Pubdate: Fri, 28 Jun 2019
Source: Wall Street Journal (US)
Copyright: 2019 Dow Jones & Company, Inc.
Author: Carol Ryan


It is wise to know where your cannabis comes from. Intoxicated by
bullish demand forecasts, pot investors aren't paying nearly enough
attention to supply.

U.S. states currently decide whether to legalize cannabis within their
own borders, even though the drug remains illegal at the federal
level. It is a misnomer to speak of a single U.S. pot industry,
considering the patchwork of self-contained cannabis economies across
the country.

Pot can't cross state lines today, even between two states where the
drug is allowed. Should federal laws change, high-cost growers and
areas with less favorable climates for cannabis growing will be undercut.

"There will be upheaval in the price structure and efficiencies are
going to set in," said Steve Schain, senior counsel at cannabis law
firm Hoban Law Group.

Oregon is ready to roll. This week, lawmakers in the West-coast state
signed into law a new bill that would allow local cannabis growers to
export over its borders if and when federal law permits. This
oversupplied state could quickly flood the market with cheap crop.

When adult use was legalized in Oregon four years ago, too many
growing licenses were issued. That has led to excess inventory-6.5
years' worth, according to a 2019 Oregon Liquor Control Commission
report. The price paid by consumers for usable marijuana has more than
halved to less than $5 a gram in the past two years.

States like Oregon that legalized marijuana a while ago tend to have
lower prices. Take pre-rolled joints: Washington is one of the
cheapest states in the U.S., at $5.50 a gram. California and Nevada,
both legalized within the last two years, are pricier at $9.60 and $14
a gram respectively, according to cannabis data company Headset. In
some states, weed can be artificially expensive because licenses have
been handed out carefully, meaning less competition among growers.

It is tricky to judge how things will shake out if internal trade
barriers come down. Some growers could benefit: The current need to
cultivate cannabis in individual states to serve the local market is
highly inefficient. Producers with operations in multiple states would
be able to consolidate in regions with the consistently sunny
conditions that the cannabis plant likes. Acreage Holdings, a large
U.S. cannabis business with a stock-market value of $1.8 billion, has
growing facilities in several northern states that aren't ideal for
growing. Cultivation will likely pivot south, hollowing out growers in
colder states like New York. State licenses to grow in Florida-where
few have been handed out-already change hands at a premium.

Given how chaotic this process is likely to be, and the fact that
cannabis stocks are already highly volatile, it may be safer to back
companies that provide services to growers but don't actually "touch
the plant." For example, Scotts Miracle-Gro supplies pot farmers with
fertilizer; KushCo Holdings offers packaging.

Investors aren't paying heed: Since the start of 2018, $3.5 billion
has been invested in cultivation and retail marijuana companies based
in the U.S., according to data from cannabis investment bank Viridian
Capital Advisors. Far less is flowing into cannabis consumption
equipment or specialized industry software, which attracted capital
worth $600 million and $210 million respectively over the same period.

Granted, it may be several years before interstate trade is possible.
Even after federal restrictions are lifted, protectionist laws at the
state level may cushion the blow for domestic growers for a time. In
the long run, however, a lot of U.S. cannabis growers will find they
are in the wrong place. Investors plowing money into pot production
better be prepared for the reckoning.
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