A copy of our combined 2006 annual report and Form 10-K for 2006 is being mailed with this proxy statement. You may receive a stand-alone copy of our 2006 Form 10-K free of charge upon written request directed to:

AGL Resources Inc. Investor Relations

P.O. Box 4569, Location 1071

Atlanta, Georgia 30302-4569

Our 2006 annual report and Form 10-K also may be accessed on our web site at www.aglresources.com or through our toll-free interactive shareholder information line at:

(877) ATG-NYSE ((877) 284-6973)

Ten Peachtree Place

Atlanta, Georgia 30309

NOTICE OF 2007 ANNUAL MEETING OF SHAREHOLDERS

By Order of the Board of Directors,

Myra C. Bierria Corporate Secretary

Who is soliciting my proxy?

The board of directors of AGL Resources is providing you these proxy materials in connection with the solicitation of proxies to be voted at our 2007 annual meeting of shareholders and at any postponement or adjournment of the annual meeting. The proxies will be voted in accordance with your instructions by John W. Somerhalder II, our president and chief executive officer; Paul R. Shlanta, our executive vice president, general counsel and chief ethics and compliance officer; and Andrew W. Evans, our executive vice president and chief financial officer, or any of them. If your shares are held in our Retirement Savings Plus Plan (our 401(k) plan, which we refer to as the RSP Plan), your proxy will be voted by Merrill Lynch Bank & Trust Co., FSB, which is the trustee for the RSP Plan, in accordance with the discretionary instructions of the Administrative Committee of the RSP Plan.

What will I be voting on?

You will be voting on:

How does the board recommend I vote on the proposals?

The board of directors recommends you vote “FOR” each of the three proposals listed above.

How do I vote?

Most of our shareholders have three options for submitting their votes:

If your AGL Resources shares are held in your name by Computershare Trust Company, N.A., our transfer agent (meaning you are a “shareholder of record”), please follow the instructions on your proxy card.

If your AGL Resources shares are held through a brokerage firm or bank (that is, in “street name”), your ability to vote by telephone or over the internet depends on the voting process of your brokerage firm or bank. Please follow the directions on your vote instruction card.

Regardless of whether your AGL Resources shares are held by Computershare or in street name, you can attend the meeting and vote your shares in person. Please note that if your shares are held in street name and you want to vote in person, you must obtain a vote instruction card from your street name nominee and bring it to the meeting.

Even if you plan to attend the meeting, we encourage you to vote your shares by telephone, internet or mail to simplify the voting process at the meeting.

How do I vote if my shares are held in the AGL Resources 401(k) plan?

If your AGL Resources shares are held in the RSP Plan, only the trustee of the plan can vote your plan shares even if you attend the annual meeting in person. The plan trustee will vote your shares in accordance with your telephone, internet or written proxy vote. Please follow the instructions on your proxy card.

Can I revoke my proxy?

Yes. You may revoke your proxy or vote instructions at any time before the annual meeting by voting again by telephone or via the internet or by timely signing and returning another proxy or vote instruction card with a later date. Additionally, if you are a shareholder of record or if you are a street name holder who has obtained a vote instruction card from your street name nominee, and you decide to attend the meeting and vote in person, you can request that any proxy or vote instruction card that you previously submitted not be used.

What if I don’t specify my choices when returning my proxy or vote instruction card?

If you return a signed and dated proxy or vote instruction card without indicating your vote, your shares will be voted “FOR” each of the three proposals specified in the notice of the meeting (except with respect to “broker non-votes” as described below) and in the discretion of the proxies on any other matter that may properly come before the meeting.

If you hold AGL Resources shares through the RSP Plan and you return the proxy card but do not properly sign or date it or specify how you want your plan shares voted, the plan trustee, upon instruction from the Administrative Committee of the RSP Plan, will vote your plan shares “FOR” each of the three proposals specified in the notice of the meeting and as

instructed by the Administrative Committee on any other proposals that may properly come before the meeting.

Can my shares be voted if I don’t submit a proxy or voting instructions?

If your AGL Resources shares are registered in your name on the books kept by our transfer agent and you do not return a signed proxy and do not vote by telephone or via the internet, your shares will not be voted.

If your AGL Resources shares are held in street name and you do not submit any voting instructions, your brokerage firm or bank may vote your shares with regard to some but not all of the proposals, as specified by stock exchange rules. We believe that under applicable stock exchange rules, brokerage firms and banks will be able to vote their customers’ unvoted shares with regard to the proposals to elect directors and ratify the appointment of our independent registered public accounting firm but not with regard to the proposal to approve the 2007 Omnibus Performance Incentive Plan. When brokerage firms and banks are not permitted to vote their customers’ unvoted shares, the affected shares are referred to as “broker non-votes.”

If your AGL Resources shares are held through the RSP Plan and you do not return the proxy card for those plan shares and do not vote by telephone or the internet, the plan trustee, upon instruction from the Administrative Committee of the RSP Plan, will vote your shares “FOR” each of the three proposals specified in the notice of the meeting and as instructed by the Administrative Committee on any other proposals that may properly come before the meeting.

How many shares can vote?

As of the February 23, 2007, record date for voting at the annual meeting, 77,881,401 shares of common stock of AGL Resources

were outstanding and entitled to be voted at the annual meeting. This total includes shares held by a trust which holds the assets of our Nonqualified Savings Plan, which we refer to as the NSP, which are not considered outstanding for financial reporting purposes. You are entitled to one vote for each share of AGL Resources common stock you owned on the record date.

Is there a list of shareholders entitled to notice of the annual meeting?

A list of shareholders entitled to notice of the annual meeting is available for inspection by any shareholder between the hours of 9:00 a.m. and 5:00 p.m., Eastern time, at our headquarters at Ten Peachtree Place, Atlanta, Georgia. Please contact our Corporate Secretary at AGL Resources Inc., P.O. Box 4569, Location 1466, Atlanta, Georgia 30302-4569, if you would like to review the shareholder list. The shareholder list will also be available at the annual meeting for inspection by any shareholder.

How many votes must be present to hold the annual meeting?

A majority of the 77,881,401 shares of AGL Resources common stock outstanding on the record date, including the shares held by the NSP trust, must be present, either in person or represented by proxy, to conduct the annual meeting.

How many votes are needed to elect directors?

Directors are elected by a plurality of the total number of votes cast, which means the six nominees who receive the largest number of properly cast votes will be elected as directors.

What happens if a director nominee fails to receive a majority of the votes cast in his election?

As described in “Proposal 1—Election of Directors—General,” our bylaws provide that if

a director nominee in an uncontested election is elected by the required plurality vote of the shareholders but does not receive the affirmative vote of the holders of a majority of the shares voted, the director must promptly tender his resignation to the board of directors following certification of the shareholder vote. The Nominating and Corporate Governance Committee must then recommend to the board of directors whether to accept or reject the tendered resignation or whether to take other action. The board must then act on the tendered resignation and publicly disclose its decision and the rationale behind the decision within 90 days after the certification of the election results.

What if I vote “withhold authority” to elect directors?

In voting for the election of directors, a vote to “withhold authority” for the election of one or more director nominees will be counted for quorum purposes, but because the vote required to elect directors is a plurality vote, a vote to “withhold authority” will not affect the outcome of the election. However, a vote to “withhold authority” will be counted for purposes of determining whether a director nominee received the affirmative vote of holders of a majority of the shares voted. Please see “What happens if a director nominee fails to receive a majority of the votes cast in his election?” above.

How many votes are required to approve the 2007 Omnibus Performance Incentive Plan?

The approval of our 2007 Omnibus Performance Incentive Plan requires a majority of the votes cast on the proposal, provided that the total votes cast on the proposal constitute a majority of the shares of common stock entitled to vote on the proposal.

How many votes are required to ratify the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm?

The ratification of the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm requires the votes cast “FOR” to exceed the votes cast “AGAINST” the proposal.

