Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The following discussion, as well as other discussions in this Annual Report on Form 10-K, contains forward-looking statements about future events and expectations within the meaning of the Private Securities Litigation Reform Act of 1995. We have based these forward-looking statements on our current expectations and projections about future results. When we use words in this document such as “anticipates,” “intends,” “plans,” “believes,” “estimates,” “projects,” “expects,” “should,” “could,” “may,” “will,” and similar expressions, we do so to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements we make regarding future prospects of growth in the petroleum additives market, other trends in the petroleum additives market, our ability to maintain or increase our market share, and our future capital expenditure levels.
We believe our forward-looking statements are based on reasonable expectations and assumptions, within the bounds of what we know about our business and operations. However, we offer no assurance that actual results will not differ materially from our expectations due to uncertainties and factors that are difficult to predict and beyond our control.
Factors that could cause actual results to differ materially from expectations include, but are not limited to, the availability of raw materials and distribution systems; disruptions at production facilities, including single-sourced facilities; hazards common to chemical businesses; the ability to respond effectively to technological changes in our industry; failure to protect our intellectual property rights; sudden, sharp, or prolonged raw material price increases; competition from other manufacturers; current and future governmental regulations; the gain or loss of significant customers; failure to attract and retain a highly-qualified workforce; an information technology system failure or security breach; the occurrence or threat of extraordinary events, including natural disasters, terrorist attacks, and health-related epidemics such as the COVID-19 pandemic; risks related to operating outside of the United States; political, economic, and regulatory factors concerning our products; the impact of substantial indebtedness on our operational and financial flexibility; the impact of fluctuations in foreign exchange rates; resolution of environmental liabilities or legal proceedings; limitation of our insurance coverage; our inability to realize expected benefits from investment in our infrastructure or from future acquisitions, or our inability to successfully integrate recent or future acquisitions into our business; and the underperformance of our pension assets resulting in additional cash contributions to our pension plans. Risk factors are discussed in Item 1A. “Risk Factors.”
You should keep in mind that any forward-looking statement made by us in this discussion or elsewhere speaks only as of the date on which we make it. New risks and uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. We have no duty to, and do not intend to, update or revise the forward-looking statements in this discussion after the date hereof, except as may be required by law. In light of these risks and uncertainties, any forward-looking statement made in this discussion or elsewhere, might not occur.
OVERVIEW
When comparing the results of the petroleum additives segment for 2021 with 2020, net sales increased 17.1% primarily due to higher lubricant additives product shipments, higher selling prices, and a favorable foreign currency impact. Petroleum additives operating profit was 15.7% lower when comparing 2021 with 2020 reflecting significantly higher raw material costs partially offset by improved product shipments and higher selling prices. In addition to rising raw material costs, we have experienced rising energy costs, transportation network issues, and other costs associated with the continuing global supply chain disruptions affecting supply and distribution. While we have made some progress in adjusting our selling prices to address these higher costs, our costs have continued to rise throughout the year outpacing our ability to adjust selling prices sufficiently to offset the cost increases.
During the year, we repurchased 566,671 shares of our common stock for a total of $196 million.
Our operations generate cash that is in excess of the needs of the business. We continue to invest in and manage our business for the long-term with the goal of helping our customers succeed in their marketplaces. Our investments continue to be in organizational talent, technology development and processes, and global infrastructure, consisting of technical centers, production capability, and geographic expansion.
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IMPACT OF THE CURRENT ECONOMIC ENVIRONMENT AND THE COVID-19 PANDEMIC
The current economic environment in which we operate is characterized by steadily rising costs, including raw material costs, limitations on certain supply availability, and a challenging supply chain network and transportation system. Because of our active business continuity process and global network, we have substantially managed through these factors during 2021 and have delivered product to our customers. We do not currently expect the supply chain network disruptions to be long-term in nature, but we cannot predict how the current economic environment may evolve over the coming months or how long the supply chain network disruptions may last. We will continue working with our customers to deliver product, but at the same time, we also expect to be challenged by these ongoing economic factors as we manage our business in 2022.
In addition, but to a lesser extent than during 2020, petroleum additives operating results for 2021 include an unfavorable impact from the economic uncertainty resulting from the ongoing effects of the COVID-19 pandemic and the related restrictions on the movement of people, goods, and services. The pace and stability of improvement in demand for our products will continue to depend heavily on economic recovery.
All of our locations around the world, including our manufacturing and research and development facilities, have continued to operate safely and without interruption during the pandemic, with only a very few government-ordered, short-term exceptions, and we expect them to continue to do so.
