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Wednesday, February 8, 2023

Legal weed supply glut pushing small businesses to ‘insolvency’

It wasn’t always Josh Keats’s job to drive the tractor.
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The co-founder of Henry’s Original once had a small crew to farm his 7-plus acres of cannabis from his base in Northern California’s Emerald Triangle. But on this fall day, it’s Keats operating the heavy machinery, trundling down rows of rich green stalks, because he had to let go two-thirds of his staff to stay afloat.

Yet, he’s grateful. Other weed growers, processors and retailers have had to make more painful cuts — or have folded altogether. “We are witnessing massive insolvency,” Keats said, “especially on the West Coast.”

The legal cannabis trade, still in its infancy, is flailing in many parts of the country as the pandemic boom that sent sales soaring has tapered off. Supply is now flooding the market in several states, economists say, depressing prices and decimating already-thin margins. And competition is sure to escalate as decriminalization spreads, large growers adopt more cost-effective technologies and the illegal market not only endures, but thrives.

The turmoil is mostly lost on consumers because weed is the rare commodity untouched by the pervasively high inflation blanketing most other goods and services. In fact, retail prices have fallen 10 percent this year in California, the nation’s largest market. It also compounds the challenges unique to this industry: Because marijuana remains illegal federally, businesses must navigate a labyrinth of overlapping regulations — creating confusion and occasionally chaos.

Essentially unable to raise prices, many cultivators and vendors are slashing them in hopes of generating any cash at all. By many accounts, the industry is struggling against unprecedented uncertainty and poised for what Keats is calling the “Great Reset.”

“It’s the worst it’s ever been,” said Tamara Kislak, owner of That Good Good Farm, a small cannabis cultivator in Mendocino County, who has worked in the industry for two decades.

“We went into this year fully knowing that we weren’t going to make money.”

The ‘green rush’ that never was

Washington and Colorado kindled the recreational trade in 2012 when they legalized marijuana use for adults 21 and older. Entrepreneurs quickly moved in — growers began converting farms, retailers began searching for investors — hoping to get in on the “green rush” certain to follow as legitamcy spread.

By 2019, pot had found legal homes in 11 states and the District of Columbia, generating a collective $1.7 billion in tax revenue, according to the Marijuana Policy Project, a cannabis policy advocacy group.

It was in this environment that Kislak saw her annual harvest of bulk flowers swell to upward of 500 pounds, and many businesses were able to find their footing. More states came online, and tax revenue surged to $3.7 billion in 2021, according to the advocacy group, then shot up to $11.2 billion in the first three months of 2022. By year’s end, legal use had grown to 21 states, two U.S. territories and D.C.

But as more businesses sprouted, society was returning to its pre-pandemic ways and facing a possible recession. Many Americans pulled back on nonessentials such as weed, and sales tumbled for some retailers. Marijuana saturated the market, forcing sellers to drop prices to unload inventory.

Kislak also scaled down, opting to focus on her craft business and produce strains like Biscotti Pancakes and Acai Cherry Sherbert. She plans to sell a little more than 100 pounds, convinced it’s the best thing she can do to maintain her business. She recently filled two 600-gallon pots with cannabis, figuring it would be better served as compost.

2022 marked the first year that any state recorded a decline in tax revenue from cannabis sales, and it occurred in five with relatively mature markets, according to a September report from The Urban-Brookings Tax Policy Center. In Colorado, sales were down every month compared with 2021, while retail prices tumbled 22 percent year-over-year. In California, tax revenue dropped year-over-year. And wholesale prices have fallen steadily in Oregon all year.

“When the industry was so new, there was sort of a sure bet,” said Brian Lewandowski, executive director of the business research division at the University of Colorado at Boulder’s Leeds School of Business. “Anybody could walk in and make money in this business and we saw people become millionaires overnight. But now it’s competitive and you have to have a lot of business acumen.”

Lewandowski sees it as a natural settling in the market, one that is bound to be painful for some businesses.

It’s a perfect storm, said Robin Goldstein, director of the Cannabis Economics Group at the University of California at Davis. “It’s a cumulation of too much production and falling prices,” he said.

While oversupply might be the sector’s most immediate challenge, it has other, more entrenched ones. Cannabis retailers are barred from many of the tax breaks and deductions commonly used in other industries. Other small businesses, for example, can write off as much as 20 percent of their qualified income.

“It’s incredibly difficult to make money if you cannot scale at a huge capacity to combat the inability to take those deductions,” said Hilary Bricken, a cannabis business lawyer at Harris Bricken in Los Angeles.

California imposes multiple taxes as product travels from farms into the hands of retail customers. Local cities or counties sometimes levy an additional tax on top of the state payments.

After harvesting, Kislak says her crop goes to a distributor for packaging and testing, as is required by California law. By the time it’s sold, as much as 40 percent of the retail price has gone to taxes, she said.

So of the $35 a customer might pay for an eighth of an ounce of marijuana, about $12 is left for Kislak’s business. Once you subtract packaging, labeling and testing costs, as well as distribution fees and a county tax, she said her profit is somewhere between $1 and $2.

“Cannabis is right now in a situation where almost nobody’s making money and people are, in fact, losing enough every day that they’re very concerned that they may not be able to last until [the market] comes back,” said Dan Sumner, an agricultural economist at the University of California at Davis, who with Goldstein co-wrote the book, “Can Legal Weed Win?: The Blunt Realities of Cannabis Economics.”

