss).

The 2003 net loss included a $27.0 million net charge for the impairment of our Blytheville facility (representing $53.1 million impairment charge to operating income less $9.9 million allocated to minority interest and $16.2 million income tax benefit).

We classify our operations into two business segments: Nitrogen Products and Methanol. The Nitrogen Products segment represents the sale of nitrogen products including that produced at our ammonia manufacturing and upgrading facilities. The Methanol segment represents sales of methanol including that produced at our two methanol manufacturing facilities.

MCC revenues and expense are included from the December 21, 2004 acquisition date and are not material.

Total revenues and operating income (loss) by segment for the years ended December 31, 2004 and 2003 follow:

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Nitrogen Products

Volumes and prices for 2004 and 2003 follow:

Nitrogen products revenues increased by $181 million to $1,320 million for 2004 compared with $1,139 million for 2003 primarily as the result of higher sales prices. Selling prices were higher as the result of increased demand and lower fertilizer supplies caused by industry-wide production curtailments since mid-2003. Price increases also reflected higher imported product costs as the result of U.S. currency declines relative to other currencies and increased international freight rates. Sales volumes in 2004 were lower than those of the previous year due mostly to the Blytheville production facility’s permanent closure in May 2004.

Nitrogen products operating income, excluding 2003 charges for the impairment of long-lived assets, increased by $105.0 million to $138.7 million for 2004 from $33.7 million for 2003. Higher selling prices and recovery of product claim costs contributed $180.4 million and $17.9 million, respectively, to 2004 operating income. These factors were partly offset by higher natural gas costs and increased expenses.

Natural gas costs increased $76.1 million from 2004 as unit costs, net of forward pricing gains and losses, were $5.37 per million British thermal units (“MMBtu”) during 2004 compared to $4.76/MMBtu during 2003. As a result of forward price contracts, 2004 natural gas costs for the nitrogen products segment were $14.6 million lower than spot prices.

Selling, general and administrative expenses assigned to the nitrogen products business segment totaled $41.9 million for 2004 compared to $30.2 million for 2003. The increase is primarily due to incentive pay accruals based on net income, professional fees associated with Sarbanes-Oxley compliance and changes in the allocation methods of centralized expense centers between the nitrogen products and methanol business segments. During 2003, $5.6 million of our selling, general and administrative expenses were allocated to the methanol business segment. Those allocations were discontinued in 2004 as a result of contracts transferring the marketing rights for our methanol production to Methanex.

Impairment of Long-Lived Assets

During 2003, we recorded a $53.1 million charge for the impairment of the Blytheville facility as we concluded that future market conditions may not justify ongoing investment in the maintenance and replacement capital required to operate the Blytheville facility for its established useful life. The Blytheville production capabilities were permanently closed in May 2004.

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Methanol

Methanol revenues were $186 million for the year ended December 31,2004. Approximately 85% of 2004 methanol revenues were realized under a contract providing Methanex with exclusive rights to all methanol production at our Beaumont facility. That contract was executed in December 2003 and requires us to sell the Beaumont production to Methanex at a price which will generally approximate cash production costs. In addition, Methanex pays us one-half of the cash margin attributable to Beaumont’s production based on realized methanol prices and actual natural gas costs. Other contract-related 2004 revenues include amounts received at signing that are deferred and recognized over the life of the contract on a straight-line basis.

During 2004, we realized $8.2 million of margin-sharing and deferred revenues under the Methanex contract. Methanol 2004 operating income also includes depreciation charges related to the Beaumont facility and earnings realized on methanol sales from our Woodward facility.

During 2003, methanol segment revenues were derived from market-based sales to third-party customers. Operating income was largely a function of revenues over production costs, including natural gas, and operating expenses.

Other Operating Activities—Net

We had $5.5 million of charges from other operating activities in 2004 compared to $6.1 million in 2003. These losses represent charges for amortization of deferred financing costs and legal fees related to general corporate activities not allocable to any particular business segment.

