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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

SECURITIES EXCHANGE ACT OF 1934

OR

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

SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

TERRA NITROGEN COMPANY, L.P.

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or organization)

73-1389684

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

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

(Address of principal executive offices)

51102-6000

(Zip Code)

(712) 277-1340

(Registrant’s telephone number)

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 is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

The aggregate market value of the voting and non-voting common units held by non-affiliates computed by reference to the price at which the common units were last sold, or the average bid and asked price of such common units, as of the last business day of the registrant’s most recently completed second fiscal quarter was $55,278,744.00.

The number of shares outstanding of the registrant’s Partnership units, as of March 1, 2005, was 18,501,576.

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Terra Nitrogen Company, L.P.

Form 10-K

PART I

ITEMS 1 AND 2. BUSINESS AND PROPERTIES

General

Terra Nitrogen Company, L.P. (“TNCLP”) is a Delaware limited partnership that conducts its operations through an operating partnership subsidiary, Terra Nitrogen, Limited Partnership (the “Operating Partnership”). Terra Nitrogen Corporation (“TNC” or “General Partner”), a Delaware corporation, is the general partner of both TNCLP and the Operating Partnership (collectively the “Partnership,” unless the context otherwise requires) and owns a consolidated 2.0% interest in the Partnership. TNC is an indirect, wholly-owned subsidiary of Terra Industries Inc. (“Terra” or “the company”), a Maryland corporation. Terra is an industry leader in the production of nitrogen products and also produces methanol. Terra is one of the largest North American producers of anhydrous ammonia and nitrogen solutions and is the largest producer of ammonia and ammonium nitrate in the United Kingdom. In addition, in December 2004, Terra acquired Mississippi Chemical Corporation, which was the United States’ largest manufacturer and marketer of agricultural-grade ammonium nitrate fertilizer.

Ownership of TNCLP is composed of the general partner interest and the limited partner interests. The limited partner interests consist of 18,501,576 common units. Terra and its subsidiaries owned 13,889,014 common units as of December 31, 2004, and the balance are traded on the New York Stock Exchange under the symbol “TNH.” The common units are referred to herein individually as a “unit” and collectively as “units.”

Terra makes available free of charge through its web site, www.terraindustries.com, TNCLP’s 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.

Partnership Products

The Partnership is a producer and distributor of nitrogen fertilizer products, which are used primarily by farmers to improve the yield and quality of their crops. The Partnership’s principal products are ammonia and urea ammonium nitrate solution (“UAN”). These products are manufactured at the Partnership’s manufacturing facility in Verdigris, Oklahoma. The Partnership’s product sales are heavily weighted toward UAN, and all of its products are sold on a wholesale basis. Although ammonia and UAN are often interchangeable, each has its own characteristics, and customer product preferences 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. The Partnership formerly produced urea by upgrading portions of its ammonia production. However, with the closing of its Blytheville manufacturing facility in May, 2004, the Partnership no longer produces urea.

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The Partnership’s nitrogen products are described in greater detail below:

Anhydrous Ammonia

The Partnership produces anhydrous ammonia (often referred to simply as “ammonia”), the simplest form of nitrogen fertilizer and the feedstock for the production of other nitrogen fertilizers. Ammonia is produced by reacting natural gas with steam and air at high temperatures and pressures in the presence of catalysts.

Ammonia contains 82% nitrogen by weight and is generally the least expensive form of fertilizer per pound of nitrogen. However, because it is a gas that must be kept under pressure and refrigerated, ammonia is more costly to store, ship and apply than other nitrogen fertilizer products and must be applied during a shorter period of the growing season. When used as a fertilizer, ammonia must be injected into the soil by specialized equipment, and soil conditions can limit its application.

In addition, in most areas of the world, especially in lesser-developed countries, dealers and farmers lack the equipment necessary to store, ship and apply ammonia and therefore must use other forms of nitrogen fertilizer. Ammonia can be upgraded into solid or liquid fertilizers, like urea and UAN, which are easier to transport, store and apply than ammonia.