How will abstentions and broker non-votes be treated for Proposals 2 and 3?

Abstentions and broker non-votes will be treated as shares present and entitled to vote for quorum purposes. Abstentions will have the same effect as votes “AGAINST” the approval of the 2007 Omnibus Performance Incentive Plan (Proposal 2). Abstentions will not affect the outcome of the vote on the proposal to ratify the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm (Proposal 3).

Without your instruction, your broker may not vote your shares on the approval of the 2007 Omnibus Performance Incentive Plan (Proposal 2). Such broker non-votes will be treated as shares entitled to vote on the proposal but will not be counted as votes cast for purposes of determining whether the total votes cast on Proposal 2 constitute a majority of the shares of common stock entitled to vote on the proposal. If the total votes cast on Proposal 2 constitute a majority of the shares of common stock entitled to vote on the proposal, then the broker non-votes will not have any effect on the approval of Proposal 2.

Could other matters be decided at the annual meeting?

We do not know of any other matters that will be considered at the annual meeting. If a matter that is not listed on the proxy or vote instruction card is properly brought before the annual meeting in accordance with Section 1.2

of our bylaws, the proxies will vote in accordance with their judgment of what is in the best interest of the Company, based on the discretionary voting authority conferred on them by the proxy and vote instruction cards.

Who will count the vote?

Representatives of Computershare, our transfer and shareholder services agent, will count the votes and act as inspector of elections.

Where and when will I be able to find the voting results?

We will post the voting results on our web site at www.aglresources.com approximately two weeks after the annual meeting. You also can find the results in our Form 10-Q for the second quarter of 2007, which we will file with the Securities and Exchange Commission, or SEC, no later than August 9, 2007.

What does it mean if I receive more than one proxy card?

It means that you have multiple accounts with brokerage firms, banks and/or our transfer agent. Please vote all of these shares. We recommend that you contact your broker, bank and/or our transfer agent to consolidate as many accounts as possible under the same name and address. All communications concerning accounts for shares registered in your name on the books kept by our transfer agent, including address changes, name changes, inquiries to transfer shares and similar issues, can be handled by making a toll-free call to Computershare’s AGL Resources Shareholder Services number at (800) 633-4236.

What do I need to bring with me if I want to attend the annual meeting?

The annual meeting is open to all holders of our common stock. To attend the annual meeting, you will need to bring an admission

ticket and valid picture identification. If your shares are registered in your name on the books kept by our transfer agent or your shares are held as 401(k) plan shares, your admission ticket is attached to your proxy card or may be printed from the internet when you vote online. If your shares are held in street name by your brokerage firm or bank, you will need to bring evidence of your stock ownership, such as a proxy obtained from your street name nominee (particularly if you want to vote your shares at the annual meeting) or your most recent brokerage account statement (in which case you will not be able to vote your shares at the meeting), together with valid picture identification. You may also request us to send you an admission ticket. If you do not have either an admission ticket or proof that you own our common stock, together with valid picture identification, you may not be admitted to the meeting.

What happens if the annual meeting is postponed or adjourned?

Your proxy will still be valid and may be voted at a postponed or adjourned meeting, unless the board of directors fixes a new record date for the postponed or adjourned meeting, which the board is required to do if the postponement or adjournment is for more than 120 days. If the meeting is postponed or adjourned, you will still be able to change or revoke your proxy until it is voted.

When are shareholder proposals for the 2008 annual meeting due?

Our bylaws require shareholders to give us advance notice of any shareholder nominations of directors and of any other matters shareholders wish to present for action at an annual meeting of shareholders. The required notice must be given within a prescribed time frame, which is calculated by reference to the date of the proxy statement relating to our most recent annual meeting.

Accordingly, with respect to our 2008 annual meeting of shareholders, our bylaws require notice to be provided to our Corporate Secretary at AGL Resources Inc., P.O. Box 4569, Location 1466, Atlanta, Georgia 30302-4569 no later than November 20, 2007. If a shareholder fails to provide timely notice of a proposal to be presented at the 2008 annual meeting, the persons designated as proxies by the board of directors will have discretionary authority to vote, and the trustee of the RSP Plan will vote in accordance with the instructions of the Administrative Committee of the RSP Plan based on its discretionary authority, on any such proposal that may come before the meeting.

If you are interested in submitting a proposal for inclusion in our proxy statement for the annual meeting in 2008, you need to follow the procedures outlined in the SEC’s Rule 14a-8. To be eligible for inclusion, your shareholder proposal intended for inclusion in the proxy statement for the 2008 annual meeting of shareholders must be received no later than November 20, 2007, by our Corporate Secretary at the address above.

This deadline does not apply to questions a shareholder may wish to ask at the annual meeting.

Who pays the costs associated with this proxy solicitation?

AGL Resources pays the expenses of soliciting proxies. AGL Resources has hired Georgeson Inc., a proxy solicitation firm, to assist in the distribution and solicitation of proxies. We expect to pay Georgeson Inc. approximately $15,000 plus reasonable out-of-pocket costs for those services. Additionally, proxies may be solicited on our behalf by directors, officers and employees, in person or by telephone, facsimile or electronic transmission. Directors, officers and employees will not be paid additional fees for those services.

Notes to Share Ownership Table

The board of directors presently consists of fourteen members, thirteen of whom are non-employee directors. The board is divided into three classes of approximately equal size, with the directors in each class serving a three-year term. The terms are staggered so that the term of one class expires at each annual meeting.

Our bylaws provide that directors are elected by a plurality of the votes cast by shareholders at a meeting at which a quorum is present. In October 2006, the board of directors adopted an amendment to the bylaws that, while not changing the requirement for a plurality vote in the election of directors, requires additionally that any director nominee in an uncontested election who does not receive the affirmative vote of a majority of the votes cast (including votes to withhold authority) with respect to that director’s election must promptly tender his or her resignation to the board following certification of the shareholder vote. The requirement that a director tender his or her resignation if he or she does not receive a majority of the votes cast does not apply in the case of a contested election where the number of nominees exceeds the number of directors to be elected.

Following such a tender of resignation, the Nominating and Corporate Governance Committee, excluding any director tendering his or her resignation if he or she is a member of the Nominating and Corporate Governance Committee, will make a recommendation to the board as to whether to accept or reject the resignation or whether other action should be taken. The board will then act on the Nominating and Corporate Governance Committee’s recommendation and publicly disclose its decision and rationale within 90 days after the date of the certification of the election results. The director who tenders his

or her resignation will not participate in the board’s decision. If the director’s resignation is not accepted by the board, the director shall continue to serve until his or her successor is duly elected or until his or her earlier death, resignation or removal. If the director’s resignation is accepted by the board of directors, any resulting vacancy may be filled as provided in the bylaws or the board of directors may decrease the size of the board.

If a majority of the Nominating and Corporate Governance Committee does not receive a majority of the votes cast in their respective elections, then the independent members of the board who did not fail to receive a majority of the votes cast will appoint a committee from among themselves to consider the resignation offers and recommend to the board whether to accept them. If the only directors who did not fail to receive a majority of the votes cast constitute three or fewer directors, all directors may participate in the action regarding whether to accept the resignation offers.

The board of directors, based on the recommendation of its Nominating and Corporate Governance Committee, has nominated Thomas D. Bell, Jr., Michael J. Durham, Charles H. McTier, Dean R. O’Hare, D. Raymond Riddle, and Felker W. Ward, Jr. for election as directors at the annual meeting. All of the nominees are current directors of the Company. If elected, Mr. McTier will hold office for a two-year term ending at the annual meeting of shareholders in 2009 and each of the remaining nominees will hold office for a three-year term ending at the annual meeting of shareholders in 2010. Each of the nominees has agreed to serve as a director if elected by the shareholders.

If any nominee becomes unable to stand for election, the board may:

Set forth below is information as of December 31, 2006, about the six director nominees, followed by information as of December 31, 2006, about all other current directors whose terms of office will continue after the annual meeting. Unless otherwise stated, all directors have been engaged in their principal occupations for more than the past five years.