Our financial position remains strong. We have sufficient access to capital, if needed, and do not anticipate any issues with meeting the covenants for all our debt agreements. Our major capital projects are continuing to progress substantially as planned.
As we operate in the chemical industry, we continue to be focused on protecting the health and safety of our employees and have procedures in place at each of our operating facilities to help ensure their well-being.
The chemical industry and our products are recognized as essential for transportation of goods and services. Our business continuity planning process focuses our efforts on managing through this challenging time and helping our customers do the same. As we are a global company and can leverage the knowledge and experience of our personnel in facilities across the world, we do not expect to experience negative impacts related to short-term travel and border restrictions.
RESULTS OF OPERATIONS
Management's discussion and analysis of our results of operations is presented below for the comparative periods of 2021 versus 2020. The discussion and analysis of our results of operations for 2020 compared to 2019 is available in Item 7 of our 2020 Annual Report on Form 10-K.
Net Sales
Our consolidated net sales for 2021 amounted to $2.4 billion, an increase of $345 million, or 17.2% from 2020.
No single customer accounted for 10% or more of our total net sales in 2021, 2020, or 2019.
The following table shows net sales by segment and product line for each of the last three years.
Years Ended December 31,
(in millions) 2021 2020 2019
Petroleum additives
Lubricant additives $ 1,999 $ 1,687 $ 1,779
Fuel additives 345 315 397
Total 2,344 2,002 2,176
All other 12 9 14
Net sales $ 2,356 $ 2,011 $ 2,190
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Petroleum Additives - The regions in which we operate include North America (the United States and Canada), Latin America (Mexico, Central America, and South America), Asia Pacific, and the Europe/Middle East/Africa/India (EMEAI) region. The percentage of net sales being generated in the regions has remained fairly consistent over the past three years, with some limited fluctuation due to various factors, including the impact of regional economic trends. North America represents around 35% of our petroleum additives net sales, while EMEAI contributes about 30%, Asia Pacific about 25% and Latin America the remaining amount. As shown in the table above, lubricant additives net sales and fuel additives net sales compared to total petroleum additives net sales has remained substantially consistent over the past three years.
Petroleum additives net sales for 2021 of $2.3 billion were approximately 17.1% higher than 2020 levels. The increase was across all regions. The North America region represented approximately 40% of the petroleum additives increase in net sales, the Asia Pacific region represented about 26%, EMEAI represented approximately 16%, and the Latin America region nearly 18% of the increase. While 2021 results continue to include some economic impact of the COVID-19 pandemic, 2020 includes a more significant impact, reflecting lower demand for petroleum additives products due to more restrictions across the world on the movement of people, goods, and services.
The approximate components of the petroleum additives increase in net sales of $342 million when comparing 2021 to 2020 are shown below in millions.
Net sales for year ended December 31, 2020 $ 2,002
Lubricant additives shipments 220
Fuel additives shipments 0
Selling prices 98
Foreign currency impact, net 24
Net sales for year ended December 31, 2021 $ 2,344
Petroleum additives shipments accounted for a $220 million increase in net sales between 2020 and 2021. Higher selling prices along with a favorable foreign currency impact contributed $122 million of the increase in net sales between 2020 and 2021. The favorable foreign currency impact resulted from the United States Dollar weakening against most of the major currencies in which we transact with the majority of the favorable impact arising from net sales denominated in the Euro and the Chinese Renminbi when comparing 2021 and 2020.
On a worldwide basis, the volume of product shipments for petroleum additives increased 11.7% when comparing 2021 with 2020. The increase in shipments was predominantly in lubricant additives which had increases across all regions. Shipments of fuel additives products increased across all regions except for the EMEAI region resulting in total fuel additives shipments being substantially flat. Product shipments during 2020 were negatively impacted due to the COVID-19 pandemic.
All Other - The “All other” category includes the operations of the antiknock compounds business, and certain contracted manufacturing and services performed by Ethyl.
Segment Operating Profit
NewMarket evaluates the performance of the petroleum additives business based on segment operating profit. NewMarket Services expenses are charged to each subsidiary pursuant to services agreements between the companies. Depreciation on segment property, plant, and equipment, as well as amortization of segment intangible assets and lease right-of-use assets, is included in segment operating profit.
The following table reports segment operating profit for the last three years. A reconciliation of segment operating profit to income before income tax expense is in Note 4.