Interest Expense—Net

Net interest expense was $49.8 million in 2004 compared with $54.5 million in 2003. The reduction in interest expense primarily related to higher cash balances and the fourth quarter $70.7 million redemption of Senior Notes due in 2010.

Minority Interest

Minority interest represents interest in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. (TNCLP). The 2004 minority interest charge of $11.2 million reflected nitrogen earnings for TNCLP, which were included in their entirety in consolidated operating results. Minority interest benefits of $8.6 million were recorded in 2003 as the result of TNCLP losses, which included an impairment charge for the Blytheville facility. These amounts are directly related to TNCLP losses and earnings.

Income Taxes

Terra’s income tax benefit was $5.0 million in 2004 and included reductions to tax reserves totaling $27.9 million for a reduced assessment by a foreign taxing authority. The 2004 benefit was net of a $2.5 million charge to eliminate tax benefits associated with U.S. losses for reasons discussed more fully under “Critical Accounting Policies”.

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Terra’s income tax benefit was $57.0 million in 2003 and also included reductions to tax reserves totaling $36.4 million for a reduced assessment by a foreign taxing authority and reversal of tax reserves provided in prior years. The 2003 benefit was reduced $0.8 million to eliminate tax benefits associated with U.S. losses.

RESULTS OF CONTINUING OPERATIONS—2003 COMPARED WITH 2002

Consolidated Results

We reported a 2003 loss from continuing operations of $12.5 million on revenues of $1,351 million compared with a loss from continuing operation of $36.2 million on revenues of $1,044 million in 2002. Basic and diluted loss per share from continuing operations for 2003 was $0.16 compared with $0.48 for 2002. The 2003 net loss included a $27.0 million net charge for the impairment of our Blytheville facility (representing a $53.1 million impairment charge to operating income less $9.9 million allocated to minority interest and $16.2 million of income tax benefit). The 2003 net loss was reduced by $36.4 million of income tax benefits for a reduced assessment by a foreign taxing authority and reversals of tax reserves established in prior years.

Total revenues and operating income (loss) by segment for the years ended December 31, 2003 and 2002 follow:

Nitrogen Products

Volumes and prices for 2003 and 2002 follow:

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Nitrogen products revenues increased by $255 million to $1,139 million for 2003 compared with $884 million in 2002 as the result of higher sales prices, partially offset by lower sales volumes. Sales prices were higher as the result of lower fertilizer supplies caused by increased demand and industry-wide production curtailments. Sales volumes in 2004 were lower than the previous year due to our own production curtailments including a decision to suspend production during the 2003 third quarter at the Blytheville facility because of high natural gas costs and the seasonal decline in nitrogen fertilizer demand and prices.

Higher selling prices contributed $265 million to 2003 results and were only partially offset by higher natural gas costs. Natural gas costs increased $228 million from 2002 as unit costs, net of forward pricing gains and losses, were $4.76 per million British thermal units (“MMBtu”) during 2003 compared to $3.03/MMBtu during 2002. As a result of forward price contracts, 2003 natural gas costs for the nitrogen products segment were $5.4 million higher than spot prices.

Impairment of Long-Lived Assets

On June 26, 2003, we suspended production at our Blytheville facility due to expectations that the facility would not cover its cash costs because of continuing high natural gas costs and the seasonal decline in nitrogen fertilizer demand and prices. In response to this action, and as required by Statement of Financial Accounting Standards No. 144, “Accounting for the Disposal of Long-Lived Assets”, a $53.1 million charge was recorded during the second quarter as discussed more fully above.

Methanol

Methanol revenues were $210 million and $158 million for the years ended December 31, 2003 and 2002, respectively. Sales prices increased from $0.49/gallon in 2002 to $0.71/gallon in 2003, but sales volumes declined 10% from 2002 to 295 million gallons. The sales decline was due, in part, to production outages related to a scheduled plant turnaround.

The methanol segment generated $1.9 million operating income in 2003 compared to $7.3 million operating income in 2002. The lower 2003 operating income reflects increased costs and lower volumes, only partially offset by higher prices. The major cost increase was to natural gas costs which, net of $1.5 million of cost increases from forward pricing contracts, were $5.16/MMBtu for 2003 compared to $3.08/MMBtu for 2002.

