Licensing Crisis Lends a Toxic Tarnish to the Golden State’s Legal Cannabis Market

By J.J. McCoy, Senior Managing Editor, New Frontier Data

What happens if you throw a party and then take the guests’ invitations away?

That, in short, is what state cannabis regulators in California are finding out. Yet all glibness aside, it represents a looming issue which while awaiting a remedy threatens to inexorably choke the supply chain for the largest legalized market in the United States.

The crisis stems from regulators’ red tape and a lack of permanent cultivation licenses in the state. It resulted from thousands of applications having been filed at the end of 2018, creating a massive backlog and exacerbating issues of application errors, confirming and verifying local authority licensing processes, and the complex certification compliance with state and federal environmental laws.

In establishing its statewide legal market last year, California issued permanent annual licenses to about 100 companies which are required to comply with the California Cannabis Track-and-Trace (CCTT) system, using Franwell’s web-based Metrc software. Meanwhile, thousands of more businesses with temporary licenses are due to see those expire well before the state can finish processing either annual or provisional licenses to replace them.

The state stopped issuing temporary licenses on Dec. 31, 2018, and those will all expire by July. Meanwhile, more than 1,000 temporary licenses issued by the California Department of Food and Agriculture (CDFA) expired in March, and another 4,000 will legally expire this month.

“If a cultivator obtained a temporary license from CDFA, they should receive a provisional license to bridge the divide until an annual license is issued,” explained Patrick Goggin, a senior attorney for Hoban Law Group who is based in San Francisco. “The problem is for folks that did not obtain a temporary license prior to when the state stopped issuing them. There are fewer in the latter category than the former. For the unlucky farmers that have not received provisional licenses, they will need to wait for CDFA to issue an annual license before operating. However, that has been the state of things since the first of the year. While I expect the fallout to be limited, it will be significant for those affected. They will need to partner with a cultivator that was issued a provisional license if they want to cultivate during this interim period. That comes with a host of issues, though, including affiliation with that license, but not insurmountable.”

The situation, of course, leaves otherwise legal operators who have acted in good faith now facing closure or being forced into legal jeopardy for maintaining soon “illegal” unlicensed operations through no fault of their own, awaiting applications that cannot be processed in a timely fashion. While some larger operations have deep-enough pockets to survive potential shutdowns as they await permanent licenses, most smaller outfits are at risk of shuttering their businesses or else violating letters of the laws.

Sacramento officials are now trying to rectify the governmental miscues by devising some legislative lifelines for those legal operators holding temporary licenses to remain viable while all the bugs get worked out.

As industry experts fear coming fallout from the disconnect, lobbyists and industry consultants in the Golden State are finding themselves working feverishly to pass state Senate Bill 67, an amendment to the California Business and Professions Code which would extend temporary business licenses till the end of the year. If the attempt to accelerate the licensing process is successful, the measure would nevertheless not become law before the end of May.

Meantime, the lapse threatens to leave much of the industry in a period of counterproductive limbo, with no legal way to keep doing business as temporary permits expire and companies are forced to helplessly wait for provisional or annual permits.

Should all the licenses due to expire be allowed to lapse, the state will have slightly more than 1,000 growers in the legal market. Due to cultivation size limits, none of the grows are larger than 22,000 square feet.

“Given that the state was previously served by more than 50,000 growers, the supply constriction that could happen in the legal market would be tectonic,” explained John Kagia, New Frontier Data’s chief knowledge officer. “The legal market is already struggling to compete against the illicit one. The illicit market would flourish against a legal market facing a major supply shortage on top of its already higher legal prices.”

According to New Frontier Data’s Senior Economist Beau Whitney, as of April 10, there were 88 permanent licenses (medical and adult-use combined) and 592 provisional licenses, or a total of 680 licenses.

Based on New Frontier Data analysis, the state’s cultivation output required to satisfy the total expected legal demand in California’s market is between 2.0 and 2.5 million pounds per year (including both medical and adult-use flower with all derivative products).

By some estimates, Whitney noted, there will ultimately be a total of 1,154 licenses issued for a total of 292 acres, equating to 12,719,520 square feet of canopy. Based on a comprehensive analysis of the output per square foot from New Frontier Data’s 2018 Energy Report, that amount of square footage would produce approximately 813,000 pounds of flower and trim (assuming it is all grown outdoors).

Similarly, New Frontier Data is modeling a total of 1,250 permanent licenses issued by the end of Q3-19. Assuming those to represent 22,000 square feet of canopy, the total estimated cultivation output amounts to 1,758,000 pounds assuming mid-range cultivation techniques (that estimated canopy chosen for the calculated difference between supply and demand to be the most conservative).

Whitney noted that even with different assumptions, industry observers are expecting a gap between the total supply and the total demand that could range between 700,000 and 1,200,000 pounds (range 242,000– 1,687,000).

According to the California Bureau of Cannabis Control (BCC), as of early March, it had issued 28 annual licenses, the CDFA had issued 20, and the California Department of Public Health (CDPH) had issued 48 as 1,200 more applications remained pending.

While some growers have reported receiving intimidating cease-and-desist letters from the state, and those with expired licenses technically cannot continue to grow or sell cannabis in the regulated marketplace, officials have informally said that they will not shut down operators who have demonstrated compliance with local regulations and have applied for annual or provisional state licenses.

Of course, such cold comfort from regulators means little to cultivators like Sunshine Johnston, owner and lead farmer of Sunboldt Grown, who dry farms 10,000 square feet of cannabis in Redcrest, California, in Humboldt County.

“The concern, really, is just not being able to make bail,” she said wryly. “I don’t know that it’s so much about people losing their farms. It’s really to do with farmers going to the [illicit] market, which is always an option unless you’re in track and trace. I don’t think it’s as much about losing farms as it is about getting these businesses going and functioning in that direction. The longer that farmers stay on the [illicit] market, the longer they delay their business development.”

Johnston herself is awaiting her farm’s annual permit. She has her county permit,
so does not need a provisional license, though until she has an annual license in hand she fears “what they might do is tell me I couldn’t plant. August 1 is the very, very latest that you can plant and still get a harvest to get to market by November 1 at the earliest.”

She adds that the uncertainty is leading to unintended consequences, including farmers selling out to the lumber rush in desperation.

“It’s opened up a whole new environmental catastrophe. The lumber prices are up, so people are cutting their trees. It’s a lot easier to cut trees than to put in a ganja farm. Farms that don’t have permits or commit violations face huge bills for environment violations (for illegal grading or stream diversions for irrigation, etc.). I think a lot of trees are getting cut this summer.”

That such a fundamental regulatory function still faces such significant challenges further indication of the state’s overall lack of readiness for establishing and regulating the world’s largest cannabis consumer market. It also serves as a cautionary reminder to keep the industry from getting out ahead of a new market’s regulations, and for policymakers to keep the process as simple and clearly communicated as possible.