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Years Ended December 31,
(in millions) 2021 2020 2019
Petroleum additives $ 281 $ 333 $ 359
All other $ (1) $ 0 $ (2)
Petroleum Additives - Petroleum additives segment operating profit decreased $52 million and gross profit decreased $45 million when comparing 2021 to 2020. Cost of goods sold as a percentage of net sales was 76.7% in 2021 and 70.4% in 2020. The operating profit margin was 12.0% in 2021 and 16.7% in 2020. Both operating profit and gross profit for 2021 and 2020 included the impact of improved selling prices and product shipments as discussed above, as well as an unfavorable foreign currency translation impact.
Throughout 2021, our operating margins have continued to decline mainly due to the prolonged period of escalating raw material costs. While we have made some progress in adjusting our selling prices to offset the effects of the higher costs, we have not been able to adjust selling prices sufficiently to offset the cost increases. We continue to experience a lag between when price increases go into effect and when margin recovery begins. This lag will continue until raw material prices stabilize. There have also been significant increases in many elements of our operating costs including utilities, logistics, insurance, and third-party manufacturing services. In addition, the worldwide supply chain disruptions continue to negatively impact our business.
In this uncertain economic environment of continuing increasing costs, operating profit margins remain a priority for us. Margin recovery and cost control will be priorities throughout 2022 with the goal of returning to our historical profit margin range. While operating margins will fluctuate from quarter to quarter due to multiple factors, we believe the fundamentals of our business and industry as a whole are unchanged.
Petroleum additives selling, general, and administrative expenses (SG&A) were $3 million, or 2.8% higher in 2021 compared to 2020. SG&A as a percentage of net sales was 5.2% in 2021 and 5.9% in 2020. Our SG&A costs are primarily personnel-related and include salaries, benefits and other costs associated with our workforce, including travel-related expenses. While personnel-related costs fluctuate from year to year, there were no significant changes in the drivers of these costs when comparing 2021 and 2020.
Our investment in petroleum additives research, development, and testing (R&D) increased approximately $4 million when comparing 2021 with 2020. As a percentage of net sales, R&D was 6.1% in 2021 and 7.0% in 2020. Our R&D investments reflect our efforts to support the development of solutions that meet our customers' needs, meet new and evolving standards, and support our expansion into new product areas. Our approach to R&D investment, as it is with SG&A, is one of purposeful spending on programs to support our current product base and to ensure that we develop products to support our customers' programs in the future. R&D investments include personnel-related costs, as well as costs for internal and external testing of our products. Substantially all investments in new product development are incurred in the United States and the U.K., with approximately 70% of total R&D being attributable to the North America and EMEAI regions. The remaining R&D is attributable to the Asia Pacific and Latin America regions and represents customer technology support services in those regions. All of our R&D is related to the petroleum additives segment.
The following discussion references certain captions on the Consolidated Statements of Income.
Interest and Financing Expenses
Interest and financing expenses were $34 million in 2021 and $26 million in 2020. The increase in interest and financing expense between 2021 and 2020 resulted primarily from higher average outstanding debt in 2021 than in 2020. The average interest rate was slightly lower in 2021 than 2020, which was mostly offset by higher amortization and fees due to the issuance of our 2.70% senior notes.
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Other Income (Expense), Net
Other income (expense), net was income of $24 million in 2021 and $46 million in 2020. The amounts for both periods included the components of net periodic benefit cost (income), except for service costs, from defined benefit pension and postretirement plans. See Note 18 for further information on total periodic benefit cost (income). The 2021 amount included a loss on marketable securities of $7 million, while 2020 included a gain of $16 million related to the sale of a non-operating parcel of real estate.
Income Tax Expense
Income tax expense was $57 million in 2021 and $61 million in 2020. The effective tax rate was 22.9% in 2021 and 18.3% in 2020. When comparing 2021 and 2020, income tax decreased $15 million due to the lower income before income taxes offset by a higher effective tax rate, which resulted in an increase of $11 million in income tax expense. The increase in the effective tax rate was primarily the result of the impact from our foreign operations, along with the non-recurring favorable adjustments in 2020 related to prior year tax filings and releasing certain tax reserves.
CASH FLOWS DISCUSSION
We generated cash from operating activities of $165 million in 2021 and $284 million in 2020.
During 2021, we used the $165 million cash generated from operations along with proceeds of $395 million from the issuance of 2.70% senior notes, $148 million of borrowings under the revolving credit facility, and cash on hand of $42 million to invest $382 million in marketable securities, repurchase $196 million of our common stock, pay $86 million of dividends on our common stock, and fund capital expenditures of $79 million. Cash flows from operating activities included cash contributions of $10 million to our pension and postretirement plans, as well as a decrease of $116 million from higher working capital requirements, which is further discussed below in the Working Capital section.