Other Operating Activities—Net

We had $6.1 million of charges from other operating activities in 2003 compared to $3.4 million in 2002. These losses represent charges for amortization of deferred financing costs and legal fees related to general corporate activities not allocable to any particular business segment. The increased 2003 loss from 2002 was primarily due to amortization of financing costs on the 2003 refinancing of Senior Notes due in 2005.

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Interest Expense—Net

Net interest expense was $54.5 million in 2003 compared with $53.3 million in 2002. The increased interest expense primarily related to higher interest rates paid on the 2003 refinancing of Senior Notes due in 2005.

Minority Interest

Minority interest benefits of $8.6 million were recorded in 2003 as the result of TNCLP losses, which included an impairment charge for the Blytheville facility, that were included in their entirety in consolidated operating results. The 2002 minority interest charge of $1.5 million reflected nitrogen earnings for TNCLP, which were included in their entirety in consolidated operating results. These amounts are directly related to TNCLP losses and earnings.

Income Taxes

Income tax benefits were recorded at an effective rate of 82% for 2003 compared with 40% for 2002. The 2003 benefit includes reductions to tax reserves totaling $36.4 million for a reduced assessment by a foreign taxing authority and reversal of tax reserves provided in prior years. These benefits were offset by $0.8 million of income tax provisions that reduced our deferred tax assets to equal net deferred tax liabilities for reasons discussed more fully above under “Critical Accounting Policies”.

LIQUIDITY AND CAPITAL RESOURCES

Our primary uses of funds are to fund our working capital requirements, make payments on our debt and other obligations and make payments for plant turnarounds and capital expenditures. The principle sources of funds will be cash flow from operations and borrowings under available bank facilities.

During 2004, cash and short-term investments increased $146.5 million. Net cash provided by operating activities was $211.5 million. Cash provided from financing activities was $34.7 million, primarily for the $120 million issuance of Series A Perpetual Preferred Shares less the redemption of $70.7 million of Senior Notes due in 2010. Cash used for investing activities was $100.6 million, primarily for acquisition of Mississippi Chemical Corporation (“MCC”) as well as capital expenditures and plant turnaround costs.

Net cash provided by 2004 operating activities was $211.5 million, composed of $170.0 million of cash provided from operating activities and $41.5 million provided by lower net working capital balances. Net working capital balances declined primarily due to an increase in customer prepayments as the result of higher prices and demand for such arrangements. We had $115.3 million in customer prepayments at December 31, 2004 for the selling price and delivery costs of nitrogen products that we will deliver during the 2005 first half.

On December 21, 2004, we acquired the outstanding common stock of MCC for a combination of our common shares, Series B preferred shares and cash totaling $54.2 million. In addition, we assumed $125 million of MCC’s existing debt obligations, $34.1 million of unfunded pension liabilities and net deferred tax liabilities of $41.6 million. The Series B preferred shares have a liquidation value of $17.3 million and we have the option to redeem the Series B shares for 2.1 million common shares at any time before October 21, 2005. If the Series B preferred shares are not redeemed, the shares will earn a cumulative

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dividend equal to 1.75% plus the October 21, 2005 yield on our Second Priority Senior Secured Notes due 2010. The MCC debt obligations were amended to extend their maturity to December 21, 2008 and are repayable at 102.4% of par. The MCC debt obligations bear cash interest at the higher of a floating base rate plus 4.6% and 9.56%. We also provided the debt holders five-year warrants to purchase 4.0 million of our common shares at $5.48 per share, which were valued at $21.1 million at MCC closing. The MCC debt obligations, which are secured by certain MCC assets, also require that we 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.

On February 22, 2005, we announced plans to prepay $50 million of the MCC debt obligations on March 21, 2005.