Board of Directors

Our business affairs are managed under the direction of the board of directors in accordance with the Georgia Business Corporation Code, our articles of incorporation and our bylaws. The role of the board of directors is to govern our affairs for the benefit of our shareholders and other constituencies, which include our employees, customers, suppliers, creditors and the communities in which we do business. The board strives to ensure the success and continuity of our business through the appointment of qualified executive management, overseen by the board.

Ethics and Compliance Program

The board of directors is responsible for overseeing management’s implementation of the Company’s ethics and compliance program to ensure that our business is conducted in a consistently legal and ethical manner. As part of the ethics and compliance program, the Company has established, and the board of directors has approved, a code of conduct entitled “Commitment to Integrity and Ethics—AGL Resources Code of Business Conduct.” Our Code of Business Conduct governs the way we treat our customers and co-workers, guides our community interactions, and strengthens our commitment to excellence and integrity. The Code of Business Conduct covers a wide range of professional conduct, including environmental, health and safety standards, employment policies, conflicts of interest, accuracy of records, fair dealing, insider trading and strict adherence to all laws and regulations applicable to the conduct of our business. Under the Code of Business Conduct, employees are required to conduct the Company’s activities in an ethical and lawful manner and all employees are expected to report any situation where they believe our

internal policies or external laws are being violated. Our Code of Business Conduct applies to our directors, officers and all of our employees.

In addition, the board of directors has adopted a Code of Ethics for the Chief Executive Officer and the Senior Financial Officers designed to deter wrongdoing and to promote: honest and ethical conduct; full, fair, accurate, timely and understandable disclosure in documents filed or submitted to the SEC; compliance with applicable governmental laws, rules and regulations; prompt internal reporting of violations of the Code of Ethics; and accountability for adherence to the Code of Ethics.

Any waiver of the Code of Business Conduct or Code of Ethics for an executive officer and, where applicable, for a member of the board of directors requires the approval of the board of directors or a duly authorized committee of the board and will be promptly disclosed on our website at www.aglresources.com. No waivers have been granted under the codes.

The board of directors also has adopted Guidelines on Significant Corporate Governance Issues, or our Corporate Governance Guidelines, that set forth guidelines for the operation of the board of directors and its committees. The board periodically reviews our governance practices and procedures, evaluating them against corporate governance best practices.

Our Code of Business Conduct, our Code of Ethics and our Corporate Governance Guidelines are available on our website at www.aglresources.com. They also are available to any shareholder upon request to Investor Relations, AGL Resources Inc. at P.O. Box 4569, Location 1071, Atlanta, Georgia 30302-4569.

Director Independence

Pursuant to New York Stock Exchange listing standards, our board of directors has adopted a formal set of categorical Standards for Determining Director Independence. In accordance with these Standards, a director must be determined to have no material relationship with the Company other than as a director in order to be considered an independent director. The Standards specify the criteria by which the independence of our directors will be determined, including strict guidelines for directors and their immediate family members with respect to past employment or affiliation with the Company or its independent registered public accounting firm. The Standards also set forth independence criteria applicable to members of the Audit Committee, the Compensation and Management Development Committee, the Nominating and Corporate Governance Committee and the Corporate Development Committee of the board of directors. The Standards meet and in some areas exceed the independence standards of the New York Stock Exchange. These Standards are available on our website at www.aglresources.com.

In accordance with these Standards, the board undertook in January 2007 an annual review of director independence. Based on this review, the board has affirmatively determined that, as to each current non-employee director (Messrs. Bell, Crisp, Durham, Johnson, Knox, Love, McTier, O’Hare, Riddle, Rubright, Ward and Wolf and Ms. Whyte), no material relationship exists that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and that each current non-employee director qualifies as “independent” in accordance with the Standards and the independence standards of the New York Stock Exchange. John W. Somerhalder II, our president and chief executive officer, is not independent because of his employment by the Company.

Mr. Somerhalder will not participate in any action of the board related to his compensation or any other matters requiring action by only non-employee directors.

In making these independence determinations, the board considered that in the ordinary course of business, transactions may occur between the Company and its subsidiaries and companies at which some of our directors are or have been directors, officers or employees. The board also considered that the Company and its subsidiaries may make charitable contributions to not-for-profit organizations where our directors or their immediate family members serve or are executive officers.

For information about certain transactions between us and business entities with which each of Messrs. Bell, Knox and Wolf are associated and the board’s determinations that these directors are independent notwithstanding these transactions, see “Certain Relationships and Related Transactions.” Additionally, in making its independence determinations, the board considered the fact that Messrs. Crisp and Durham are each non-employee directors of public corporations with which we or our subsidiaries conduct business in the ordinary course and that Ms. Whyte is an employee, but not an executive officer, of a public company that in the ordinary course of its business guarantees payment of certain debt obligations of one of our subsidiaries but to which we have made no premium or other payments in the past three years. The board of directors concluded that these relationships are not material and have no effect on the independence of those directors.

Policy on Related Person Transactions

The board of directors recognizes that related person transactions present a heightened risk of conflicts of interest and therefore, in December 2006, adopted a written policy with respect to related person transactions. For the purpose of the policy, a “related person

transaction” is a transaction between us and any related person, other than (1) transactions available to all employees or customers generally, or (2) transactions involving less than $120,000 when aggregated with all similar transactions. “Related persons” are (a) executive officers as defined under Section 16 of the Securities Exchange Act of 1934, as amended, (b) executive and senior vice presidents of AGL Resources, (c) each member of the board of directors, (d) holders of more than 5% of our common stock and (e) any immediate family member, as defined under the Exchange Act, of the persons listed in (a) through (d) above.

Under the policy, when management becomes aware of a related person transaction involving a dollar amount that is less than one percent of either the Company’s consolidated gross revenues or the consolidated gross revenues of the related person, or any affiliate of such related person, for the prior fiscal year, management reports the transaction to the Nominating and Corporate Governance Committee. When management becomes aware of a related person transaction involving a dollar amount that is equal to or exceeds one percent of either the Company’s consolidated gross revenues or the consolidated gross revenues of the related person, or any affiliate of such related person, for the prior fiscal year, management reports the transaction to the Nominating and Corporate Governance Committee and requests approval or ratification of the transaction.

Transactions requiring approval or ratification must be (1) on terms comparable to those that could be obtained in arm’s length dealings with an unrelated third person; and (2) approved by a majority of the disinterested members of the Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee will report to the full board all related person transactions presented to it.

None of the related party transactions referred to in this proxy statement was required to be reviewed by the Nominating and Corporate Governance Committee because the board of directors had not yet adopted the policy at the time of the transactions.

Board and Committee Meetings

Members of the board are kept informed through reports routinely presented at board and committee meetings by our chief executive officer and other officers and through other means. During 2006, the board of directors held eight meetings. Each director attended 75% or more of the aggregate of all meetings of the board and each committee on which he or she served.

Executive Sessions without Management

To promote open discussion among the non-management directors, the board of directors schedules regular executive sessions in which the non-management directors meet without management’s participation. Such sessions are scheduled to occur at every regularly scheduled board meeting. The presiding director at such executive sessions is the Chairman of the Executive Committee of the board of directors. Mr. Riddle served from April 2006 through December 2006 as Chairman of the Executive Committee. During Mr. Riddle’s service as our interim chairman and chief executive officer from January 2006 until March 2006, Mr. Ward served as the presiding director at the executive sessions and as Chairman of the Executive Committee. During 2006, the board met in executive session five times.

Communications with Directors

Shareholders and other interested parties may communicate with our board of directors or, alternatively, with the presiding director of executive sessions of our non-management directors or with the non-management directors as a group via our Ethics and

Compliance Helpline at (800) 350-1014 or at www.mycompliancereport.com. A copy of our Procedures for Communicating with the Board of Directors of AGL Resources Inc. is available on our web site at www.aglresources.com and is available in print to any shareholder who requests it from our Corporate Secretary at AGL Resources Inc., P.O. Box 4569, Location 1466, Atlanta, Georgia 30302-4569.