And because the legal market is relatively young, entrepreneurs are still rushing in. “It’s a new industry and everyone wants to get into it, and everyone thinks they’ll become the leading brand of weed,” Goldstein said.

That optimism was bolstered during the pandemic, when many Americans went in search of recreational outlets or stress relief, especially in areas with shelter-in-place orders.

Revenue spiked 40 percent at Sacramento-based Kolas in 2020, when the pandemic took hold, said Eric Luchini, the retailer’s marketing director. It also sold four times as many edibles designed to help people sleep than it had the year before.

“There was always a saying that cannabis was recession-proof, and now, pandemic-proof?” Luchini recalled.

But demand waned in some areas as consumer habits shifted. Meanwhile, small operators faltered as large conglomerates with more money and resources entered the market. All the while, the illegal market remained robust, further undercutting legal sellers.

Now, “a lot of people are leaving,” Kislak said. “It’s pretty sad. There’s a lot of loss of culture.”

In California’s Emerald Triangle, where weed has been grown for decades both illicitly and for medical marijuana, and farmers have forged strong bonds, legalization brought a mixture of relief and new challenges. Kislak sees small farmers who have a real love for their craft getting squeezed and feels her community starting to fray.

Because of the fragmented nature of marijuana sales in the United States, it’s difficult to precisely measure price fluctuations. But growers and retailers have seen a clear impact. Keats said that 15 years ago, a pound of outdoor-grown flower could sell for $3,500. After a temporary drop in 2017, it stabilized to around $1,200 to $1,600 for years. Now it’s worth less than half that.

Carl Giannone, the co-founder of cannabis company Trade Roots in Massachusetts, said an eighth of an ounce used to reliably sell for $55. Now he has to price it near $40.

“And the scary part is that product that’s selling for $40, I can buy from a large wholesaler for $7.50,” he said.

“The green rush has never happened,” Luchini said.

Illegal sales thrive: ‘There is only one market’

Over the summer, Oregon State Police seized 5,000 illegal marijuana plants from several greenhouses near the California border. In October, they confiscated another 8,000. Similar seizures continue across the country even as public opinion warms to weed use and decriminalization.

Goldstein estimates that two-thirds of the marijuana sold in California moves on the black market even now, nearly five years after recreational stores came on the scene. And authorized sellers must try to match illegal vendors on price despite their significant overhead, including taxes, licensing fees and testing requirements.

Cannabis still flows between markets with relative ease and snakes its way throughout the country.

“There is not a legal market and an illicit market,” said Jamie Warm, co-founder of Henry’s Original in Mendocino County. “There are no barriers. There is one market.”

Some of that movement comes from illegal distributors who transport mass amounts of product across state lines. Other times, it’s smaller grass-roots efforts.

A tech worker in San Francisco, who requested anonymity to discuss his weed practices, buys marijuana vape cartridges from authorized retailers in California and ships them periodically to friends in Ohio who can’t yet buy legal recreational weed.

He does this even as the sale or transport of weed across state lines remains prohibited. But he’s been making fewer shipments since Michigan legalized marijuana and retailers began selling in 2019; now his friends will occasionally make the hours-long drive to buy it there and bring it back to Ohio.

In New York City, one unlicensed seller said much of the product he buys through a wholesaler comes from California, sometimes packaged like marijuana sold in retail stores. The regulations seem arbitrary, the New York vendor said, who requested anonymity to discuss his operation.

“It’s illicit or non-illicit based on the goofy whims of some [expletive] dudes in suits,” he said, while smoking a sativa-Indica hybrid from a bong. “Typically humorless guys in suits.”

He’s been charging about $50 for an eighth of an ounce for much of the year. But after New York decriminalized recreational pot in 2021 and brought on the promise of more competition, he decided to diversify.

“I have a chef who makes birthday cakes,” he said.

When marijuana measures hit state ballots, advocates often equate legal sales with crime reduction — buyers could bypass dealers for reputable stores subject to regulatory oversight. But many longtime users will continue to buy from whomever they’ve patronized for years.

Stigma around marijuana persists in many settings, bolstered by its classification as a Schedule I drug alongside heroin and ecstasy, media portrayals of unsafe dealers and stereotypes of lazy stoners. Many companies still require drug tests, including for marijuana, before employment or at randomly selected times even in states that allow recreational use.

Business owners say they have to push past such perceptions and show they are responsible farmers and sellers, curating the substance in artisanal ways and encouraging responsible use.

“Federal legalization couldn’t come quick enough,” Keats said. “It is definitely the salvation for the industry in terms of opening access to the consumer and de-stigmatizing cannabis consumption.”

He and other purveyors are hopeful that full decriminalization is on the horizon, though that could also bring a whole host of new regulatory pressures.

The White House signaled a softening approach to marijuana this fall, when President Biden announced pardons for anyone convicted of pot possession at the federal level and urged governors to do the same. He also fast-tracked a review of whether marijuana should remain a Schedule I drug, the most dangerous category. Earlier this year, Senate Majority Leader Charles E. Schumer (D-N.Y.) introduced a bill to decriminalize cannabis, and he has encouraged the idea of allowing cannabis companies access to banking institutions.

Federal legalization could make it less risky and more attractive for investors to fund businesses, and potentially standardize regulatory and tax burdens. But it’s unclear how quickly change could occur. In the meantime, many entrepreneurs are just trying to hang on.

The truth is, Warm said, “It’s awful.”

*****

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