During 2020, we used the $284 million of cash generated from operations along with $19 million of cash on hand to repurchase $101 million of our common stock, pay $83 million of dividends on our common stock, repay $45 million on our revolving credit facility, and fund $93 million for capital expenditures. Cash flows from operating activities included a decrease of $54 million from higher working capital requirements, cash contributions of $11 million to our pension and postretirement plans, and a gain of $16 million related to the sale of a parcel of non-operating real estate.
FINANCIAL POSITION AND LIQUIDITY
Cash
At December 31, 2021, we had cash and cash equivalents of $83 million as compared to $125 million at the end of 2020.
Cash and cash equivalents held by our foreign subsidiaries amounted to approximately $81 million at December 31, 2021 and $97 million at December 31, 2020. Periodically, we repatriate cash from our foreign subsidiaries to the United States through intercompany dividends and loans. We do not anticipate significant tax consequences of future distributions of foreign earnings.
A portion of our foreign cash balances is associated with earnings that we have asserted are indefinitely reinvested. We plan to use these indefinitely reinvested earnings to support growth outside of the United States through funding of operating expenses, research and development expenses, capital expenditures, and other cash needs of our foreign subsidiaries.
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Debt
A summary of our debt instruments follows. A full discussion is in Note 14.
2.70% Senior Notes - On March 18, 2021, we issued $400 million aggregate principal amount of 2.70% senior notes due 2031 at an issue price of 98.763%. We intend to use the net proceeds from the offering for the repayment or redemption of our 4.10% senior notes and for general corporate purposes. We incurred financing costs in 2021 of approximately $4 million related to the 2.70% senior notes, which are being amortized over the term of the notes. We were in compliance with all covenants under the indenture governing the 2.70% senior notes as of December 31, 2021.
4.10% Senior Notes - At both December 31, 2021 and December 31, 2020, we had $350 million of 4.10% senior notes due 2022 with interest payable semiannually and which are senior unsecured obligations. We were in compliance with all covenants under the indenture governing the 4.10% senior notes as of December 31, 2021 and December 31, 2020. In February 2022, we announced the redemption of the entire outstanding principal amount of the 4.10% senior notes. See Note 24 for further information on the redemption.
3.78% Senior Notes - On January 4, 2017, we issued $250 million in senior unsecured notes in a private placement with The Prudential Insurance Company of America and certain other purchasers. These notes bear interest at 3.78% and mature on January 4, 2029. Interest is payable semiannually. Principal payments of $50 million are payable annually beginning on January 4, 2025. We have the right to make optional prepayments on the notes at any time, subject to certain limitations. We were in compliance with all covenants under the 3.78% senior notes as of December 31, 2021 and December 31, 2020.
Revolving Credit Facility – On March 5, 2020, NewMarket and certain foreign subsidiary borrowers entered into a Credit Agreement (the Credit Agreement) with a term of five years. The Credit Agreement provides for a $900 million, multicurrency revolving credit facility with a $500 million sublimit for foreign currency borrowings, a $50 million sublimit for letters of credit, and a $20 million sublimit for swingline loans. The Credit Agreement includes an expansion feature which allows us, subject to certain conditions, to request an increase in the aggregate amount of the revolving credit facility or obtain incremental term loans in an amount up to $425 million. NewMarket's obligations under the Credit Agreement are unsecured and the obligations of foreign subsidiary borrowers are fully and unconditionally guaranteed by NewMarket. The revolving credit facility is available on a revolving basis until March 5, 2025.
There was $148 million outstanding borrowings under the revolving credit facility at December 31, 2021 compared to no outstanding borrowings at December 31, 2020. Outstanding letters of credit amounted to $2 million at both December 31, 2021 and December 31, 2020 resulting in the unused portion of the applicable credit facility amounting to $750 million at December 31, 2021 and $898 million at December 31, 2020.
The average interest rate for borrowings under the credit facilities was 1.6% during 2021 and 1.4% during 2020.
The Credit Agreement contains financial covenants that require NewMarket to maintain a consolidated Leverage Ratio (as defined in the Credit Agreement) of no more than 3.75 to 1.00 except during an Increased Leverage Period (as defined in the Credit Agreement). At December 31, 2021, the Leverage Ratio was 3.36. We were in compliance with all covenants under the revolving credit facility in effect at December 31, 2021 and at December 31, 2020.
Other Borrowings - Two of our subsidiaries in Singapore and China each have access to separate short-term lines of credit of $10 million. One of our subsidiaries in the U.K. has access to a short-term line of credit of 10 million Euro. There was no activity on these lines of credit in 2021 or 2020.