Committees of the Board

The board of directors has established seven standing committees to assist it in discharging its duties. During 2006, the board of directors also appointed an ad hoc Search Committee

of the board in connection with its search for our new president and chief executive officer following the resignation of our former chairman, president and chief executive officer as of December 31, 2005. Actions taken by any committee of the board are reported to the board, usually at the board meeting next following a committee meeting. Each standing committee has adopted a written charter, which is available on our web site at www.aglresources.com and is available upon request to our Corporate Secretary at AGL Resources Inc., P.O. Box 4569, Location 1466, Atlanta, Georgia 30302-4569. The committees of the board and their current members are as shown in the following table.

Audit Committee

The Audit Committee met eight times during 2006. The Audit Committee’s primary function is to assist the board of directors in fulfilling its oversight responsibilities. Among other things, the Audit Committee monitors (1) the integrity of our financial statements, including our internal control over financial reporting, (2) our compliance with legal and regulatory requirements, (3) the independent registered public accounting firm’s qualifications and independence, (4) the performance of our internal audit function, and (5) the performance of the independent registered public accounting firm. Our chief financial officer, chief ethics and compliance officer, chief auditor and controller and representatives of our independent registered public accounting

firm each provide a quarterly report to and meets in separate executive sessions with the Audit Committee each quarter.

The board of directors has determined that all members of the Audit Committee satisfy the enhanced independence standards applicable to all members of the Audit Committee under the independence requirements of the SEC, the New York Stock Exchange and the Company’s Standards for Determining Director Independence. The board also has determined that all members of the Audit Committee meet the financial literacy requirements of the New York Stock Exchange listing standards. The board has further determined that Michael J. Durham, the Audit Committee Chair, is a “financial expert” within the meaning of SEC regulations.

Additional information regarding the Audit Committee and its functions and responsibilities is included in this proxy statement under the captions “Audit Committee Report” and “Proposal 3—Ratification of the Appointment of PricewaterhouseCoopers LLP as our Independent Registered Public Accounting Firm for 2007.”

Compensation and Management Development Committee

The Compensation and Management Development Committee met seven times during 2006. All members of the Compensation and Management Development Committee are independent, non-employee directors, as defined under the listing standards of the New York Stock Exchange and our Standards for Determining Director Independence. Among other things, the Compensation and Management Development Committee assists the board of directors in its efforts to achieve its goal of maximizing the long-term total return to shareholders by establishing policies by which officers, directors and employees are to be compensated in accordance with the board’s compensation philosophy and objectives and by overseeing management succession and executive development processes.

The board of directors delegated to the Compensation and Management Development Committee the following areas of responsibilities that are more fully described in the Compensation and Management Development Committee’s charter:

The Compensation and Management Development Committee has delegated to our chief executive officer the authority to grant equity awards to employees of the Company solely in connection with non-annual grants to employees other than executive officers. The Committee has established narrowly defined, pre-approved parameters regarding the terms and conditions of grants under the delegated authority, including the eligible employee groups, the maximum number of shares subject to the delegation, the determination of the exercise price and other terms and conditions of the awards. In 2006, the Committee also adopted a stock option grant policy that provides additional terms and conditions for grant making. See “Compensation Discussion and Analysis—When Long-term Grants are Made” for more detail concerning our stock option grant policy.

Our chief executive officer, based on the performance evaluations of the other executive officers, recommends to the Compensation and Management Development Committee compensation for those executive officers. The executive officers, including our chief executive officer, also provide recommendations to the Committee from time to time related to compensation philosophy, program design, compliance, performance measures and competitive strategy.

The Compensation and Management Development Committee’s charter provides that the Committee, in its sole discretion, has the authority to retain a compensation consultant. Accordingly, Towers Perrin was retained directly by the Compensation and Management Development Committee to assist it in 2006. Towers Perrin’s role is to

provide expertise and data as needed by the Committee pertaining to all aspects of executive and director compensation, including but not limited to advice and counsel as to the amount and form of executive and director compensation, and to advise the Committee on emerging trends, best practices and regulatory practices.

Corporate Development Committee

The Corporate Development Committee met three times during 2006. The Corporate Development Committee’s primary function is to assist the board of directors in fulfilling its oversight responsibilities by reviewing (1) management’s efforts to identify and evaluate opportunities to acquire or develop assets that complement our asset base and support our long-term strategic plan for growth and expansion, and (2) any other matters that the board of directors may delegate to the Corporate Development Committee from time to time.

Environmental and Corporate Responsibility Committee

The Environmental and Corporate Responsibility Committee met four times during 2006. The Environmental and Corporate Responsibility Committee’s primary function is to assist the board of directors in fulfilling its oversight responsibilities. Among other things, the Environmental and Corporate Responsibility Committee (1) reviews and monitors corporate policy with respect to our relationships with employees, shareholders, customers, competitors, suppliers and our communities, (2) identifies and monitors emerging political, social and environmental trends and public policy issues that may affect our business operations, performance or public image, and (3) reviews and monitors matters relating to employee and community health and safety.

Executive Committee

The Executive Committee met once during 2006. The Executive Committee may meet

during intervals between board meetings and has all the authority of the board, subject to limitations imposed by law or our bylaws.

Finance and Risk Management Committee

The Finance and Risk Management Committee met five times during 2006. The Finance and Risk Management Committee’s primary function is to assist the board of directors in fulfilling its oversight responsibilities. Among other things, the Finance and Risk Management Committee oversees (1) the management of our balance sheet including leverage, liquidity, funding sources, and related matters, (2) management’s assessments, actions, processes and procedures concerning our exposure to risks identified in the Finance and Risk Management Committee’s charter, and (3) any other matters that the board may delegate to the Finance and Risk Management Committee from time to time. Our chief risk officer provides a quarterly report to and meets in executive session with the Finance and Risk Management Committee at each regularly scheduled meeting.

Nominating and Corporate Governance Committee

The Nominating and Corporate Governance Committee met four times during 2006. All members of the Nominating and Corporate Governance Committee are independent, non-employee directors, as defined under the listing standards of the New York Stock Exchange and our Standards for Determining Director Independence. The Nominating and Corporate Governance Committee’s primary responsibilities include (1) identifying individuals qualified to serve on the board of directors and recommending director nominees for selection by the full board of directors or shareholders, and (2) evaluating, formulating and recommending to the board of directors corporate governance policies.

In 2006, the Nominating and Corporate Governance Committee recommended, and the board of directors adopted, non-substantive amendments to our Standards for Determining Director Independence, which are available on our web site at www.aglresources.com and are available upon request to our Corporate Secretary at AGL Resources Inc., P.O. Box 4569, Location 1466, Atlanta, Georgia 30302-4569.

Nomination of Director Candidates. The board of directors is responsible for recommending director candidates for election by the shareholders and for electing directors to fill vacancies or newly created directorships. The board of directors has delegated the screening and evaluation process for director candidates to the Nominating and Corporate Governance Committee, which identifies, evaluates and recruits highly qualified director candidates and recommends them to the board of directors. Potential candidates for director may come to the attention of the Nominating and Corporate Governance Committee through current directors, management, professional search firms, shareholders or other persons.

If the Nominating and Corporate Governance Committee has either identified a prospective nominee or determined that an additional or replacement director is required, the Nominating and Corporate Governance Committee may take such measures that it considers appropriate in connection with its evaluation of a director candidate, including candidate interviews, engagement of an outside firm to gather additional information and inquiry of persons with knowledge of the candidate’s qualifications and character. In its evaluation of director candidates, including the members of the board of directors eligible for reelection, the Nominating and Corporate Governance Committee considers the current size and composition of the board of directors and the needs of the board of directors and the respective committees of the board in

view of the criteria for directors described in our Corporate Governance Guidelines, a copy of which is available on our web site at www.aglresources.com.