During the 2004 fourth quarter, we issued 4.25% Cumulative Convertible Perpetual Series A Preferred Shares with a liquidation value of $120 million for net proceeds of $115.8 million. The Series A preferred shares are not redeemable by us, are convertible into our common stock at a conversion price of $9.96 per common share at the option of the holder and may at our option be automatically converted to common shares after December 20, 2009 if the closing price for our common shares exceeds 140% of the conversion price for any twenty days within a consecutive thirty day period prior to such conversion. Upon the occurrence of a fundamental change to our capital structure, including a change of control, merger, or sale of the Company, holders of the Series A preferred shares may require us to purchase any or all of their shares at a price equal to their liquidation value plus any accumulated, but unpaid, dividends. We also have the right, under certain conditions, to require holders of the Series A preferred shares to exchange their shares for convertible subordinated debentures with similar terms.

On November 15, 2004, we redeemed $70.7 million Second Priority Senior Secured Notes due 2010 for $78.8 million, including redemption premiums.

During 2004 and 2003, we funded plant and equipment purchases of $18.5 million and $8.6 million, respectively, primarily for replacement or stay-in-business capital needs. We expect 2005 plant and equipment purchases to approximate $25 million consisting primarily of expenditures for replacement of equipment at manufacturing facilities.

Plant turnaround costs represent cash used for the periodic scheduled major maintenance of our continuous process production facilities that is performed at each plant generally every two years. We funded $28.9 million and $28.1 million of plant turnaround costs in 2004 and 2003. We estimate 2005 plant turnaround costs will approximate $35 million.

On December 21, 2004, we entered into revolving credit facilities totaling $200 million that expire in June 2008. Borrowing availability under the credit facility is generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible inventory, less outstanding letters of credit. These facilities include $50 million only available for the use of TNCLP, one of our consolidated subsidiaries. At December 31, 2004, borrowing availabilities exceeded the credit facilities’ $200 million maximum. There were no outstanding revolving credit borrowings and there were $31.0 million in outstanding letters of credit, resulting in remaining borrowing availability of approximately $169.0 million under the facilities. We are required to maintain a combined minimum unused borrowing availability of $30 million. The credit facility also requires that we adhere to certain limitations on

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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 our borrowing availability falls below a combined $60 million, we are required to have generated $60 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.

Our ability to meet credit facility covenants will depend on future operating cash flows, working capital needs, receipt of customer prepayments and trade credit terms. Failure to meet these covenants could result in additional costs and fees to amend the credit facility or could result in termination of the facility. Access to adequate bank facilities is critical to funding our operating cash needs. Based on our December 31, 2004 financial position and current market conditions for our finished products and natural gas, we anticipate that we will be able to meet our covenants through 2005.

Our ability to manage our exposure to commodity price risk in the purchase of natural gas through the use of financial derivatives may be affected by limitations imposed by our bank agreement covenants.

Contractual obligations and commitments to make future payments were as follows at December 31, 2004:

Our pension liabilities were $428 million at December 31, 2004, which was $138 million higher than our pension plan assets. The pension liability was computed based on a 5.7% discount rate, which was based on yields for high-quality corporate bonds (Moody’s Investor Service “AA” rated or equivalent) with a maturity approximating the duration of our pension liability. Future declines in comparable bond yields would increase our pension liability and future increases in bond yields would decrease our pension liability. Our pension liability net of plan assets could increase or decrease depending on the extent that returns on pension plan assets are lower or higher than the discount rate. In addition, the pension liability for our U.K. pension plan, which includes provisions to adjust benefit payments for general inflation rates, was estimated based on a 3% inflation rate. Our pension liability could increase or decrease based on actual U.K. inflation rates. Our cash contributions to pension plans were $16.5 million in 2004 and are

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estimated at $10 million in 2005 and 2006. Actual contributions could vary from these estimates depending on actual returns for plan assets, legislative changes to pension funding requirements and/or plan amendments.

Expenditures related to environmental, health and safety regulation compliance are primarily composed of operating costs that totaled $13.8 million in 2004. Because environmental, health and safety regulations are expected to continue to change and generally to be more restrictive than current requirements, the costs of compliance will likely increase. We do not expect compliance with such regulations will have a material adverse effect on the results of operations, financial position or net cash flows.

