Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign currency exchange rate risk
Net sales originating from our foreign-based operations, primarily Europe, South America, and Asia, accounted for approximately 25 percent of our net sales in 2024. 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, the Brazilian real, 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 Brazilian real, the Chinese renminbi, and the euro. A hypothetical 10 percent adverse change, excluding the impact of any hedging instruments, in the average Brazilian real, Chinese renminbi, and euro to U.S. dollar exchange rates during the year ended December 31, 2024, would have decreased our net sales and income before income taxes for the year ended December 31, 2024, by approximately $18 million or one percent and $6 million or one percent, respectively. Comparatively, a hypothetical 10 percent adverse change in the average Brazilian real, Chinese renminbi, and euro to U.S. dollar exchange rates during the year ended December 31, 2023 would have decreased our net sales and income before income taxes for the year ended December 31, 2023, by approximately $20 million or one percent and $5 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. Our largest customer as of December 31, 2024, had accounts receivable of $8.3 million and $7.5 million as of December 31, 2024 and 2023, respectively. Sales to our largest customer, which is in our Performance Materials segment, were approximately six percent of total net sales for the year ended December 31, 2024, and four percent for each of the years ended December 31, 2023, and 2022, respectively. Sales to the automotive industry, which represents our largest industry concentration, were approximately 40 percent of our consolidated Net sales. No customer individually accounted for greater than 10 percent of Ingevity's consolidated Net sales.
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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 CTO, which, excluding CTO resales, represents approximately 14 percent of consolidated cost of sales and 38 percent of our full company raw materials purchases for the year ended December 31, 2024. 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, 2024, 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, 2024, by approximately $13.0 million or one percent, which we may not have been able to pass on to our customers. Comparatively, based on average pricing during the year ended December 31, 2023 , 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, 2023 by approximately $29.3 million or two percent . The repositioning of the Performance Chemicals reportable segment and the termination of the long-term CTO supply contract have significantly reduced the Company's volume requirements and exposure to CTO beginning in 2025.
Natural gas price risk
Natural gas, both direct and indirect, is our largest form of energy costs constituting approximately four percent of our cost of goods sold for the year ended December 31, 2024. 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 for more information on our natural gas price risk hedging program. For the year ended December 31, 2024, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $3.6 million or 37 basis points. Comparatively, for the year ended December 31, 2023, a hypothetical, unhedged 10 percent increase in natural gas pricing would have resulted in an increase to cost of sales of approximately $4.7 million or 39 basis points. As of December 31, 2024, we had 1.8 million mmBTUS (millions of British Thermal Units) in open natural gas derivative contracts, designated as cash flow hedges. As of December 31, 2024, open natural gas derivative contracts hedge a portion of forecasted transactions until December 2025. The fair value of the open natural gas derivative contracts as of December 31, 2024 and 2023 was a net asset (liability) of $0.3 million and $(0.9) million, respectively.
Interest rate risk
During the third quarter of 2024, we entered into a floating-to-fixed interest rate swap with a notional amount of $200.0 million to manage the variability of cash flows in the interest rate payments associated with our existing Secured Overnight Financing Rate ("SOFR") based interest payments, effectively converting $200.0 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 one-month U.S. dollar SOFR and in return are obligated to pay interest at a fixed rate of 3.84 percent until August 2026. The fair value of outstanding interest rate instruments at December 31, 2024 and 2023 was an asset of $0.6 million and zero, respectively.
As of December 31, 2024, approximately $555 million of our borrowings, adjusted for our $200 million floating-to-fixed interest rate swap, include a variable interest rate component. As a result, we are subject to interest rate risk with respect to such floating-rate debt. The weighted average interest rate associated with our variable interest rate borrowings, was 6.52 percent for the period ended December 31, 2024. For the year ended December 31, 2024, a hypothetical 100 basis point increase in the variable interest rate component of our borrowings would increase our annual interest expense by approximately $6 million or eight percent. Comparatively, for the year ended December 31, 2023, a hypothetical 100 basis point increase in the variable interest rate component of our borrowings would have increased our annual interest expense by approximately $8 million or 10 percent.
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