The Nominating and Corporate Governance Committee will consider director nominees proposed by shareholders. A shareholder may recommend a person for nomination for election to our board of directors by writing to our Corporate Secretary at AGL Resources Inc., P.O. Box 4569, Location 1466, Atlanta, Georgia 30302-4569. Pursuant to our Corporate Governance Guidelines, each submission must include:

A shareholder’s recommendation for a candidate for nomination to be elected at the next annual meeting of shareholders must be received by our corporate secretary no later than 45 days prior to the end of the year

preceding such annual meeting of shareholders. The Nominating and Corporate Governance Committee will evaluate these recommendations in the same manner as it evaluates all other nominees, using the criteria described in our Corporate Governance Guidelines.

The Nominating and Corporate Governance Committee periodically engages a third party search firm, Russell Reynolds Associates, Inc., to identify possible candidates for the Nominating and Corporate Governance Committee’s consideration based on skills and characteristics identified by the Nominating and Corporate Governance Committee and in light of gaps in board composition that the Nominating and Corporate Governance Committee may identify from time to time as the issues facing the board evolve. Such skills and characteristics desirable in the context of the then current make-up of the board of directors may include diversity, age, business or professional background, financial literacy and expertise, availability, commitment,

independence and other relevant criteria. Mr. McTier, who is the one director who is new to our board, was identified by a non-management member of the board of directors. The Nominating and Corporate Governance Committee engaged Russell Reynolds to interview and gather additional information concerning Mr. McTier’s qualifications and characteristics in light of the then current needs of the board. Mr. McTier is standing for election by the shareholders at the annual meeting.

Search Committee

The Search Committee met nine times during 2006. Messrs. Bell, Crisp, Johnson and Rubright, all of whom are independent and non-employee directors, served as members of the Search Committee. The responsibility of the Search Committee was to identify and recommend to the full board the hiring of our president and chief executive officer following the resignation of our former chairman, president and chief executive officer as of December 31, 2005.

The Audit Committee of the board of directors is composed of five directors who are independent directors, as defined under the listing standards of the New York Stock Exchange and the Company’s Standards for Determining Director Independence. The Audit Committee operates under a written charter adopted by the board of directors, a copy of which is available on the Company’s web site at www.aglresources.com.

The Audit Committee reviews the Company’s financial reporting process on behalf of the board of directors. In fulfilling its responsibilities, the Audit Committee has reviewed and discussed the audited financial statements contained in the Company’s Annual Report on Form 10-K for 2006 with management and the Company’s independent

registered public accounting firm, PricewaterhouseCoopers LLP. Management is responsible for the Company’s financial statements and the financial reporting process, including the system of internal control over financial reporting. PricewaterhouseCoopers is responsible for expressing an opinion on the conformity of those audited financial statements with accounting principles generally accepted in the United States and on management’s assessment of and the effectiveness of the Company’s internal control over financial reporting.

The Audit Committee has discussed with PricewaterhouseCoopers the matters required to be discussed by Statement on Auditing

Standards No. 61, Communication with Audit Committees, as amended, regarding PricewaterhouseCooper’s judgments about the quality of the Company’s accounting principles as applied in its financial reporting. In addition, the Audit Committee has discussed with PricewaterhouseCoopers its independence from the Company and its management, including the matters in the written disclosures and the letter provided to the Audit Committee by PricewaterhouseCoopers as required by Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees. The Audit Committee has concluded that PricewaterhouseCoopers is independent from the Company and its management.

Based on the reviews and discussions referred to above, the Audit Committee recommended and concurred with the board of directors’

decision to approve the inclusion of the audited financial statements in the Company’s Annual Report on Form 10-K for 2006 for filing with the SEC.

Michael J. Durham (Chair)

Dennis M. Love

D. Raymond Riddle

Bettina M. Whyte

Henry C. Wolf

The information contained in the Audit Committee Report shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference in such filing.

The Compensation and Management Development Committee of the board of directors is composed of five directors who are independent directors, as defined under the listing standards of the New York Stock Exchange and the Company’s Standards for Determining Director Independence. The Compensation and Management Development Committee operates under a written charter adopted by the board of directors, a copy of which is available on the Company’s web site at www.aglresources.com.

The Compensation and Management Development Committee has reviewed and discussed with management the “Compensation Discussion and Analysis,” or CD&A, section of this proxy statement required by Item 402(b) of Regulation S-K of the SEC. Based on the Committee’s review and discussions with management, the Committee recommended to the board of

directors that the CD&A be included in the Company’s annual report on Form 10-K and in this proxy statement.

Arthur E. Johnson (Chair)

Thomas D. Bell, Jr.

Charles R. Crisp

Dean R. O’Hare

James A. Rubright

The information contained in the Compensation and Management Development Committee Report shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that we specifically incorporate it by reference in such filing.

The following directors served on the Compensation and Management Development Committee during 2006: Thomas D. Bell, Jr., Charles R. Crisp, Arthur E. Johnson (Chair), Dean R. O’Hare and James A. Rubright. None of such persons was, during 2006 or previously, an officer or employee of AGL Resources or any of its subsidiaries and each such person was an independent director as defined under the listing standards of the New York Stock Exchange and our Standards for Determining Director Independence.

Thomas D. Bell, Jr. is Chairman, President and Chief Executive Officer of Cousins Properties Incorporated. Cousins holds a 50% general partnership interest in Ten Peachtree Place Associates, or TPPA, which owns the building where we lease space for our corporate headquarters. Mr. Bell is not an officer of TPPA. Although Cousins is the

managing member of TPPA, major business decisions for the TPPA partnership must be decided unanimously by Cousins and its partner. Prior to Mr. Bell joining our board of directors, we entered into a ten-year lease agreement with TPPA that commenced in 2003. Cousins’ 50% interest in the amount we paid in lease payments to TPPA in 2004 was approximately $2,863,000, in 2005 was approximately $2,993,000 and in 2006 was approximately $3,104,000, which was less than 1% of both our consolidated gross revenues and Cousins’ consolidated gross revenues for such respective years. Revenue amounts of less than 1% do not create any presumption of materiality, and hence create no issue with regard to a director’s independence from management, under our Standards for Determining Director Independence.

General

A director who is one of our employees receives no additional compensation for his or her services as a director or as a member of a committee of our board. A director who is not one of our employees (a non-employee director) receives compensation for his or her services as described in the following paragraphs. All directors are reimbursed for reasonable expenses incurred in connection with attendance at board and committee meetings.

Initial Stock Award

Stock awards include shares of our common stock and common stock equivalents as more fully described in the following paragraphs. All stock awards are 100% vested as of date of grant and eligible for dividend treatment at the same rate as our other shares of common stock.

Upon his or her initial election or appointment to the board, each non-employee director receives 1,000 shares of our common stock.

Annual Retainer

Each non-employee director receives an annual retainer for service as a director on the first day of each annual service term. The amount and form of the annual retainer is fixed from time to time by resolution of the board. Effective as of the date of the 2007 annual meeting of shareholders, the annual retainer will increase from $90,000 to $105,000, of which (1) $35,000, or the Cash Portion, will be payable in cash and $70,000, or the Equity Portion, will be payable in shares of our common stock. Alternatively, a director may choose to receive his or her entire retainer (including the Cash Portion) in shares of our common stock, or to defer the retainer under the CSE Plan. During the 2006 service term, the annual retainer was $90,000, of which the Cash Portion was $30,000 and the Equity Portion was $60,000.

Amounts deferred under the CSE Plan are invested in common stock equivalents that track the performance of our common stock and are credited with equivalents to dividend payments that are made on our common stock. At the end of a non-employee director’s board service, a participating director receives a cash distribution based on the then-current market value of his or her common stock equivalents and dividend equivalents.