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We had long-term debt of $1.1 billion at December 31, 2021 and $599 million at December 31, 2020. The increase in debt resulted from the issuance of the $400 million 2.70% senior notes, as well as additional borrowings outstanding under the revolving credit facility during 2021.
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As a percentage of total capitalization (total long-term debt and shareholders’ equity), our total long-term debt increased from 44.1% at the end of 2020 to 59.9% at the end of 2021. The change in the percentage was primarily the result of the increase in long-term debt, partially offset by a small increase in shareholders' equity. The change in shareholders’ equity primarily reflects our earnings and an increase in the funded position of our defined benefit plans mostly offset by stock repurchases, dividend payments, and the impact of the foreign currency translation adjustment. Normally, we repay any outstanding long-term debt with cash from operations or refinancing activities.
Working Capital
Including cash and cash equivalents and the impact of foreign currency on the balance sheet, at December 31, 2021, we had working capital of $663 million, resulting in a current ratio of 1.91 to 1. Our working capital at December 31, 2020 on the same basis was $586 million, resulting in a current ratio of 2.87 to 1.
The most significant change in working capital since December 31, 2020 resulted from the investment of the proceeds from the issuance of the 2.70% senior notes in marketable securities, the impact of which was mostly offset by our 4.10% senior notes becoming payable within 12 months. In addition to these items, cash and cash equivalents decreased as outlined in the cash flows discussion above, while accounts receivable, inventories, and accounts payable all increased.
Trade accounts receivable balances increased when compared to December 31, 2020 resulting primarily from higher shipment volumes in 2021 along with higher selling prices this year. Income and other tax receivables also increased reflecting overpayment of estimated income taxes in the fourth quarter of 2021, as well as higher balances of value added taxes for which we expect to be reimbursed. The increase in inventories was primarily related to higher production of products in certain regions, along with increased costs across all regions. The increase in accounts payable reflected higher costs, including raw material costs, as well as higher inventory levels in some regions.
Capital Expenditures
Capital expenditures were $79 million for 2021 and $93 million for 2020. We currently estimate capital expenditures in 2022 will be in the range of $75 million to $85 million as we anticipate spending on several improvements to our manufacturing and R&D infrastructure around the world. We expect to continue to finance capital spending through cash provided from operations, as well as with borrowing available under our $900 million revolving credit facility.
Environmental Expenses
We spent approximately $35 million in 2021 and $29 million in 2020 for ongoing environmental operating and clean-up costs, excluding depreciation of previously capitalized expenditures. These environmental operating and clean-up expenses are included in cost of goods sold. We expect to continue to fund these costs through cash provided by operations.
Liquidity and Contractual Obligations
We have both current and long-term obligations that have known payment streams and are discussed throughout this Report on Form 10-K. The more material of these include debt-related obligations, lease obligations, purchase commitments, including those for property, plant, and equipment, contributions to pension and postretirement benefit plans, and environmental dismantling and decontamination.
The debt-related contractual obligations include both principal payments on outstanding long-term debt and the related interest payments. The maturity dates and interest rates, as well as information on the repayment of the principal on our long-term debt is detailed above in the Debt section, as well as in Note 14. At December 31, 2021, all of our long-term debt was at fixed rates, except for the revolving credit facility. Interest is paid semi-annually on our fixed rate long-term debt agreements.
As detailed in Note 14, our revolving credit facility currently utilizes LIBOR in establishing certain interest rates on the facility. Interest rates determined based on LIBOR are being discontinued by June 2023 and replaced with a yet to be determined rate. While we do expect some impact to interest expense, we do not expect a significant impact to our financial results because of the elimination of LIBOR.
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Note 17 provides information by year on our lease obligations which have commenced, as well as lease commitments which have not yet commenced. Note 18 includes information on contributions to pension and postretirement benefit plans, as well as benefit payments to participants. Benefit payments under these plans are predominantly paid from assets held in trust. Further information on purchase commitments, including those for purchases of property, plant, and equipment is in Note 21.
The annual operating expenses and capital expenditures associated with compliance with environmental, health, and safety regulations are included in Item 1, Governmental and Environmental Regulations. In addition to these costs, there are expected cash flows for dismantling and decontamination of environmental sites. At December 31, 2021, these costs were estimated at $1 million in each of 2022 through 2026, and $9 million thereafter.
We expect that cash from operations, together with borrowing available under our credit facilities, will continue to be sufficient for our operating needs and planned capital expenditures for both a short-term and long-term horizon.
