Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign currency
We have foreign-based operations, primarily in Europe, South America and Asia, which accounted for approximately 26 percent of our net sales in 2021. We have designated the local currency as the functional currency of our significant operations outside of the U.S. The primary currencies for which we have exchange rate exposure are the U.S. dollar versus the euro, the Japanese yen, the pound sterling, and the Chinese renminbi. In addition, certain of our domestic operations have sales to foreign customers. In the conduct of our foreign operations, we also make inter-company sales. All of this exposes us to the effect of changes in foreign currency exchange rates. Our earnings are therefore subject to change due to fluctuations in foreign currency exchange rates when the earnings in foreign currencies are translated into U.S. dollars. In some cases, to minimize the effects of such fluctuations, we use foreign exchange forward contracts to hedge firm and highly anticipated foreign currency cash flows. Our largest exposures are to the Chinese renminbi and the euro. A hypothetical 10 percent adverse change, excluding the impact of any hedging instruments, in the average Chinese renminbi and euro to U.S. dollar exchange rates during the year ended December 31, 2021 would have decreased our net sales and income before income taxes for the year ended December 31, 2021 by approximately $21.9 million or two percent and $8.9 million or five percent, respectively. Comparatively, a hypothetical 10 percent adverse change in the average Chinese renminbi and euro to U.S. dollar exchange rates during the year ended December 31, 2020 would have decreased our net sales and income before income taxes for the year ended December 31, 2020 by approximately $19 million or two percent and $6 million or two percent, respectively.
Concentration of credit risk
The financial instruments that potentially subject Ingevity to concentrations of credit risk are accounts receivable. We limit our credit risk by performing ongoing credit evaluations and, when necessary, requiring letters of credit, guarantees or collateral. We had accounts receivable from our largest customer of $6.6 million and $5.7 million as of December 31, 2021 and 2020, respectively. Sales to this customer, which are included in the Performance Materials segment, were approximately five percent, five percent, and four percent of total net sales for each of the years ended December 31, 2021, 2020, and 2019, respectively. Sales to the automotive industry represented approximately 35 percent of Ingevity’s consolidated Net sales and are our largest industry concentration risk. No customer individually accounted for greater than 10 percent of Ingevity's consolidated net sales.
Commodity price risk
A portion of our manufacturing costs include purchased raw materials, which are commodities whose prices fluctuate as market supply and demand fundamentals change. Accordingly, product margins and the level of our profitability tend to fluctuate with the changes in these commodity prices. The cost of energy is a manufacturing cost that is exposed to commodity pricing. Our energy costs are diversified among electricity, steam and natural gas, with natural gas comprising our largest energy input.
Crude tall oil price risk
Our results of operations are directly affected by the cost of our raw materials, particularly crude tall oil ("CTO"), which represents approximately 10 percent of consolidated cost of sales and 22 percent of our raw materials purchases for the year ended December 31, 2021. Pricing for CTO is driven by the limited supply elasticity of the product and competing demands for its use, both of which drive pressure on price. Our gross profit and margins could be adversely affected by increases in the cost of CTO if we are unable to pass the increases on to our customers. CTO is a thinly traded commodity with pricing commonly established for periods ranging from one quarter to one year. We try to protect against pricing fluctuations through various business strategies. Based on average pricing during the year ended December 31, 2021, a hypothetical unhedged, unfavorable 10 percent increase in the market price for CTO would have increased our cost of sales for the year ended December 31, 2021 by approximately $9 million or one percent, which we may or may not have been able to pass on to
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our customers. Comparatively, based on average pricing during the year ended December 31, 2020 , a hypothetical unhedged, unfavorable 10 percent increase in the market price for CTO would have increased our cost of sales for the year ended December 31, 2020 by approximately $8 million or one percent.
Natural gas price risk
Natural gas, both direct and indirect, is our largest form of utility costs constituting approximately five percent of our cost of goods sold for the year ended December 31, 2021. Increases in natural gas costs, unless passed on to our customers, would adversely affect our results of operations. If natural gas prices increase significantly, our business or results of operations may be adversely affected. We enter into certain derivative financial instruments in order to mitigate expected fluctuations in market prices and the volatility to earnings and cash flow resulting from changes to pricing of natural gas purchases. Refer to the Note 9 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information on our natural gas price risk hedging program. For the year ended December 31, 2021, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $4.3 million or 50 basis points. As of December 31, 2021, we had 1.4 million and 1.0 million mmBTUS (millions of British Thermal Units) in aggregate notional volume of outstanding natural gas commodity swap contracts and zero cost collar option contracts, respectively, designated as cash flow hedges. Comparatively, for the year ended December 31, 2020, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $2.4 million or 30 basis points. As of December 31, 2021, open commodity contracts hedge forecasted transactions until March 2023. The fair value of the outstanding designated natural gas commodity hedge contracts as of December 31, 2021 and 2020 was a net liability of $0.6 million and $0.1 million, respectively.
Interest Rate Risk
As of December 31, 2021, approximately $328 million of our borrowings include a variable interest rate component. As a result, we are subject to interest rate risk with respect to such floating-rate debt. For the year ended December 31, 2021, a hypothetical 100 basis point increase in the variable interest rate component of our borrowings would increase our annual interest expense by approximately $3 million or seven percent. Comparatively, for the year ended December 31, 2020, a hypothetical 100 basis point increase in the variable interest rate component of our borrowings would have increased our annual interest expense by approximately $4 million or eight percent.
As of December 31, 2021, we have entered into an interest rate swap with a notional amount of $166.2 million to manage the variability of cash flows in the interest rate payments associated with our existing LIBOR-based interest payments, effectively converting $166.2 million of our floating rate debt to a fixed rate. In accordance with the terms of this instrument, we receive floating rate interest payments based upon three-month U.S. dollar LIBOR and in return are obligated to pay interest at a fixed rate of 3.79 percent until July 2023. The fair value of the interest rate swap was an asset (liability) of $(4.0) million and $(8.9) million at December 31, 2021 and 2020, respectively.
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