Committee Chair Retainer

Effective as of the date of the 2007 annual meeting of shareholders, committee chairs will receive an annual retainer on the first day of each annual service term. The Audit Committee chair will receive $12,000; the Compensation and Management Development Committee chair will receive $8,000; and all other committee chairs will receive $6,000. The committee chair retainer is payable, at the election of each director, in cash or shares of our common stock, or it may be deferred under the CSE Plan.

Meeting Fees

Each non-employee director receives $2,000 for attendance in person or by telephone at each meeting of the board and any committee of the board of which he or she is a member.

Meeting fees may be paid in cash or, at the election of a director, may be deferred under the CSE Plan. As noted above, under the CSE Plan, deferred meeting fees are invested in common stock equivalents that track the performance of our common stock and are credited with dividend equivalent payments. At the end of a non-employee director’s board service, a participating director receives a cash distribution based on the then-current market value of his or her common stock equivalents and dividend equivalents.

Non-Employee Director Compensation Paid

As noted above, during the 2006 service term, each non-employee director other than Mr. McTier received compensation as follows:

Upon his election to the board in December 2006, Mr. McTier received an initial stock award of 1,000 shares; an annual retainer of $37,500, which represents a pro-rated retainer; and $2,000 for attendance in person or by telephone at each meeting of the board and any committee of the board of which he is a member.

The following table sets forth compensation earned and paid to or deferred by each non-employee director for service as a director during 2006.

Share Ownership and Holding Period Requirements for Non-Employee Directors

In order to serve on our board, directors are required to own shares of our common stock. Our share ownership guidelines for non-employee directors require that non-employee directors own shares of our common stock having a value of at least $300,000, which represents five times the value of the Equity Portion, and ten times the value of the Cash Portion of the annual retainer. As a result of the $10,000 increase in the Equity Portion of the annual retainer that will become effective as of the date of the 2007 annual meeting of shareholders, the share ownership requirement will be increased by $50,000 to $350,000, effective as of the date of the annual meeting of shareholders. Each director has five years from the date of his or her initial election to meet the share ownership requirement. Common stock

equivalents and shares issuable upon the exercise of vested stock options are included in the determination of the ownership guideline amount. We believe that the equity component of non-employee director compensation serves to further align the interests of the non-employee directors with the interests of our shareholders.

Under the terms of the 2006 Non-Employee Directors Equity Compensation Plan, non-employee directors will be required to hold shares awarded under the plan until the earlier of (i) five years from the date of the initial stock award or stock grant; (ii) termination of the non-employee director’s service; or (iii) a change in control of the Company. Shares subject to the holding period include all shares issued in connection with an initial stock award under the plan and all shares issued under the plan in payment of all or part of a director’s annual retainer.

This Compensation Discussion and Analysis, or CD&A, provides an overview of our compensation objectives and policies, the elements of compensation that we provide to our top executive officers, and the material factors that we considered in making the decisions to pay such compensation. Later in this proxy statement under the heading “Executive Compensation,” you will find a series of tables containing specific information about the compensation earned or paid in 2006 to the following individuals, whom we refer to as our named executive officers:

The discussion below is intended to help you understand the information provided in those tables and put that information into context within our overall compensation program.

Executive Compensation Program Objectives

Our executive compensation program has three primary and related objectives:

In accordance with these goals, we provide a significant portion of each executive’s compensation in the form of at-risk incentive awards that measure individual performance and our success as a company in achieving our business strategy and objectives. With respect to Company performance, we focus on two primary criteria:

The program is governed by the Compensation and Management Development Committee, or the Committee, of our board of directors. Information about the Committee and its composition, responsibilities and operations can be found on page 19 of this proxy statement, under the caption “Corporate Governance—Compensation and Management Development Committee.”

Compensation Program Elements and their Purpose

Our executive compensation program consists primarily of the following integrated components: base salary, annual incentive awards, and long-term incentive opportunities, which together make up an executive’s total direct compensation in a given year. The program also

contains elements relating to retirement, severance, and other employee benefits.

Determining the Amount of Each Element

We review each executive officer’s compensation annually for market competitiveness and performance impact. For 2006, the Committee engaged the services of Towers Perrin, an independent compensation consultant, to benchmark base salary, target annual incentive opportunities and annual long- term incentive market rates from three market perspectives:

Atmos Energy Corporation

Energen Corporation

Equitable Resources, Inc.

National Fuel Gas Company

New Jersey Resources Corporation

Nicor Inc.

ONEOK, Inc.

Peoples Energy Corporation

Piedmont Natural Gas Company, Inc.

Questar Corporation

UGI Corporation

WGL Holdings, Inc.

Western Gas Resources Inc.

    (acquired by Andarko Petroleum             Corporation in August 2006)

Proxy peers represent those companies with whom we feel our performance is most comparable, but for compensation purposes this group provides a very limited view of the available labor market. In addition, our company is larger and has a broader scope of business than most of our proxy peers. Our industry peers include a much larger list of companies and provide a more accurate understanding of the broader labor market in which we compete for executive talent. A review of general industry data provides the Committee with the broadest perspective on the competitive labor market. We review the peer groups annually to assure that we have the appropriate marketplace focus.

The Committee examines each component of pay on a standalone basis and taken together as a whole and adjusts levels of base pay and targets for annual and long-term incentives with a bias to performance-based outcomes. We seek to be generally competitive with the 75th percentile of our proxy peers and the 50th percentile of our industry peers across the three pay elements that make up total direct compensation (base salary, annual incentive and long-term incentives). For 2006, total direct compensation for our named executive officers was consistent with these benchmarks.

Benchmarking practices also provide the Committee with insight regarding the effective relative mix of short- and long-term incentives and the mix of cash and stock-based pay.

Enterprise and individual performance among the peer groups may cause our competitive posture to vary from year to year in the aggregate or on an individual executive level. We do not apply a specific formula to determine any adjustments to overall or individual executive pay. Instead, the Committee determines individual compensation amounts in a deliberative process with input from the Committee’s independent executive compensation consultant.

For 2006, the Committee determined that base salary, target annual incentives and target long-term cash awards for the named executive officers represented a mix that was appropriately competitive when compared to the peer groups. The factors that went into this decision are described below.

Base salary—The factors that the Committee considered in setting base salary for our named executive officers in 2006 included: pay for comparable positions among peers,

our company’s performance, individual executive performance, internal equity comparisons and time elapsed plus any changes in position scope or responsibility since the last pay increase. In 2006, three of our named executive officers were in new roles of increased responsibility and correspondingly received significant salary increases (Mr. Madden as executive vice president external affairs, Mr. Evans as executive vice president and chief financial officer and Mr. Martinez as executive vice president utility operations). These appointments became effective in late 2005. Messrs. Evans and Martinez received additional salary adjustments mid-2006 to recognize their progress in their new executive roles and to better position their compensation from a competitive standpoint.

Annual incentives—Our Annual Incentive Plan, or AIP, provides the framework for annual incentives that include all full-time employees (unless excluded by their Collective Bargaining Agreement or by a separate business unit plan). In 2006, our named executive officers (other than Mr. Schantz, as described below) also participated in our Executive Performance Incentive Plan, or EPIP, which was approved

by our shareholders and is intended to qualify for the performance- based compensation exception to the deduction limits under Section 162(m) of the U.S. tax code.

For 2006, the Committee derived performance measures from our annual operating plan and business strategy, as reviewed by the board of directors. Measures applicable to the named executive officers included our corporate EPS target, which was weighted at 75% of the total award, and individual performance, which was weighted at 25%. The individual goals for each executive were aligned with our corporate objectives under the following themes: provide superior growth in earnings and dividends, build on our growing reputation for customer service excellence through enhanced logistics, make people our competitive advantage, and be relentless in business process improvement. Despite this weighting, the Committee determined that no incentive pay would be received unless the threshold EPS performance goal was met. The Committee feels that EPS is an appropriate measure of our performance, as it reflects any growth of the business and any changes in the value of shareholder investment. EPS also is a common measure of general financial and operating health used by stock and financial analysts as well as investors. For our chief executive officer, the individual performance component was based on the Committee’s assessment, at the end of the year, of his performance against individual objectives established at the time he was hired in 2006. For the other named executive officers, our chief executive officer performed a similar assessment of their performance related to their respective individual goals and reviewed that assessment with the Committee. The individual performance component was based on the Committee’s assessment, at the end of the year, of each executive’s performance against individual objectives established at the beginning of the year.