UAN

The Partnership produces UAN by upgrading portions of its ammonia production. UAN is produced by combining urea solution and ammonium nitrate solution. UAN is a liquid fertilizer and, unlike ammonia, is odorless and does not need to be refrigerated or pressurized when transported or stored.

The nitrogen content of UAN is typically 28% to 32% by weight. As a liquid, UAN has many advantages over solid fertilizers and anhydrous ammonia. UAN may be applied more uniformly than non-liquid products and may be mixed with various crop protection products or other nutrients, permitting the farmer to apply several materials simultaneously, thus reducing energy and labor costs. In addition, UAN, unlike ammonia, may be applied from ordinary tanks and trucks and can be applied to the soil either through spraying, injecting or through irrigation systems throughout the growing season. Moreover, due to its stable nature, UAN can be a preferred fertilizer choice for crops requiring soil surface applications (such as no-till row crops) since UAN is less subject to volatization losses. The use of conservation tilling and “no-till” farming techniques, which reduce erosion, has increased in the U.S. over the past decade. This trend, if continued, will likely increase UAN demand.

Marketing and Distribution

The Partnership sells its products primarily in the Central and Southern Plains and Corn Belt regions of the U.S. The Partnership’s production facility in Verdigris, Oklahoma is located near the major crop producing and consuming areas of the U.S., and has ready access to barge, truck and rail transportation. In addition, the Verdigris facility has an ammonia pipeline to transport product to primary markets. The Partnership’s products are marketed and distributed through an organization based in Sioux City, Iowa that provides combined services to the Partnership and to Terra. For further information on the combined organizations of the General Partner and its affiliates, see Footnote 4 to Item 8 “Financial Statements and Supplementary Data.”

All of the Partnership’s sales are at the wholesale level. The Partnership’s customers for fertilizer products are dealers, national farm retail chains, distributors and other fertilizer producers and traders. National farm retail chains have both distribution and application capabilities. Distributors operate as wholesalers

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and sell directly to dealers and national farm retail chains, which, in turn, sell directly to farmers. Many dealers maintain year-round storage capacity for inventory as well as application equipment. The Partnership sells a majority of its nitrogen fertilizer products to dealers. No single customer accounted for more than 10% of the Partnership’s 2004 sales.

Production and Terminal Facilities

Production Facility

The Partnership’s production facility in Verdigris, Oklahoma produces all of the Partnership’s nitrogen fertilizer products. This facility has the production capacity shown in the table on the right.

The Partnership’s manufacturing facility is 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 the Verdigris, Oklahoma manufacturing facility was 98% in 2004, 101% in 2003 and 105% in 2002.

In May, 2004, the Partnership discontinued production at its Blytheville, Arkansas nitrogen products manufacturing facility and began preparations for permanently closing the production plants. The ammonia plant and the UAN plant at the Blytheville facility is being dismantled and sold as used parts and scrap. The urea plant remains intact and is being marketed for sale as a used asset. Terra expects to operate the Blytheville facility’s storage and distribution assets as a terminal for ammonia produced at its Verdigris, Oklahoma facility or obtained from other sources.

The Partnership owns all of its manufacturing and terminal facilities in fee, unless otherwise stated below.

The Verdigris, Oklahoma facility is made up of two ammonia plants, two nitric acid plants, two UAN plants and a port terminal. The Partnership owns the plants in fee, while the port terminal is leased from the Tulsa-Rogers County Port Authority. The leasehold interest on the port terminal is scheduled to expire in April 2009.

The Blytheville, Arkansas facility consists of an anhydrous ammonia plant, a granular urea plant and a UAN plant, all of which the Partnership has permanently closed. TNCLP leases the real estate underlying the ammonia plant from the City of Blytheville at a nominal annual rate. The ammonia plant real estate lease is scheduled to expire in November 2009, and the Partnership has an option to extend that lease for 10 successive terms of five years each at the same rental rate. The Partnership has an unconditional option to purchase the ammonia plant real estate for a nominal price at the end of the lease term (including any renewal term). The real estate underlying the urea and UAN plants is also leased from the City of Blytheville. That lease is scheduled to expire in October 2010, and the Partnership has an option to extend that lease for two successive terms of five years each at the same rental rate. The Partnership also has a similar, unconditional option to purchase the urea plant real estate for a nominal price.