Pension and Postretirement Benefit Plans
Our U.S. and foreign benefit plans are discussed separately below. The information applies to all of our U.S. benefit plans. Our foreign plans are quite diverse, and the actuarial assumptions used by the various foreign plans are based upon the circumstances of each particular country and retirement plan. We use a December 31 measurement date to determine our pension and postretirement expenses and related financial disclosure information. Additional information on our pension and postretirement plans is in Note 18 .
U.S. Pension and Postretirement Benefit Plans —The average remaining service period of active participants for our U.S. plans is 13.4 years, while the average remaining life expectancy of inactive participants is 22.1 years. We utilize the sex distinct Pri-2012 table with separate rates for annuitants, non-annuitants, and contingent annuitants, projected generationally using Scale MP-2021 in determining the impact of the U.S. benefit plans on our financial statements.
Investment Return Assumptions and Asset Allocation —We periodically review our assumptions for the long-term expected return on pension plan assets. As part of the review and to develop expected rates of return, we considered an analysis of expected returns based on the U.S. plans’ asset allocation as of both January 1, 2022 and January 1, 2021. This analysis reflects our expected long-term rates of return for each significant asset class or economic indicator. The range of returns developed relies both on forecasts and on broad-market historical benchmarks for expected return, correlation, and volatility for each asset class. The asset allocation for our U.S. pension plans is predominantly weighted toward equities. Through the ongoing monitoring of our investments and review of market data, we have determined that we should maintain the expected long-term rate of return for our U.S. pension plans at 8.0% at December 31, 2021.
An actuarial gain on the assets occurred during both 2021 and 2020 as the actual investment return for all of our U.S. qualified pension plans exceeded the expected return by approximately $83 million in 2021 and $43 million in 2020. Investment gains and losses are recognized in earnings on an amortized basis over a period of 5 years. The amortization of the actuarial net loss is expected to be approximately $2 million in 2022 resulting primarily from the actuarial loss on plan liabilities which has only partially been offset by the investment gains on plan assets. We expect that there will be continued volatility in pension expense as actual investment returns vary from the expected return, but we continue to believe the potential long-term benefits justify the risk premium for equity investments.
At December 31, 2021, our expected long-term rate of return on our postretirement plans was 4.0%. This rate varies from the pension rate of 8.0% primarily because of the difference in investment of assets. The assets of the postretirement plan are held in an insurance contract, which results in a lower assumed rate of investment return.
Pension expense and the life insurance portion of postretirement expense are sensitive to changes in the expected return on assets. For example, decreasing the expected rate of return by 100 basis points to 7.0% for pension assets and 3.0% for postretirement benefit assets (while holding other assumptions constant) would increase the forecasted 2022 expense for our U.S. pension and postretirement plans by approximately $6 million. Similarly, a 100 basis point increase in the expected rate of return to 9.0% for pension assets and 5.0% for postretirement benefit assets (while holding other assumptions constant) would reduce forecasted 2022 pension and postretirement expense by $6 million.
Discount Rate Assumption —We develop the discount rate assumption by determining the single effective discount rate for a unique hypothetical portfolio constructed from investment-grade bonds that, in the aggregate, match the projected
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cash flows of each of our retirement plans. The discount rate is developed based on the hypothetical portfolio on the last day of December. The discount rate at December 31, 2021 was 2.875% for all plans.
Pension and postretirement benefit expense is also sensitive to changes in the discount rate. For example, decreasing the discount rate by 100 basis points to 1.875% (while holding other assumptions constant) would increase the forecasted 2022 expense for our U.S. pension and postretirement benefit plans by approximately $10 million. A 100 basis point increase in the discount rate to 3.875% would reduce forecasted 2022 pension and postretirement benefit expense by $4 million.
Rate of Projected Compensation Increase —We have maintained our rate of projected compensation increase at December 31, 2021 at 3.5%. The rate assumption was based on an analysis of our projected compensation increases for the foreseeable future.
Liquidity — Cash contribution requirements to the pension plan are sensitive to changes in assumed interest rates and investment gains or losses in the same manner as pension expense. While we do not expect to make a cash contribution to our U.S. qualified pension plans, we expect our aggregate cash contributions to the U.S. pension plans will be approximately $3 million in 2022. We expect our contributions to the postretirement benefit plans will be approximately $2 million in 2022.
Foreign Pension Benefit Plans —Our foreign pension plans are quite diverse. The following information applies only to our U.K. pension plan, which represents the majority of the amounts recorded in our financial statements for our foreign pension plans. The average remaining service period of active participants for our U.K. plan is 15 years, while the average remaining life expectancy of inactive participants is 25 years. In determining the impact of the U.K. pension plans on our financial statements, we utilize the S3P (Light) mortality tables and allow for future projected improvements in life expectancy in line with the CMI 2020 model with the core smoothing parameter, an initial addition to mortality improvements of 0.3% per year, and a 2020 experience weighting of 20% with a long-term rate of improvement of 1% per year based on the membership of the plan.