We incurred $2.4 million of 2004 capital expenditures to ensure compliance with environmental, health and safety regulations. We may be required to install additional air and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors to continue to achieve compliance with the Clean Air Act and similar requirements. These equipment requirements typically apply to competitors as well. We estimate that the cost of complying with these existing requirements in 2005 and beyond will be less than $20 million, including the plants acquired in the MCC acquisition.

We own 75.1% of the common units of TNCLP which, in accordance with the partnership agreement, permits us to call all common units that we do not own.

During 2004, 2003 and 2002, we distributed $8.1 million, $1.2 million and $1.8 million, respectively, to the minority TNCLP common unitholders. In addition, $3.0 million of distributions are payable to the minority TNCLP common unitholders on February 28, 2005. TNCLP distributions are based on “Available Cash” (as defined in the Partnership Agreement).

Cash balances at December 31, 2004 were $233.8 million, all of which is unrestricted.

RECENTLY ISSUED ACCOUNTING STANDARDS

In March 2004, the Financial Accounting Standards Board (“FASB”) approved the consensus reached on the Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. The objective of this Issue is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. The accounting provisions of EITF 03-1 are effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. The impact of the adoption on the company’s financial position or net income was not material.

In November 2004, the FASB issued Statement of Financial Standards (“SFAS”) No. 151 “An Amendment of ARB No. 43, Chapter 4”. The statement clarifies the abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) that should be recognized as current-period charges. In addition, the statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The statement is effective for fiscal years beginning after June 15, 2005. The impact of the adoption on the company’s financial position or net income has not been determined.

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In December 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets, an amendment of Accounting Principles Bulletin (“APB”) Opinion No. 29”. The statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges on nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the company are expected to change significantly as a result of the exchange. The statement is effective for fiscal periods beginning after June 15, 2005. The impact of the adoption on the company’s financial position or net income has not been determined.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. This standard eliminated the alternative of accounting for share-based compensation using APB Opinion No. 25. The revised standard generally requires the recognition of the cost of employee services based on the grant date fair value of equity or liability instruments issued. The effective date of the statement is effective for interim periods beginning after June 15, 2005. The impact of the adoption on the company’s financial position or net income has not been determined.

In December 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act) was signed into law. The Act introduced a prescription drug benefit under Medicare Part D and a federal subsidy to sponsors of retirement health care plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In May 2004, the FASB issued FSP 106-2, which provides accounting guidance to sponsors of postretirement health care plans that are impacted by the Act. The FSP is effective for interim or annual periods beginning after June 15, 2004. Although detailed regulations necessary to implement the Act have not yet been finalized, the company believes that certain drug benefits offered under postretirement health care plans will qualify for the subsidy under Medicare Part D. The effects of the subsidy were factored into the 2004 annual year-end valuation. The reduction in the benefit obligation attributable to past service cost was approximately $429,000 and has been reflected as an actuarial gain.

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 financial markets, general economic conditions within the agricultural industry, competitive factors and price changes (principally, sales prices of nitrogen and methanol 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 “Factors that Affect Operating Results” section of this discussion.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Risk Management and Financial Instruments

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We use derivative financial instruments to manage risk in the areas of (a) foreign currency fluctuations, (b) changes in natural gas prices and (c) changes in nitrogen prices and (d) changes in interest rates. See Note 16 to the Consolidated Financial Statements for additional information on the use of derivative financial instruments.

Our policy is to avoid unnecessary risk and to limit, to the extent practical, risks associated with operating activities. Our management may not engage in activities that expose Terra to speculative or non-operating risks and is expected to limit risks to acceptable levels. The use of derivative financial instruments is consistent with our overall business objectives. Derivatives are used to manage operating risk within the limits established by our Board of Directors, and in response to identified exposures, provided they qualify as hedge activities. As such, derivative financial instruments are used to manage exposure to interest rate fluctuations, to hedge specific assets and liabilities denominated in foreign currency, to hedge firm commitments and forecasted natural gas purchase transactions, to set a floor for nitrogen selling prices and to protect against foreign exchange rate movements between different currencies that impact revenue and earnings expressed in U.S. dollars.