The Partnership’s fixed assets are subject to a lien securing an $8.2 million note payable by the Partnership to a subsidiary of Terra.

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Terminal Facilities

The Partnership owns and operates four terminals used to store and distribute its products to customers. The Partnership owns UAN terminals near Dublin, Indiana (Henry and Wayne Counties), Blair, Nebraska (Washington County), and Pekin, Illinois (Tazewell County). In addition, the Blair, Nebraska terminal stores and distributes ammonia. The Partnership operates the Blytheville, Arkansas storage and distribution assets as an ammonia terminal.

Breakdown of Revenue by Product

Revenue contributions of the Partnership’s principal products (as a percentage of the Partnership’s total revenues) for each of the last three years appear in the table at right.

Credit

The Partnership’s credit terms are generally 15-30 days from date of invoice, but may be extended for longer periods during certain sales seasons consistent with industry practices. The Partnership’s bad debt write-offs have been less than $0.5 million annually for each of the past three years.

Revolving Credit Facility

The Partnership has a $50 million revolving credit facility that expires in June 2008. A portion of this facility is available for swing loans and for the issuance of letters of credit. At December 31, 2004, there were no revolving credit borrowings, and there were no outstanding letters of credit, resulting in remaining borrowing availability of $50 million under the facility. The credit agreement requires us to maintain certain financial ratio covenants relating to minimum earnings, maximum capital expenditures and minimum liquidity. We must also adhere to certain limitations on additional indebtedness, liens, investments, asset sales, restricted payments and transactions with affiliates, among others. Terra is not a party to the credit agreement, but Terra and its domestic subsidiaries (other than the Partnership) have guaranteed, on an unsecured basis, the Partnership’s obligations thereunder. Should for whatever reason Terra no longer be in a position to provide a guarantee, the facility would continue to be available to the Partnership.

Seasonality and Volatility

The fertilizer business is seasonal, based upon the planting, growing and harvesting cycles. Inventories must be accumulated to allow for 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.

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

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Nitrogen fertilizer price levels are influenced by world supply and demand for ammonia and nitrogen-based products. Long-term demand is affected by population growth and rising living standards that determine food consumption. Shorter-term demand is affected by world economic conditions and international trade decisions. 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, South America and Trinidad. During the period 2002-2003, favorable nitrogen prices in the industry spurred capacity additions in the form of new and expanded production facilities. More recently, depressed U.S. prices and margins for nitrogen products have resulted in some curtailments or shutdowns of North American capacity. Most, but not all, of these shutdowns are expected to be permanent.

Raw Materials

The principal raw material used to produce manufactured nitrogen products is natural gas. The Partnership believes there is a sufficient supply of natural gas for the foreseeable future and has entered into firm transportation contracts to minimize the risk of interruption or curtailment of natural gas supplies during the peak-demand winter season.

Terra’s natural gas procurement policy, which also applies to the Partnership’s gas procurement, is to fix or cap the price of 20% to 80% of its natural gas requirements for a rolling 12-month period, and up to 50% of its natural gas requirements for the subsequent 24-month period, provided that such arrangements would not result in costs greater than expected selling prices for the finished products. Departures from the policy are permitted with the approval of Terra’s Board of Directors. Capping natural gas prices is accomplished through various supply contracts, financial derivatives and other instruments. A significant portion of global nitrogen products production occurs at facilities with access to fixed-priced natural gas supplies. These facilities’ natural gas costs have been and likely will continue to be substantially lower than the Partnership’s.

If natural gas prices rise, the Partnership may benefit from its use of forward-pricing techniques. Conversely, if natural gas prices fall, the Partnership 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 designated price, which price is referenced to physical natural gas prices or appropriate NYMEX futures contract prices.

Transportation

The Partnership uses several modes of transportation to ship product to customers, including railroad cars, common carrier trucks, barges and common carrier pipelines. The Partnership uses approximately 49 liquid and anhydrous ammonia fertilizer terminal storage facilities in numerous states. Railcars are the major source of transportation for shipments from the Partnership’s manufacturing facilities. Terra currently leases approximately 2,400 railcars. The Partnership also owns 10 nitric acid railcars. In addition, the Verdigris facility distributes ammonia through a common carrier pipeline.