For 2006, total payout opportunity ranged from 0% to 200% of the target opportunity, based on each of the performance factors, corporate and individual, on a weighted basis. To achieve a 200% award, performance must have met or exceeded maximum performance levels on both measures. Target opportunities for named executive officers ranged from 60% to 75% of base salary. For 2006, our EPS target was $2.63 and our actual reported EPS was $2.73, which represented performance at the 200% level. Each of our named executive officers met or substantially exceeded their individual goals.

Mr. Schantz serves as president of Sequent Energy Management, LP, or Sequent, our asset management company, which maintains an annual incentive program specific to its employees and separate from the EPIP. The Sequent incentive plan is described in more detail on page 42 of this proxy statement in the narrative discussion of the Grants of Plan-Based Awards. While Mr. Schantz was not a participant in the EPIP or the Sequent incentive plan, in establishing his incentive compensation for 2006, the Committee considered the factors described above relating to the EPIP, the annual incentive compensation payable to Mr. Schantz’s direct reports under the Sequent plan, and Sequent’s performance. The Sequent plan provides for mandatory deferral of 50% of any amount earned by a participant for a plan year, which exceeds the participant’s annual base salary for that year. The deferred amount is payable in approximately equal installments on each of the first two anniversaries of the deferral date. If a participant experiences a termination of employment, for any reason, before an anniversary date, the applicable installment is forfeited. During the deferral period, deferred amounts earn interest calculated at the appropriate treasury rate. This deferral feature also applies to Mr. Schantz’ annual incentive compensation. Sequent substantially exceeded the performance measures established under its incentive plan for the 2006 plan year.

Long-term incentives (LTI)—For 2006, the Committee, utilizing market and benchmarking data furnished by its consultant, determined that overall potential LTI compensation for the named executive officers should range between 70% and 250% of base salary.

As noted earlier, for 2006 we used three vehicles to deliver LTI, each having their respective purpose and proportion of total LTI grant value. The use of the proportional mix of options, restricted stock units and performance cash awards was set with an eye towards the respective attributes that each of these vehicles represent from the Company’s and executive’s perspective, as described below.

The realized compensation value from LTI is ultimately determined by our stock price performance over the term of the awards and, in the case of the equity portion, the executive’s decisions as to when to exercise stock options and to sell shares.

Factors influencing actual individual grant levels include executive level and position, past performance, retention concerns, if any, and company performance. The 20%-40%-40% mix used in 2006 was determined based upon peer group data and by balancing factors that included the cost of equity awards and projected impact on shareholder dilution.

Allocating Between Long-term and Annual Compensation

We seek to maintain an executive compensation program that is balanced in terms of each element of pay relative to

competitive practices, with the incentive emphasis placed on long-term versus short-term results. The overall program is intended to balance business objectives for executive pay for performance, retention, competitive market practices and shareholder interests. For 2006, approximately 55% to 75% of the annual total direct compensation target opportunity was subject to performance risk for named executive officers through the annual and long-term incentive plans. Annual incentive awards, which constitute short-term incentives, accounted for slightly more than 20% of annual target compensation for all executives. LTI awards made up over 50% of the annual target compensation mix for our chief executive officer and between 33% and 47% for other named executive officers. The Committee developed target total direct compensation and these relative divisions between short- and long-term incentives for 2006 in coordination with its independent consultant based on the consultant’s research regarding effective and emerging practice among proxy peers and industry peers.

A total of 60% of the LTI target value in 2006 was delivered through stock-based awards, and the remaining 40% was cash value earned on the basis of earnings growth and dividend yield over a three-year performance period to end on December 31, 2008. The Committee believes that this mix effectively aligns the executive’s interests with shareholders’ interests while also providing the executive with a measure of diversification by means of the cash component.

When Long-term Grants are Made

The Committee typically grants LTI awards annually at a regularly scheduled meeting of the board of directors, usually in late January or early February. The meeting date is scheduled well in advance and without regard to potential stock price movement.

On October 25, 2006, the Committee adopted a stock option grant policy, or the Policy. The

Policy provides that in the ordinary course, stock option grants to executive officers and annual stock option grants to all other key employees will be made by the Committee at a regularly scheduled meeting. However, the Policy also provides that the Committee may make grants through use of a unanimous written consent, in lieu of a meeting, but only when circumstances prevent the action from being taken at a regularly scheduled meeting. Any non-annual grant of options issued to non-executive officers by our chief executive officer pursuant to delegated authority generally will have a grant date of the first business day of the month following our chief executive officer’s approval of the grant. The exercise price of all stock options must be no less than the closing price of our common stock as of the trading day immediately preceding the date of grant. All stock option grants must be documented in minutes, unanimous written consents or delegated authority grant reports approved by the Committee and must be promptly communicated to the option recipient by means of an option agreement or notice.

The Role of Executive Officers in Determining Executive Compensation

Our chief executive officer develops recommendations regarding executive compensation, including proposals relative to compensation for individual executive officers, using internal and external resources. These resources include such things as compensation surveys, external data and reports from consultants and data, reports and recommendations from internal staff. Recommendations from our chief executive officer include and consider all aspects of the compensation program—philosophy, design, compliance and competitive strategy—as well as specific actions regarding individual executive officer compensation. The Committee reviews these recommendations with Towers Perrin, its independent compensation consultant, and decides

whether to accept, reject, or revise this proposal. The Committee may recommend certain decisions to the full board for its approval.

Our chief financial officer assists the Committee in understanding key business drivers included in program designs, especially incentive programs. This may include defining related measures and explaining the mutual influence on or by other business drivers and the accounting and tax treatment relating to certain awards. Our chief financial officer also provides regular updates to the Committee regarding current and anticipated performance outcomes and their impact on executive compensation.

Our general counsel ensures that appropriate plan documentation and approvals are received in order to keep executive pay programs in compliance with applicable laws and stock exchange listing requirements. Our general counsel also advises the Committee and board of directors regarding compliance with appropriate governance standards and requirements.

Discretion to Modify Awards

As previously noted, annual incentive awards are based on our company’s and each individual executive officer’s performance over the most recently completed fiscal year. Individual performance accounts for 25% of total performance for an executive officer. The Committee reserves the right to adjust individual goals during the course of the year in order to reflect changes in the Company and its business.

In determining the corporate performance component under our EPIP, the Committee has the authority to:

No such discretion was exercised in determining award payments for 2006 performance.

Under the LTI program the Committee has discretion to extend an award that would otherwise be forfeited, but not beyond the original term of the award. The Committee does not generally have the authority to unilaterally rescind an award. Each award defines the terms under which it would be forfeited according to the terms approved by shareholders in the 1999 Long-Term Incentive Plan.

Impact of Restated Earnings on Previously Paid or Awarded Compensation

We have not had to restate earnings in a manner that would impact incentive award payments. If future restatements are necessary, the Committee and the board of directors will consider the facts and circumstances relating to the cause of the restatement, as well as the requirements under Section 304 of the Sarbanes-Oxley Act of 2002, in determining whether any payments based upon the financial results were made unjustly and the materiality and methods for recovering such payments.

