California’s cannabis legalization strategy has failed to knock out the state’s entrenched black market cannabis sales, and countless consumers are still turning to illicit California dispensaries.
High taxes and the presence of black market dispensaries are cutting into the projected tax revenues for California’s cannabis industry. In a state that was promised billions in tax revenue, the latest projections fall considerably short of expectations. “A projected windfall of tax revenue was a major selling point for legal cannabis in California,” reported the Los Angeles Times. According to the latest state budget documents, California is now expecting a US$223 million shortfall in cannabis tax revenue through June 2020.
Industry insiders are attributing the loss in projected revenue to high taxes and strict licensing regulations that failed to incentivize consumers to turn away from black market sources.
“That’s the thing about California,” said Tom Adams, Managing Director at BDS Analytics. “It was the most loosely regulated medical market ever, and turned into one of the most tightly regulated adult-use markets ever, and the highest-cost adult-use regulatory regimes, so you saw the market shrink in its first year.”
What’s sustaining California’s illegal cannabis market?
Much of California’s black market blues can be traced back to the high tax rates imposed by state regulators and local municipalities on cannabis products. The lack of licensed retail stores has made matters worse, providing black market operators with an opportunity to compete based on convenience.
Under California’s new cannabis tax scheme, consumers are paying as much as 45 percent in taxes on their cannabis purchases. That includes a 15 percent excise tax on recreational and medical cannabis sales and a cultivation tax on growers that amounts to US$9.25 per ounce of flower or US$2.75 per ounce of leaves. In addition, local municipalities can tack on taxes of 5 to 15 percent on sales and cultivation. With noticeably higher price tags, legal cannabis retailers are finding themselves increasingly undercut by a thriving black market as consumers look for cheaper, more readily available products.
“The fact is consumers don’t know that they’re going to an illegal store. They don’t know who has licenses and who doesn’t, so consumers are being duped into going into illegal dispensaries because the pricing is cheaper,” Corey Mangold, CEO of Orchid Ventures (CSE:ORCD,OTC Pink:ORVRF), told the Investing News Network (INN). Orchid’s premium vape brand has developed a loyal consumer following, with its product lines currently sold in more than 250 dispensaries across California and Oregon. The company has expansion plans targeting Nevada, Washington, Michigan, Florida and Massachusetts.
Municipalities refusing cannabis retail licenses are placing another strain on growth in the legal market. For comparison, consider the cannabis retail landscape in Colorado. California’s population size is six times that of Colorado, which has 562 licensed cannabis stores to California’s 620 licensed stores. Consumers in California’s underserved areas inevitably turn to black-market retail shops, which are estimated to number more than 1,000 in Los Angeles alone. Many of these stores were legal before the new legislation came into effect and they have not yet complied with the new licensing regulations in an effort to avoid the taxes and higher costs faced by licensed cannabis stores. These illegal stores are now flying under the radar and undercutting legal dispensaries with lower prices.
California dispensary struggles
The inability to displace the black market could have negative consequences not only for the legal cannabis industry in California, but the entire country. The fact that the state is raking in far less revenue than expected from recreational cannabis sales may dissuade other states from taking the plunge into legal cannabis, ultimately stalling projected growth in the overall US legal cannabis market.
Across the United States, total recreational cannabis sales in 2018 increased by 16 percent to US$9.8 billion, according to a report by BDS Analytics and Arcview Market Research, compared to the 35 percent growth that occurred from 2013 to 2017. “The main reason for the slowdown was the troubled launch of adult-use sales in California on January 1, 2018,” said the report. This slowdown in growth can have a ripple effect throughout all levels of the industry.
“The black market hurts the industry in many ways, the first of which is financial,” said Mangold. “The legal cannabis industry is backed by institutional and private investors that have sunk billions of dollars into the sector. When consumers purchase from the black market, that money goes to companies that are not paying taxes or offering employees livable wages and health benefits. Secondly, purchasing cheaper cannabis products from black market sources can come at a cost to consumer safety. Black market products aren’t tested for pesticides or residual solvents, both of which can be extremely harmful and even fatal.”
Under California law, all cannabis products, such as flower, concentrates and edibles, must undergo strict consumer safety testing by independent labs. Illegal products sold at unlicensed dispensaries are unlikely to have been tested by state standards and could be tainted with mold, pesticides, heavy metals and even fecal matter.
“When you buy flower from legal cannabis growers you know it is pesticide and heavy metal free and of the highest quality,” Paul Chow, co-founder and director of vertically integrated cannabis company Next Green Wave (CSE:NGW,OTCQX:NXGWF), told INN. “Everything is tested and you can see for yourself the breakdown of every plant, including the harvest and shelf dates.”
Licensed cannabis companies have raised concerns to state officials about threats to consumer safety and loss of revenue to illegal dispensaries, along with what they see as a perceived lack of action against the illicit cannabis trade.
Legal cannabis expected to survive
In late June, California launched a three year, US$1.7 million public information campaign known as “Get #weedwise” in an effort to encourage cannabis consumers to purchase safety-tested products from licensed sources. Bureau of Cannabis Control Chief Lori Ajax said, “(The campaign) will directly impact consumer safety by clarifying that only cannabis purchased from licensed retailers has met the state’s safety standards.”
The campaign includes ads on social media sites and billboards driving home the point that illegal cannabis products pose a risk to health and safety. “Do you know what’s hiding in your counterfeit edibles?” asks one ad. “Does your oil have something to hide?” reads another. The ads also include a call to action for cannabis consumers to visit the state’s online database, CApotcheck.com, where they can make a quick check to ensure they are shopping at a licensed dispensary.
Supporting legal retailers and keeping their products out of unlicensed shops is one way California cannabis brands can differentiate themselves and gain an advantage in this evolving marketplace. “Many of the major brands can be found inside the illegal stores,” said Mangold. Orchid Ventures’ vaporizers and premium cannabis oils are not among those products sold in illegal shops. “Those companies that take the moral high ground and don’t sell into the black market will ultimately gain the respect of legal retail outlets, government officials and agencies, and eventually the consumer. Enabling the black market doesn’t benefit an industry that’s trying desperately to erase the past of prohibition.”
The California Bureau of Cannabis Control’s “Get #weedwise” campaign is a part of a larger effort to send a message to black-market stores and growers that if they continue to sidestep state law, they will be shut down. Agency spokesman Alex Traverso says the state’s plan to fight the proliferation of black market cannabis includes enforcing cannabis regulations via shutdowns of illegal stores and grow operations, and expediting business license applications for those that opt to go the legal route.
California has not seen the billion-dollar cannabis bonanza its budget office anticipated, but the demand is there. The recreational market is still in its infancy and the road to a more mature industry has involved some significant obstacles. As the state’s leaders get more serious about stamping out black market sales, cannabis companies that eschew illicit shops could be better positioned to capture market share in the legal industry.
This article was originally published by the Investing News Network in July 2019.
This INNSpired article was written according to INN editorial standards to educate investors.
INN does not provide investment advice and the information on this profile should not be considered a recommendation to buy or sell any security. INN does not endorse or recommend the business, products, services or securities of any company profiled.