The Partnership transports purchased natural gas to its Verdigris, Oklahoma facility via an intrastate pipeline. This pipeline is not an open-access carrier, but is nonetheless part of a widespread regional

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system through which Verdigris can receive natural gas from any major Oklahoma source. The Partnership also has limited access to out-of-state natural gas supplies for this facility.

Research and Development

The Partnership currently is not undertaking any significant, ongoing research and development efforts.

Competition

Nitrogen products are global commodities, and the Partnership’s customers include distributors, industrial end-users, dealers and other fertilizer producers. Customers make purchasing decisions principally on the delivered price and availability of the product. The Partnership competes with a number of domestic and foreign producers, including state-owned and government-subsidized entities. Some of the Partnership’s principal competitors may have greater total resources and may be less dependent on earnings from nitrogen fertilizer sales than the Partnership. Some foreign competitors may have access to lower cost or government-subsidized natural gas supplies, particularly those with facilities in warmer climates. Natural gas comprises a significant portion of the raw materials cost of the Partnership’s nitrogen products. Competitive natural gas purchasing is essential to maintaining a low-cost product position. The Partnership competes with other manufacturers of nitrogen products on delivery terms and availability of products, as well as on price.

Environmental and Other Regulatory Matters

The Partnership’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. The Partnership’s facilities require operating permits that are subject to review by governmental agencies. The Partnership is 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 or other regulatory agencies. The Partnership takes 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 remediation by federal or state regulatory authorities, the Partnership may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) or analogous laws for all or part of the costs of such investigation and remediation.

Freeport-McMoRan Resource Partners, Limited Partnership (a former owner and operator of the Partnership’s production facilities) has retained liability for certain environmental matters originating prior to the Partnership’s acquisition of these facilities.

The Partnership may be required to install additional air and water quality control equipment, such as low NOx burners, scrubbers, ammonia sensors and continuous emission monitors, at its facilities to comply with Clean Air Act, Clean Water Act and similar requirements. These equipment requirements also typically apply to competitors as well. The Partnership estimates that the cost of additional equipment to comply with these requirements in 2005 and beyond will be less than $10 million.

The Partnership 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. The Partnership does not expect its compliance

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with such regulations to have a material adverse effect on its results of operations, financial position or net cash flows.

The Partnership’s capital expenditures related to environmental control in 2004 were approximately $0.9 million. Environmental capital expenditures by the Partnership are projected to be approximately $1.2 million for 2005 and approximately $3.5 million for 2006.

The Partnership 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, the Partnership is exposed to risks relating to possible releases of hazardous substances into the environment. Such releases could cause substantial damage 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 the Partnership’s facilities.

Revenues and Assets

The Partnership’s revenues from external customers, measure of profit and loss and total assets for the years 2002-2004 is set forth in Item 8 of this Annual Report on Form 10-K under the caption “Financial Statements and Supplementary Data.”

Employees

The Partnership does not have any employees.

The General Partner, Terra Nitrogen Corporation, is responsible for managing the Partnership. As of December 31, 2004, the General Partner had 171 employees. None of the General Partner’s employees that work in connection with the Partnership’s business are subject to collective bargaining agreements. The General Partner considers its labor relations to be good.

Limited Call Right

Since less than 25% of the issued and outstanding units are held by non-affiliates of the General Partner, the Partnership, at the General Partner’s sole discretion, may call, or assign to the General Partner or its affiliates its right to acquire, all such outstanding units held by non-affiliated persons. The General Partner and its affiliates owned 75.1% of the common units at December 31, 2004. If the General Partner elects to acquire all outstanding units, TNCLP is required to give at least 30 but not more than 60 days’ notice of its decision to purchase the outstanding units. The purchase price per unit will be the greater of (1) the average of the previous 20 trading days’ closing prices as of the date five days before the purchase is announced and (2) the highest price paid by the General Partner or any of its affiliates for any unit within the 90 days preceding the date the purchase is announced.

