California versus the illicit market

California is the cannabis king by a wide margin. The top-selling cannabis state generated $3.1 billion in 2019 with a predicted growth to $7.2 billion in 2024. That’s 40% larger than all of Canada and 253% mightier than Colorado.

The Golden State’s licensed farms grow as much as 9 million pounds of cannabis per year—a number that looks great on paper for investors and aspiring entrepreneurs, but doesn’t exactly tell the full story.

While the legal cannabis market is booming in California, the state has problems to sort out between the industry and its consumers. Due to a variety of factors, including skyrocketing prices and a lack of dispensaries, California’s legal market can only support between 1.8 to 2.2 million pounds per year, or about 20% of what’s being grown.

So what happens with the remaining 80%?

Most of that cannabis is still being sold to and used by consumers, just not through state-sanctioned dealers. According to recent reports, illegal sellers in California outnumber legal, regulated businesses by nearly 3 to 1.

The United Cannabis Business Association, a California-based group of legal cannabis businesses, found nearly 3,000 unlicensed, unregulated storefronts and delivery services in operation, vastly outnumbering the 873 legal outlets to purchase cannabis.

“We’re the only state to go recreational and see a year-over-year reduction in legal sales,” UCBA president Jerred Kiloh said in a letter to Gov. Gavin Newsom and state cannabis czar Nicole Elliott.

According to a report from BDS Analytics, the illegal market in California rakes in as much as $8.7 billion per year, dwarfing the legal market. While there’s clearly no issue with cannabis supply, the proper balance with demand is more challenging.

To start, the demand for legal cannabis in California has been suppressed by both state and federal red tape.

Many counties and cities refuse to allow recreational cannabis sales. According to Alex Traverso, spokesman for the state’s Bureau of Cannabis Control, fewer than 25% of California’s cities allow legal sales. BDS Analytics found that for every 35,137 Californian adults, there’s only one dispensary where they can legally get recreational cannabis. In Oregon, it’s one for every 5,567 adults, and in Colorado, one for every 4,240 adults.

In Sacramento, there are only 30 dispensaries for the roughly 500,000 residents, with 10 more potentially slated to open, including some out of the city’s Cannabis Opportunity Reinvestment and Equity Program.

So if cannabis users can’t legally buy from a local dispensary, many go to black market sources.

Businesses in those cities and counties that allow recreational sales, however, must pay local taxes (4% in Sacramento) on top of the 15% state tax, along with the costs of permits for growing, selling and operating legally. That’s a burden their competitors in the black market can avoid.

Paul Clemons, director of licensing and compliance at Florin Wellness Center, told SN&R that taxes, fees and red tape are driving up the price of legal cannabis.

“Let’s look at it like gas,” Clemons said. “Gas is a pretty cheap commodity. It’s all the taxes we’re placing on it that makes it expensive, especially here in California.”

Phil Blurton, owner of All About Wellness in Sacramento, told KCRA in November that fees and taxes are “making the cost of our product so expensive the black market is booming now.”

Clemons cited other expenses facing Sacramento cannabis businesses, such as HD cameras that record 90 days, required in dispensaries. “People don’t think of the bandwidth of internet that takes, or the costs of storage,” he said. “The amount of money that takes in general is a lot.”

“Although we do have high hopes for 2020, I still think we’re very much so fighting these new industry woes,” Clemons added.

So how do you compete with a black market product that’s cheaper and easier to get?

Many suggest handing out more licenses, allowing more people to open businesses to sell cannabis—the free market approach. With more retail competition, eventually prices for the legal product would go low enough to kill the black market.

In Oregon, growers amassed an excess of 2 million pounds of legally grown cannabis, far exceeding the in-state demand. With federal law still preventing interstate cannabis trade and growers sitting on massive stashes of excess cannabis, they turned to the black market. That led to something authorities called “diversion,” or the illegal funneling of legally grown Oregon cannabis to surrounding states—and it happened a lot.

Between July 2015 and January 2018, 14,550 pounds of Oregon-grown cannabis was seized on its way to 37 other states, shorting the state of Oregon about $48 million in lost potential profit.

“You’re never going to eliminate [the illicit market] until most of the states are legal,” Adam Smith of the Craft Cannabis Alliance, a group in Oregon advocating for small cannabis farmers, told Politico. “As long as half the country still can’t get it legally, there’s a market for it illegally.”

Despite the seeming doom and gloom around the prices, taxes and costs on both the consumer and the buyer in the Californian legal cannabis market, it’s not all bad news on the horizon for 2020.

More and more states—including Arizona, New Jersey and Pennsylvania—are making the push to legalize recreational use in 2020. Recreational cannabis is supported by an overwhelming two-thirds of American adults.

Lifting the federal ban on cannabis would allow California’s cannabis industry to grow, and allowing legal interstate cannabis trade would let California legally offload surplus cannabis to Nevada and others states short on supply.