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 24 percent of our net sales in 2022. 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, 2022, would have decreased our net sales and income before income taxes for the year ended December 31, 2022, by approximately $19 million or one percent and $7 million or two 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, 2021 would have decreased our net sales and income before income taxes for the year ended December 31, 2021, by approximately $22 million or two percent and $9 million or five percent, respectively.
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Concentration of credit risk
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. Our largest customer as of December 31, 2022, had accounts receivable of $9.3 million and $5.7 million as of December 31, 2022 and 2021, respectively. Sales to our largest customer, which is from our Performance Materials segment, were approximately four percent of total net sales for each of the years ended December 31, 2022, 2021, and 2020, respectively. Sales to the automotive industry, which represents our largest industry concentration, were approximately 30 percent of our consolidated Net sales. No customers individually accounted for greater than 10 percent of Ingevity's consolidated Net sales.
Commodity price risk
A portion of our manufacturing costs includes 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 sources of 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 ope rations are directly affected by the cost of our raw materials, particularly crude tall oil ("CTO"), which represents approximately 14 percent of consolidated cost of sales and 22 percent of our full company raw materials purchases for the year ended December 31, 2022. Pricing for CTO is driven by the limited supply of the product and competing demands for its use, both of which drive pressure on its 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. Based on average pricing during the year ended December 31, 2022, 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, 2022, by approximately $11 million or one percent, which we may or may not have been able to pass on to our customers. Comparatively, 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.
Natural gas price risk
Natural gas, both direct and indirect, is our largest form of energy costs constituting approximately seven percent of our cost of goods sold for the year ended December 31, 2022. 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 to mitigate expected fluctuations in market prices and the volatility to earnings and cash flow resulting from changes to the pricing of natural gas purchases. Refer to 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, 2022, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $7.9 million or 70 basis points. As of December 31, 2022, we had 1.4 million and 0.5 million mmBTUS (millions of British Thermal Units) in the 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, 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, 2022, open commodity contracts hedge forecasted transactions until December 2023. The fair value of the outstanding designated natural gas commodity hedge contracts as of December 31, 2022 and 2021 was a net liability of $1.6 million and $0.6 million, respectively.
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Interest Rate Risk
As of December 31, 2022, approximately $828 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, 2022, a hypothetical 100 basis point increase in the variable interest rate component of our borrowings would increase our annual interest expense by approximately $8 million or 11 percent. Comparatively, for the year ended December 31, 2021, a hypothetical 100 basis point increase in the variable interest rate component of our borrowings would have increased our annual interest expense by approximately $3 million or seven percent.
During the year we had floating-to-fixed interest rate swaps with a combined 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. Per the terms of these instruments, we received floating rate interest payments ba sed upon the three-month U.S. dollar LIBOR and in return were obligated to pay interest at a fixed rate of 3.79 percent until July 2023. Due to the repayment of our term loan (refer to Note 10 to the Consolidated Financial Statements included within Part II. Item 8 of this Form 10-K for more information), in 2022, we terminated these interest rate swap instruments. Upon termination of the interest rate swap instruments, we reclassified a $1.7 million gain from AOCI into Interest income on the consolidated statement of operations. The fair value of outstanding interest rate instruments at December 31, 2022 and 2021 was an asset (liability) of zero and $(4.0) million, respectively.
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