ITEM 3. LEGAL PROCEEDINGS

There is no pending or threatened litigation to the knowledge of the Partnership that would have a material adverse effect on the business or financial condition of the Partnership.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNITHOLDERS

No matters were submitted to a vote of unitholders of TNCLP during the fourth quarter of 2004.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S UNITS AND RELATED UNITHOLDER MATTERS AND ISSUER PURCHASES OF SECURITIES

TNCLP’s common units are listed on the New York Stock Exchange under the symbol TNH. The high and low sales prices of the common units for each quarterly period for 2004 and 2003, as reported on the New York Stock Exchange Composite Price History, are shown on the right.

Based on information received from TNCLP’s transfer and servicing agent, the number of registered unitholders as of March 1, 2005 is 250. TNC owned 11,172,414 common units as of December 31, 2004. Terra Capital, Inc. owned 2,716,600 common units as of December 31, 2004.

The quarterly cash distributions paid to the holders of common units and the General Partner in 2004 and 2003 appear in the table on the right.

Under TNCLP’s limited partnership agreement, cash distributions to unitholders are based on Available Cash for the quarter as defined therein. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. For additional information regarding cash distributions, see the “Liquidity and Capital Resources” section of “Management’s Discussion and Analysis.” There are a number of factors which affect the amount of taxable income reported to unitholders including Partnership earnings, capital spending and cash distributions.

ITEM 6. SELECTED FINANCIAL DATA

Selected Historical Financial and Operating Data

The following table sets forth the Partnership’s historical financial and operating data for each of the five years ended December 31, 2004. This information should be read in conjunction with Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes included elsewhere in this report.

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Selected Historical Financial and Operating Data

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

Introduction

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

High nitrogen margins in 1995 led to capacity expansion projects globally that resulted in capacity increases that were, in the short term, substantially greater than demand growth, causing oversupply conditions that reduced nitrogen prices. Since 1998, that new global capacity has been partially offset by demand growth as well as permanent plant closings in the U.S. and Europe.

During 2003, we determined that market conditions did not justify the ongoing investment in maintenance and replacement capital necessary to extend operations for the remainder of the established useful life at our Blytheville, Arkansas facility. Accordingly, we recorded a $40.7 million charge in 2003 as an “Impairment of long-lived assets” and permanently halted production at the facility in May 2004. We continue to produce nitrogen products at our Verdigris, Oklahoma facility.

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 we compete with nitrogen products imported from regions with lower natural gas costs, the oversupply situation during most of the three years ending December 31, 2002 did not permit us to increase selling prices to levels necessary to cover the natural gas cost increases. This 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. Offshore 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 primarily depend upon the operating rates for our plants. We may purchase product from other manufacturers or importers for resale, but gross margins on those volumes would rarely be significant. The profitability and cash flows from our operations 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 operating results include the number of planted acres, transportation costs, weather conditions (particularly during the planting season), grain prices and other variables described in Items 1 and 2 in the “Business and Properties” section of this report.

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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 amounts being reported under different assumptions and conditions. Our critical accounting policies are described below.

Impairments of Long-Lived Assets

We 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.

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. Gains or losses associated with the settlement of nitrogen derivative contracts are included as revenues.

Inventory Valuation

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

Derivatives and Financial Instruments

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

The General Partner enters into derivative instruments including future contracts, swap agreements, and purchased options to cap or fix prices for a portion of our natural gas production requirements. The General Partner also uses similar derivative instruments to fix or set floor prices for a portion of our nitrogen sales volumes. The General Partner has designated, documented and assessed accounting hedge relationships, which mostly resulted in cash flow hedges that require the Partnership to record the

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derivative assets or liabilities at their fair value on its 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.

