Colorado and marijuana, supply and demand | FT Alphaville

Colorado and marijuana, supply and demand

The case study in how a business can exist outside of the embrace of traditional banking — as, in this case, traditional banking is afraid of being done for money laundering, since the product in question is still illegal on a Federal level — continues.

That’s despite the efforts of Fourth Corner Credit Union in Denver, which, per the NYT, “applied in November to the Federal Reserve for a “master account,” which would allow it to interact with other financial institutions and open its doors to some of the hundreds of state-licensed marijuana businesses in Colorado.” It didn’t go well.

Still though, the legal pot industry is forging on regardless.

From Convergex’s “Beige Book of Pot” on Monday (with our emphasis):

Our most recent survey showed even more progress among our contacts’ stores, and demonstrated the natural evolution of a maturing industry. Here are our findings from the interviews we conducted last week:

After falling significantly over the past year, recreational marijuana prices have mostly stabilized. From June 2014 through our prior survey this past June, prices declined from an average of $50-$70 to $30-$45 for an eighth, and $300-$400 to the lower end of about $300 for an ounce. Some stores even sell an ounce for as low as $200. In our most recent survey, conducted last week, contacts reported no change to those June 2015 price levels.

“Greater competition” topped our respondents’ list when we asked what factors caused this year’s declines in price. While demand remains high, supply continues to increase. There are a couple of factors at play here. First, only existing medical marijuana dispensaries were given licenses to sell retail cannabis when it was first legal to do so on January 1st, 2014. This was lifted after nine months, in which new entrants could open their own recreational marijuana stores.

To put this in perspective, there were 156 retail marijuana stores and 204 retail marijuana cultivation facilities at the beginning of 2014, according to the Colorado Marijuana Enforcement Division.At the end of December 2014, there were 322 retail stores and 397 retail cultivations respectively. The MED also reported growth of about 110% in issued retail licenses last year. The latest stats posted on the MED’s siteshow 385 retail stores and 496 retail cultivations as of August 3rd, 2015, or a jump of 20% and 25% respectively since the end of last year.

Second, the State’s vertical integration requirement, in which recreational stores must grow most of their own marijuana (70/30), was rescinded last October. This allows an individual to apply for a license to grow and sell wholesale marijuana to retail stores or marijuana infused product manufactures without owning a store. Consequently, additional licenses awarded to retail stores and grow operations have likely contributed to pricing pressure due to more supply.

One contact noted that since the last time we had spoken in June, three new stores opened near his shop. Therefore, our survey participants said retail stores have dropped prices to stay competitive and attract more customers. One contact said offering eighths at a discount of $35 rather than their typical $45 tier has proved very successful. Quality helps protect against cutting costs too low, but given the number of stores available especially in concentrated areas, such as Denver, consumers are willing to drive for the best prices. Additionally, another contact highlighted that wholesale prices are getting cheaper: “Who can get the best deal a pound?” Overall, answers for what’s driving prices lower are threefold: the opening of new retail dispensaries, the ability to produce more, and the advent of more wholesale companies.

Customer flow increased. We’ve generally heard a range of 100 to 300 daily customers in previous surveys, but contacts reported an uptick to about 150 to 350. Many respondents reported gains in traffic over the past year with some noting the summer as responsible for the recent bump. Holidays and weekends also draw in customers. Most stores said that during regular weeks, their busiest days are when people get paid (just like other retail businesses) – typically the first Friday and 15th of every month, for example.

The average transaction size remains similar to our survey in June at about $50 to $60, although that’s down from $100 last year. These transactions typically include combinations of flower, such as an eighth or half eighth, joints, and edibles. Otherwise, some contacts highlighted large purchases of $300 to $500 worth of product when purchasing concentrates and stocking up on edibles. Yes, sour gummies are still the top choice edible among consumers. In terms of the most popular products, there was a wide consensus that vaping cartridges continue to grow in demand. They described them as the “new big thing”, or next wave of products evolving and coming out in different forms. It takes longer to feel the same effects as flower, for example, but it was characterized as odorless and easier to use.