Investment Return Assumptions and Asset Allocation — We periodically review our assumptions for the long-term expected return on the U.K. pension plan assets. The expected long-term rate of return is based on both the asset allocation, as well as yields available in the U.K. markets.
The target asset allocation in the U.K. is to be invested 40% in pooled equities funds, 40% in pooled government bonds, and 20% in pooled diversified growth funds. The actual allocation at the end of 2021 was 42% in pooled equities funds, 39% in pooled government bonds, and 19% in pooled diversified growth funds. Based on the actual asset allocation and the expected yields available in the U.K. markets, the expected long-term rate of return for the U.K. pension plan was 4.6% at December 31, 2021.
Actuarial gains on the assets occurred during both 2021 and 2020 as the actual investment return exceeded the expected investment return by approximately $8 million in 2021 and $4 million in 2020. Investment gains and losses are recognized in earnings on an amortized basis over a period of years. The amortization of the actuarial net gain is expected to be expense of approximately $0.5 million in 2022 resulting primarily from the actuarial loss on the plan liabilities, which has only partially been offset by investment gains on the plan assets. We expect that there will be continued volatility in pension expense as actual investment returns vary from the expected return, but we continue to believe the potential benefits justify the risk premium for the target asset allocation.
Pension expense is sensitive to changes in the expected return on assets. For example, decreasing the expected rate of return by 100 basis points to 3.6% (while holding other assumptions constant) would increase the forecasted 2022 expense for our U.K. pension plan by approximately $2 million. Similarly, a 100 basis point increase in the expected rate of return to 5.6% (while holding other assumptions constant) would reduce forecasted 2022 pension expense by approximately $2 million.
Discount Rate Assumption —We utilize a yield curve based on AA-rated corporate bond yields in developing a discount rate assumption. The yield appropriate to the duration of the U.K. plan liabilities is then used. The discount rate at December 31, 2021 was 1.9%.
Pension expense is also sensitive to changes in the discount rate. For example, decreasing the discount rate by 100 basis points to 0.9% (while holding other assumptions constant) would increase the forecasted 2022 expense for our U.K.
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pension plans by approximately $2 million. A 100 basis point increase in the discount rate to 2.9% would reduce forecasted 2022 pension expense by approximately $1 million.
Rate of Projected Compensation Increase —Our rate of projected compensation increase at December 31, 2021 is 4.2%. The rate assumption was based on an analysis of our projected compensation increases for the foreseeable future.
Liquidity — Cash contribution requirements to the U.K. pension plan are sensitive to changes in assumed interest rates and investment gains or losses. We expect our aggregate U.K. cash contributions will be approximately $5 million in 2022.
OUTLOOK
Our stated goal is to provide a 10% compounded return per year for our shareholders over any five-year period (defined by earnings per share growth plus dividend yield), although we may not necessarily achieve a 10% return each year. We continue to have confidence in our customer-focused strategy and approach to the market. We believe the fundamentals of how we run our business - a long-term view, safety-first culture, customer-focused solutions, technology-driven product offerings, and world-class supply chain capability - will continue to be beneficial for all of our stakeholders over the long term.
We expect our petroleum additives segment to experience impacts to its operating performance due to the current economic environment, as we continue to see challenges with the global supply network, inflationary trends, and raw material price escalation and volatility. We expect that the petroleum additives market will grow in the 1% to 2% range annually for the foreseeable future. We plan to exceed that growth rate over the long-term.
Over the past several years we have made significant investments in our business as the industry fundamentals remain positive. These investments have been and will continue to be in organizational talent, technology development and processes, and global infrastructure, consisting of technical centers, production capability and geographic expansion. We intend to utilize these investments to improve our ability to deliver the solutions that our customers value, expand our global reach, and enhance our operating results. We will continue to invest in our capabilities to provide even better value, service, technology, and customer solutions.
Our business generates significant amounts of cash beyond its operational needs. We regularly review our many internal opportunities to utilize excess cash from technological, geographic, production capability, and product line perspectives. We believe our capital spending is creating the capability we need to grow and support our customers worldwide, and our research and development investments are positioning us well to provide added value to our customers. Our primary focus in the acquisition area remains on the petroleum additives industry. It is our view that this industry segment will provide the greatest opportunity for solid returns on our investments while minimizing risk. We remain focused on this strategy and will evaluate any future opportunities. We will continue to evaluate all alternative uses of cash to enhance shareholder value, including stock repurchases and dividends.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following discussion highlights some of the more critical areas where a significant change in facts and circumstances in our operating and financial environment could cause a change in future reported financial results.