Accounting and Tax Treatment of Direct Compensation

For executives, all compensation is subject to federal, state and local taxes as ordinary income or capital gains as various tax jurisdictions provide. Section 162(m) of the U.S. tax code places a limit of $1,000,000 on the amount of compensation that we may deduct in any one year with respect to any one of our named executive officers. However, qualifying performance-based compensation will not be subject to the deduction limit if certain requirements are met. The Committee

anticipates that awards under our long-term incentive programs and the corporate portion of the annual incentive for executives under the EPIP will continue to qualify as performance-based compensation. To maintain flexibility in compensating our executives, however, the Committee reserves the right to use its judgment to authorize compensation payments that may be subject to the limit when the Committee believes that such payments are appropriate. Accordingly, certain components of our executive compensation program are designed to be qualifying performance-based compensation under Section 162(m) while others are not.

With the adoption of FAS 123R, we do not expect accounting treatment of differing forms of equity awards to vary significantly and, therefore, accounting treatment is not expected to have a material effect on the selection of forms of compensation.

Stock Ownership

We maintain stock ownership guidelines that are designed to ensure sustained, meaningful

executive share ownership, align executive long-term interests with shareholder interests, and demonstrate our officers’ commitment to enhancing long-term shareholder value. As chief executive officer, Mr. Somerhalder is expected to own shares of stock with a market value of at least five times his annual base salary, and our other named executive officers are expected to own shares of stock with a market value of two or three times their annual base salaries, depending on position level. Attainment of these ownership levels are reviewed regularly by the Committee. We include all of the stock owned by an executive, his restricted stock and vested stock options, and stock included in his account under our RSP and NSP Plan in calculating compliance with the ownership guidelines. Reports are provided regularly to the Committee as to the status of each executive’s stock ownership. As of December 31, 2006, each of our named executive officers has either met his stock ownership requirements or has made significant progress toward meeting the ownership requirement within the required time period.

Grants of Plan-based Awards

The Compensation and Management Development Committee granted the following types of plan-based awards in 2006:

Non-equity Incentive Plan Awards

Equity-based Plan Awards

Non-equity Incentive Plan Awards

Estimated future payouts under non-equity incentive plan awards include both annual cash incentive grants and performance cash grants.

Annual cash incentive grants

Unlike base salary that is fixed, annual cash incentive grants are a part of compensation that is intended to vary as a direct reflection of performance as measured over our twelve-month fiscal year.

For Messrs. Somerhalder, Evans, Martinez and Madden, annual cash incentives are granted under the AIP and EPIP. Under the EPIP, we measure company performance. Under the AIP, we measure business unit and individual performance. The annual performance measurement period under both plans corresponds with our fiscal year and ends December 31. Target incentive opportunity is expressed as a percent of base salary. Total payout opportunity ranges from 0% to 200% of the target opportunity. The Company must meet or surpass its corporate EPS performance threshold in order for any cash incentive payments to be made under either plan, irrespective of the level of individual performance. For 2006, at the senior executive level, target incentive opportunity ranged from 60% to 75% of base salary, and weighting is 75% on corporate EPS results

and 25% on individual performance. The corporate portion of these awards is intended to qualify as “performance-based compensation” under Section 162(m) of the U.S. tax code.

Mr. Schantz’s annual cash incentive arrangement is based upon our EPS, Sequent’s corporate performance (as measured under the Sequent annual incentive plan), and Mr. Schantz’s individual performance in leading the Sequent business. Under the Sequent annual incentive plan, Sequent’s performance is measured by its earnings before taxes, or EBT, as of December 31, 2006, against expectations set earlier in the year. Target incentive opportunity is expressed as a percent of salary. Actual payout is based on a bonus pool that equals a percentage of Sequent’s EBT. Sequent must meet or surpass its EBT threshold in order for any incentive payments to be made, irrespective of the level of individual performance. There is no cap on the level of individual payout. Mr. Schantz does not participate, directly, in the Sequent annual incentive plan. However, Sequent’s performance against its annual incentive plan’s performance measures and the amounts earned under the plan by Mr. Schantz’s direct reports were additional factors considered by the Compensation and Management Development Committee in determining Mr. Schantz’s 2006 annual incentive payment. The Sequent annual incentive plan provides for mandatory deferral of 50% of any amount earned by a participant for a plan year, which exceeds the participant’s annual base salary for that year. The deferred amount is payable in approximately equal installments on each of the first two anniversaries of the deferral date. If a participant experiences a termination of employment, for any reason, before an anniversary date, the applicable installment is forfeited. During the deferral period, deferred amounts earn interest calculated at the appropriate treasury rate. The deferral feature described above also applies to Mr. Schantz’ annual incentive.

At the beginning of the fiscal year, the Compensation and Management Development Committee makes annual cash incentive grants by establishing performance targets and setting individual target opportunities. Following the end of the fiscal year, the Compensation and Management Development Committee certifies performance achieved and authorizes payouts.

Actual annual cash incentive payouts earned in 2006 and paid in 2007 are included in the Summary Compensation Table above.

Performance Cash Awards

Performance cash awards represent an opportunity to receive a cash award subject to the achievement of certain pre-established performance criteria. Performance cash awards have a 36-month performance measurement period that ends on December 31, 2008, and a performance measure that relates to our average annual growth in earnings per share plus the average dividend yield. Total payout opportunity ranges from 0% to 140% of the target opportunity. The Company must meet or surpass its threshold level in order for any award to be paid. For 2006, at the senior executive level, performance cash awards represent 40% of long-term incentive awards and range between 29% and 56% of a senior executive officer’s base salary.

The Compensation and Management Development Committee makes performance cash grants at the beginning of the fiscal year by establishing performance targets and setting individual target opportunities. Following the end of the performance measurement period, the Compensation and Management Development Committee certifies performance achieved and authorizes payouts. The Committee intends that these awards qualify as “performance-based compensation” under Section 162(m) of the U.S. tax code.

Equity Incentive Plan Awards

Equity incentive plan awards include restricted stock, restricted stock units and stock options. These awards are intended to reward performance over a long-term with clear links to shareholder value appreciation. The incentive opportunity is expressed as a percentage of base salary. The actual compensation realized from these incentives will vary as a reflection of stock price performance over time.

Stock Awards. Stock awards, which include restricted stock and restricted stock units, are subject to time-based vesting according to the terms of the respective stock award agreement. Stock awards are subject to transfer restrictions and subject to forfeiture upon a recipient’s termination of employment for any reason prior to vesting. Upon a change in control of the Company, all stock awards immediately become vested.

Our restricted stock units have a 12-month performance measurement period with a pre-established performance hurdle. The performance measure for the 2006 restricted stock unit awards relates to a basic earnings per share goal.

If the performance measure is not achieved, the restricted stock units are forfeited. If the performance hurdle is achieved, the restricted stock units convert to an equal number of shares of restricted stock and, thereafter, vest ratably over a three-year period.

Restricted stock units are not eligible for dividend credit or voting. During the vesting period for restricted stock, the recipient has the right to vote the stock and receive dividends. These awards are intended to qualify as “performance-based compensation” under Section 162(m) of the U.S. tax code.

Stock Options. All stock options are granted at fair market value as of the date of grant. Fair market value is defined under the terms of our

applicable plans as the closing price of our common stock as of the trading day immediately before the date of grant.

Employee stock options are subject to time-based vesting and are exercisable according to the terms of the respective option agreement. Stock options granted to non-employee directors are 100% vested as of the date of grant. The exercise price of options may be paid in cash, by delivery of already-owned shares of our common stock or by other methods approved by our Compensation and Management Development Committee. The expiration date for stock options is ten years from the date of grant for

options other than reload options. Reload options, which are available only with respect to options granted in the past, have an expiration date that is the same date as the expiration date of the original underlying option. Options are subject to early termination upon the occurrence of certain events related to termination of employment or service. All options immediately become exercisable in the event of a change in control.

An option holder realizes value from a stock option only to the extent that the price of our common stock on the exercise date exceeds the exercise price of the option on the grant date.

Notes to Grants of Plan-Based Awards Table

Notes to annual incentive awards

Notes to performance cash awards

Notes to restricted stock and restricted stock units

Notes to stock options