The use of derivative financial instruments subjects Terra to some inherent risks associated with future contractual commitments, including market and operational risks, credit risk associated with counterparties, product location (basis) differentials and market liquidity. Terra continuously monitors the valuation of identified risks and adjusts the portfolio based on current market conditions.

Foreign Currency Fluctuations

Our policy is to manage risk associated with foreign currency fluctuations by entering into forward exchange and option contracts covering specific currency obligations or net foreign currency operating requirements, as appropriate. Such hedging is limited to the amounts and duration of the specific obligations being hedged and, in the case of operating requirements, no more than 75% of the forecasted requirements. The primary currencies to which we are exposed are the Canadian dollar and the British pound. At December 31, 2004, we had nominal forward currency positions that were matched with committed capital expenditures.

Natural Gas Prices—North American Operations

Natural gas is the principal raw material used to manufacture nitrogen and methanol. Natural gas prices are volatile and we mitigate some of this volatility through the use of derivative commodity instruments. Our current policy is to hedge 20%-80% of our natural gas requirements for the upcoming 12 months and up to 50% of requirements for the following 24-month period, provided that such arrangements would not result in costs greater than expected selling prices for our finished products. We notify the Board of Directors when we deviate from this policy. Annual North American natural gas requirements are approximately 106 million MMBtu. We have hedged 28% of our expected 2005 North American requirements and none of our requirements beyond December 31, 2005. The fair value of these

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instruments is estimated based on quoted market prices from brokers, realized gains or losses and our computations. These instruments and other natural gas positions fixed natural gas prices at $16.8 million more than published prices for December 31, 2004 forward markets. Market risk is estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in price. As of December 31, 2004 our market risk exposure related to future natural gas requirements being hedged was $8.6 million based on a sensitivity analysis. Changes in the market value of these derivative instruments have a high correlation to changes in the spot price of natural gas. Since we forward price only a portion of our natural gas requirements, this hypothetical adverse impact on natural gas derivative instruments would be more than offset by lower costs for all natural gas we purchase.

Natural Gas Prices—Trinidad Operation

The natural gas requirements of Point Lisas Nitrogen Limited, an ammonia production joint venture in which Terra has a 50% interest, are supplied under contract with the Natural Gas Company of Trinidad and Tobago. The cost of natural gas to the joint venture fluctuates based on changes in the market price of ammonia.

Natural Gas Prices—United Kingdom Operations

To meet natural gas production requirements at our United Kingdom production facilities, we generally enter into one- or two-year gas supply contracts and fix prices for 20%-80% of total volume requirements. Annual procurement requirements for U.K. natural gas are approximately 26 million MMBtu. As of December 31, 2004, we had fixed-price contracts for 19% of our expected 2005 U.K. natural gas requirements and none of our 2006 natural gas requirements. Our U.K. fixed-price contracts for 2005 natural gas purchases were at prices $1.3 million higher than published prices for December 31, 2004 forward markets. We do not use derivative commodity instruments for our United Kingdom natural gas needs.

Nitrogen Prices

The prices for nitrogen products can be volatile and we mitigate some of this volatility through the use of derivative commodity instruments. Our current policy is to hedge no more than 20% of our expected production for the upcoming 12 months and no more than 50% of any single month’s expected production. We notify the Board of Directors when we exceed this policy. We have hedged less than 4% of our expected 2005 North American sales of nitrogen solutions. The fair value of these instruments is estimated based on quoted market prices from brokers, realized gains or losses and our computations. These instruments fixed nitrogen solution prices at $1.6 million less than published prices for December 31, 2004 forward markets.

Interest Rate Fluctuations

The table below provides information about our financial instruments that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. We had no financial derivatives outstanding at December 31, 2004.

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Interest Rate Sensitivity

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Statements of Financial Position