Factors That Affect Operating Performance

Factors that may affect the Partnership’s operating results include: the relative balance of supply and demand for nitrogen fertilizers, 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 effects general weather patterns have on the timing and duration of fieldwork for crop planting and harvesting, the effect of environmental legislation on supply and demand for the Partnership’s 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 is natural gas. Natural gas costs in 2004 accounted for about 65% of total costs and expenses for the Partnership. A significant increase in the price of natural gas that is not covered by forward pricing arrangements or recovered through an increase in the price of related nitrogen products would have an adverse effect on the Partnership’s business, financial condition and results of operations. A portion of global nitrogen products is manufactured at facilities with access to fixed-price natural gas supplies that have been, and could continue to be, priced substantially lower than the Partnership’s natural gas.

The Partnership enters into forward pricing contracts for natural gas when such arrangements would not result in costs that would be greater than expected selling prices for finished products manufactured by the Partnership. Terra’s natural gas forward pricing policy (which is applicable to the Partnership) has been to fix or cap the price of between 20% and 80% of its natural gas requirements for a rolling 12-month period and up to 50% of its natural gas requirements for the subsequent 24-month period through supply contracts, financial derivatives and other instruments. Deviations from this policy are permitted through notification to Terra’s Board of Directors. The Partnership’s December 31, 2004 forward positions do not extend beyond 2005 and covered 29% of the Verdigris facility’s 2004 natural gas consumption.

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 influence food consumption. Short-term demand is affected by world economic conditions and international trade decisions. For example, 2001 demand was reduced, in part, due to relatively high nitrogen prices and low 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.

Weather can significantly affect demand for the Partnership’s products. Weather conditions that delay or intermittently disrupt fieldwork during the planting season may cause agricultural customers to use forms of nitrogen fertilizer that are more or less favorable to the Partnership’s 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. Conversely, low crop yields often increase the planted areas in the subsequent growing season, which, in turn, increases the demand for nitrogen fertilizer.

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The Partnership’s business is highly seasonal, with the majority of its products used during the second quarter in conjunction with spring planting. Due to the business’ seasonality and the relatively brief periods during which products can be used by customers, the Partnership and its customers generally build inventories during the second half of the year to ensure product availability during the peak sales season. For its current level of sales, the Partnership requires lines of credit to fund inventory increases and to support customer credit terms. The Partnership believes that its credit facilities are adequate for expected 2005 sales levels.

The Partnership’s operations may be subject to significant interruption if its facility were to experience a major accident or natural disaster. The Partnership currently maintains insurance, including business interruption insurance, which it believes is sufficient to cover major damage to any of its facilities.

RESULTS OF OPERATIONS—2004 COMPARED WITH 2003

The Partnership’s sales volumes and prices for 2004 and 2003 follow (quantities in thousands of tons):

Revenues for 2004 increased $15.2 million, or 4%, to $419.6 million compared with $404.4 million in 2003 as the result of higher selling prices partly offset by lower sales volumes. Sales prices were higher as the result of increased demand and lower nitrogen 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 the previous year due to the Blytheville production facility’s permanent closure in May 2004.

Gross profits during 2004 were $55.7 million, an increase of $41.0 million from 2003. Higher 2004 selling prices contributed $51.4 million to gross profits, but were offset by higher natural gas costs and increased fixed cost spending. The 2004 cost of natural gas purchases increased $7.8 million, or 3% over 2003 as unit costs, net of forward pricing gains and losses, increased to $5.38 per million British thermal units (“MMBtu”) for 2004 compared to $5.21/MMBtu for 2003. Natural gas costs in 2004 were $8.8 million lower than spot prices as the result of forward price contracts. Higher fixed cost spending, primarily for unplanned maintenance, reduced gross profits $3.9 million from 2003.

Operating expenses of $10.7 million increased $1.6 million, or 18%, as the result of higher spending for administrative activities, mostly related to incentive compensation plans.

During 2003, the Partnership recorded a $40.7 million charge for the impairment of Blytheville’s long-lived assets as the Partnership’s general partner, TNC, 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.

2004 net interest income improved by $1.1 million compared with that of 2003 due to lower borrowing levels and higher cash balances.