Income Taxes
We file United States, foreign, state, and local income tax returns. Significant judgment is required in determining our worldwide provision for income taxes and recording the related tax assets and liabilities. Any significant impact as a result of changes in underlying facts, law, tax rates, or tax audits could lead to adjustments to our income tax expense, effective tax rate, financial position, or cash flow.
Deferred income taxes are provided for the estimated income tax effect of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities, as well as for net operating losses and tax credit carryforwards. When recording these deferred tax assets and liabilities, we must estimate the tax rates we expect will apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. In addition, we may record valuation allowances to reduce deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized. Judgment is required as we consider the scheduled reversal of
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deferred tax assets and liabilities, projected future taxable income, and tax planning strategies in making this assessment. If our estimates and assumptions change from those used when we recorded deferred tax assets and liabilities, the effect on our results of operations and financial position could be material.
The income tax returns for our entities in the United States and in foreign jurisdictions are open for examination by tax authorities. We assess our income tax positions and record a liability for all years open for examination based upon our evaluation of the facts, circumstances, and information available at the reporting date. The economic benefit associated with a tax position will be recognized only if we determine it is more likely than not to be upheld on audit. Although we believe our estimates and judgments are reasonable, actual results could differ, resulting in gains or losses that may be material to our results of operations and financial position.
At each interim reporting period, we estimate an effective income tax rate that is expected to be applicable for the full year. Our provision for income taxes is impacted by the income tax rates of the countries where we operate. A change in the geographical source of our income can affect the effective tax rate. Significant judgment is involved regarding the application of global income tax laws and regulations when projecting the jurisdictional mix of income. Additionally, interpretations of tax laws, court decisions, or other guidance provided by taxing authorities influence our estimate of the effective income tax rate. As a result, our actual effective income tax rate and related income tax liabilities may differ materially from our estimated effective tax rate and related income tax liabilities.
Intangibles (net of amortization) and Goodwill
We have certain identifiable intangibles amounting to $4 million and goodwill amounting to $124 million at December 31, 2021 that are discussed in Note 11. These intangibles and goodwill relate to our petroleum additives business. The intangibles are being amortized over periods with up to approximately 7 years of remaining life. We continue to assess the market related to the intangibles and goodwill, as well as their specific values and evaluate the intangibles and goodwill for any potential impairment when significant events or circumstances occur that might impair the value of these assets. We have concluded the values are appropriate, as are the amortization periods for the intangibles. However, if conditions were to substantially deteriorate in the petroleum additives market, it could possibly cause a decrease in the estimated useful lives of the intangible assets or result in a noncash write-off of all or a portion of the intangibles and goodwill carrying amounts. A reduction in the amortization period of the intangibles would have no effect on cash flows. We do not anticipate such a change in the market conditions in the near term.
Pension Plans and Other Postretirement Benefits
We use assumptions to record the impact of the pension and postretirement benefit plans in the financial statements. These assumptions include the discount rate and the expected long-term rate of return on plan assets. A change in any of these assumptions could cause different results for the plans and therefore, impact our results of operations, cash flows, and financial condition. We develop these assumptions after considering available information that we deem relevant. Information is provided on the pension and postretirement plans in Note 18 . In addition, further disclosure of the effect of changes in these assumptions is provided in the Financial Position and Liquidity section of Item 7.
Environmental and Legal Proceedings
We have disclosed our environmental matters in Item 1 of this Annual Report on Form 10-K, as well as in Note 21 . Our estimates for costs that will be incurred to satisfy our obligations related to environmental matters are affected by many variables, including our judgment regarding the extent of remediation that will be required, future changes in and enforcement and interpretation of laws and regulations, current and future technology available, and timing of remediation activities. While we currently do not anticipate significant changes to the many factors that could impact our environmental requirements, we continue to keep our accruals consistent with these requirements as they change.
Also, as noted in the discussion of Legal Proceedings in Item 3 of this Annual Report on Form 10-K, while it is not possible to predict or determine with certainty the outcome of any legal proceeding, it is our opinion, based on our current knowledge, that we will not experience any material adverse effects on our results of operations, cash flows, or financial condition as a result of any pending or threatened proceeding.
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RECENTLY ISSUED ACCOUNTING STANDARDS
For a full discussion of the more significant recently issued accounting standards, see Note 23.