And again, this (dangerous, fiddly, holding company stuff aside) is mostly happening outside the traditional banking system – meaning safes, lots of cash, guards, armoured vehicles, etc. That all costs money. For everyone, really.

The obvious points are lack of capital for expansion, the risks of crime ( do watch the NYT’s vid), the transaction costs and, you’d think compellingly, the tax issues. From a recommended recent paper on all of this by Julie Andersen Hill

Perhaps more importantly from a public policy standpoint, when marijuana-related businesses are outside the banking system, those businesses are harder to tax and regulate. Colorado and Washington allow recreational marijuana use but regulate marijuana similarly to alcohol. They prohibit the sale of marijuana to minors, require that businesses be registered, and take other regulatory measures designed to keep the marijuana industry separate from other illegal drugs. Both states plan to fund the monitoring and registration of growers, distributors, retailers, and medical users by taxing the marijuana industry itself. But cash businesses have opportunities and incentives to underreport taxes. Without anticipated tax revenues, states could potentially have trouble funding their regulatory structures. Cash businesses may also be more likely to funnel earnings to illicit activities. Finally, tax authorities (including federal tax authorities) prefer to be paid by check, credit card, or electronic deposit, rather than with bags of cash smelling of weed.

From her conclusion:

During the 1992 presidential campaign, a reporter asked candidate Bill Clinton whether he had ever smoked pot. Soon-to-becomePresident Clinton famously responded that he had “experimented” with it but “didn’t inhale.” This provides an apt metaphor for the federal government’s current approach to banking the marijuana industry. On one hand, the Department of Justice and FinCEN seem to be experimenting with marijuana. Their guidance suggests they will not punish financial institutions for providing services to state-legal marijuana-related businesses. On the other hand, the federal government’s marijuana experimentation falls far short of a deep inhale. Marijuana is illegal under federal law. Financial institutions that service the marijuana industry face possible federal criminal and civil punishment. As long as marijuana banking is illegal and punishable under federal law, financial institutions will avoid state-legal marijuana businesses.

For the state-legal marijuana industry to access banking, reforms must begin with Congress. Congress could open the door to marijuana banking by either decriminalizing marijuana or by removing criminal and civil penalties associated with marijuana banking. At the same time, federal financial regulators must set achievable due diligence expectations for banks offering services to the marijuana industry. If federal regulators unreasonably require financial institutions to police marijuana businesses’ compliance with all federal and state law, institutions will continue to avoid the marijuana industry.

And from Convergex again on how the pot industry continues to deal, and not deal, with this while, as the FT notes, a marijuana banking amendment winds through Congress:

Overall, although new stores continue to open for business, one contact emphasized that it is not easy starting out: “People don’t realize the costs of operating a business within the industry”. It requires a significant amount of initial capital, including high licensing costs, for example. Nonetheless, if entrepreneurs can make it, there’s a tremendous opportunity to earn outsized returns on capital. Looking at the latest available tax data from the Colorado Department of revenue shows marijuana dispensaries could earn over $500 million in retail sales this year. For example, the state grossed $5.84 million in revenues from the 10% retail sales tax in July, which suggests stores earned $58.4 million in revenue. That’s a 97% rise from the prior year.

From January through July, stores grossed about $309.1 million in revenue from recreational marijuana sales, almost more than all of last year’s aggregate retail sales. The average revenue earned during the first seven months of this year was $44.2 million. If we take a conservative estimate of $40 million in earnings for every month during the balance of this year, stores could earn just over $500 million compared to $313 million in 2014.

Not bad at all, considering.

Related links:
Don’t get your marijuana investment advice from Twitter (or anywhere else) – FTAV
Major NY banks plan to avoid medical marijuana firms – Politico, Sept 17