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RESULTS OF OPERATIONS—2003 COMPARED WITH 2002

The Partnership’s sale volumes and prices for 2003 and 2002 follow (quantities in thousands of tons):

Revenues for 2003 were $404.4 million and increased $77.5 million, or 24%, from $326.9 million in 2002. Selling prices were higher as the result of lower nitrogen fertilizer supplies caused by increased demand and industry-wide production curtailments. Sales volumes in 2003 were lower than the previous year due to curtailments of Partnership production. The partnership ceased production at the Blytheville, Arkansas facility and one of the two Verdigris, Oklahoma ammonia plants on February 27, 2003 because of high natural gas prices. The Partnership resumed full capacity production at both facilities on March 13, 2003 when natural gas prices decreased and product prices improved. On July 1, 2003, the Partnership suspended ammonia and urea production at Blytheville due to concerns that the facility would not cover its cash costs because of continuing high natural gas costs and seasonal declines in fertilizer prices. Blytheville production resumed on October 1, 2003 in response to higher urea selling prices and improved seasonal demand.

Gross profits during 2003 were $14.7 million, a decline of $1.2 million from 2002. Higher 2003 selling prices contributed $113 million to gross profits, but were more than offset by higher natural gas costs, lower sales volumes and idle plant costs. The 2003 cost of natural gas purchases increased $104 million, or 67% over 2002 as unit costs, net of forward pricing gains and losses, increased to $5.21 per million British thermal units for 2003 compared to $3.12/MMBtu for 2002. Natural gas costs in 2003 were $3.0 million higher than spot prices as the result of forward price contracts.

Operating expenses of $9.1 million declined $0.3 million from 2002, or 4%, as the result of reduced headcount and lower spending for administrative activities.

During 2003, the Partnership recorded a $40.7 million charge for the impairment of Blytheville’s long-term assets as the Partnership’s general partner, TNC, 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.

Net interest expense of $0.2 million was $0.1 million lower than in 2002 due to lower borrowing levels and higher cash balances.

Liquidity and Capital Resources

Net cash provided by operating activities for 2004 was $87.2 million compared to $20.1 million in 2003, an increase of $67.1 million principally due to higher earnings and working capital changes. Working capital changes represented a $31.9 million increase to 2004 cash flows due to a $11.6 million increase to current liabilities from higher customer prepayments, which reflected the higher price and demand for prepayment arrangements as compared to the previous year, and a $19.1 million reduction to year-end receivables and inventory balances due principally to the 2004 cessation of production at the Blytheville

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facility. At December 31, 2004, we had received $52.9 million of customer prepayments that we expect to substantially fulfill during the first half of 2005.

Capital expenditures of $5.1 million during 2004 were used primarily to fund replacement and stay-in-business additions to plant and equipment. The Partnership expects 2005 capital expenditures to approximate $7.0 million to fund replacement and stay-in-business additions to plant and equipment.

Contractual obligations and commitments to make future payments, other than notes due to affiliates, were as follows at December 31, 2004:

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

On December 21, 2004, the Partnership entered into a $50 million revolving bank credit facility that expires in June 2008. Under the credit facility, the Partnership may borrow an amount generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible finished goods inventory, less outstanding letters of credit. The Partnership’s borrowings under the credit facility are secured by substantially all of its working capital. At December 31, 2004, borrowing availability exceeded $50 million and the Partnership had no outstanding borrowings or letters of credit under the facility. Management expects the facility to be adequate to meet the Partnership’s operating cash needs.

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

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

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We currently anticipate that the Partnership will be able to meet its covenants through 2005. Nevertheless, if there were to be any adverse changes in the factors listed above, there can be no assurance that this would be the case.

Expenditures related to environmental, health and safety regulation compliance are primarily composed of operating costs that totaled $3.3 million, $1.9 million and $3.1 million in 2004, 2003 and 2002, respectively. 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. The Partnership does not expect its compliance with such regulations will have a material adverse effect on its results of operations, financial position or net cash flows.

In addition, the Partnership incurred $855,000, $0 and $808,000 of capital expenditures in 2004, 2003 and 2002, respectively, related to capital improvements to ensure compliance with environmental, health and safety regulations. The Partnership 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. The Partnership estimates that the cost of complying with these existing requirements in 2005 and beyond will be less than $10 million.

