Nicol was elected as MSP for Aberdeen South in the first elections to the Scottish Parliament. He later helped negotiate the Partnership Agreement for the coalition government with the Labour Party. He later served in the Scottish Executive as Deputy Minister for Enterprise and Lifelong Learning, then as Deputy Minister for Education, Europe and External Affairs, and as Deputy Minister for Education and Young People. Following the 2003 election, he was appointed Minister for Transport. During his time in this post, he was responsible for approving the controversial M74 extension.
Deputy First Minister
Following the resignation of Jim Wallace in May 2005 as leader of the Scottish Liberal Democrats, Nicol announced his intention to stand for the leadership. He defeated rival candidate, Mike Rumbles, who advocated ending the coalition agreement with the Scottish Labour Party, winning 76.6%, becoming the Deputy First Minister on 23 June 2005. Following his leadership victory, a mini-reshuffle of the Scottish cabinet, saw him take on the role of Minister for Enterprise and Lifelong Learning.
Opposition
Following the 2007 election, with the SNP emerging the largest party by one seat but short of an overall majority, it held discussions with the Scottish Green Party and also intimated that it would be open to discussions with the Liberal Democrats. However, since the Liberal Democrats had indicated that they would not enter discussions with parties which continued to favour a referendum on independence, no formal talks were held: the SNP became a minority administration and Nicol led his party to the opposition benches. Despite being out of government, his party worked with the minority SNP Government on certain issues where they broadly agreed, including replacing the council tax with a local income tax to fund a proportion of local government revenue. He developed a reputation among some journalists as an effective and forceful critic of some aspects of the Scottish Government's policy and performance, especially at First Minister's Question Time. Along with Wendy Alexander and Annabel Goldie, he took his party into the Commission on Scottish Devolution chaired by Sir Kenneth Calman, but was opposed to any suggestion that this would result in powers of the Parliament being returned to Westminster.
Resignation as Party Leader
On 2 July 2008, Nicol announced he was stepping down as party leader with immediate effect because of the pressures of leading a political party while having a young family based in Aberdeen, some distance from the Parliament in Edinburgh. Nicol's resignation took many in Scottish politics by surprise, and came only four days after the resignation of the former leader of Labour in the Scottish Parliament, Wendy Alexander. He was succeeded by Tavish Scott. On 24 September 2010, Nicol announced he would not be standing again at the Scottish elections in May 2011.
House of Lords
On 2 February 2011, he was created a life peer as Baron Stephen, of Lower Deeside in the City of Aberdeen, and was introduced in the House of Lords on 7 February 2011, where he sits on the Liberal Democrat benches. He said he will use his new position to help reform the House of Lords.