Quarterly distributions to TNCLP’s partners are based on Available Cash for the quarter as defined in the TNCLP Agreement of Limited Partnership. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. Distributions paid to the partners in 2004, 2003 and 2002 were $33.0 million, $4.7 million and $7.6 million, respectively.

Distributions of Available Cash are made 98% to the Limited Partners and 2% to the General Partner, except that the General Partner is entitled, as an incentive, to larger percentage interests to the extent that distributions of Available Cash exceed specified levels. The specified levels are increased by the amount of quarterly distributions to holders of Common Units that are less than $0.605 per unit. As of December 31, 2004, the cumulative shortfall on quarterly distributions to holders of Common Units that must be paid before the General Partner receives an incentive payment was $221.9 million, or $11.99 per unit.

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

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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.

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 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.

General Partner Option to Effect Mandatory Redemption of Partnership Units

At December 31, 2004, the General Partner and its affiliates owned 75.1% of the Partnership’s outstanding units. When less than 25% of the issued and outstanding units are held by non-affiliates of the General Partner, as is the case at December 31, 2004, the Partnership, at the General Partner’s sole discretion, may call, or assign to the General Partner or its affiliates its right to acquire, all such outstanding units held by non-affiliated persons. If the General Partner elects to acquire all outstanding units, the Partnership is required to give at least 30 but not more than 60 days’ notice of its decision to purchase the outstanding units. The purchase price per unit will be the greater of (1) the average of the previous 20 trading days’ closing prices as of the date five days before the purchase is announced and (2) the highest price paid by the General Partner or any of its affiliates for any unit within the 90 days preceding the date the purchase is announced.

Dependence on Terra Industries

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

Forward-Looking Precautions

Information contained in this report, other than historical information, may be considered forward-looking. Forward-looking information reflects management’s current views of future events and financial performance that involve a number of risks and uncertainties. The factors that could cause actual results to differ materially include, but are not limited to, the following: changes in the financial markets, general economic conditions within the agricultural industry, competitive factors and price changes (principally, nitrogen products selling prices 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 the financial position, results of operations or cash flows of the Partnership due to adverse changes in financial and commodity market prices and rates. The Partnership uses derivative financial instruments to manage risk in the area of changes in natural gas prices. The Partnership has no foreign currency exchange rate risk and all debt carries variable interest rates and approximates fair value.

The General Partner’s policy is to avoid unnecessary risk and to limit, to the extent practical, risks associated with operating activities. The General Manager may not engage in activities that expose the Partnership to speculative or non-operating risks. Management is expected to limit risks to acceptable levels. The use of derivative financial instruments is consistent with the overall business objectives of the Partnership. Derivatives are used to manage operating risk within the limits established by the General Partner’s Board of Directors, and in response to identified exposures, provided they qualify as hedge activities. As such, derivative financial instruments are used to hedge firm commitments and forecasted commodity purchase transactions. The use of derivative financial instruments subjects the Partnership 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. The General Partner continuously monitors the valuation of identified risks and adjusts the portfolio based on current market conditions.

Natural gas is the principal raw material used to manufacture nitrogen. Natural gas prices are volatile and the General Partner manages some of this volatility through the use of derivative commodity instruments. Terra Industries’ hedging policy (which is applicable to TNCLP) is described under the previous heading, “Factors that Affect Operating Performance”. The Partnership has hedged 29% of expected 2005 requirements and none of its requirements beyond December 31, 2005. The fair value of these instruments is estimated based on published referenced prices and quoted market prices from brokers. These instruments fixed natural gas prices at $6.1 million higher 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 price change. As of December 31, 2004, the Partnership’s market risk exposure related to future hedged natural gas requirements was $2.7 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 the Partnership forward prices only a portion of its natural gas requirements, this hypothetical adverse impact on natural gas derivative instruments should be more than offset by lower costs for natural gas purchases.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Balance Sheets

See Notes to the Consolidated Financial Statements

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Consolidated Statements of Operations

See Notes to the Consolidated Financial Statements

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Consolidated Statements of Partners’ Capital

See Notes to the Consolidated Financial Statements

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Consolidated Statements of Cash Flows