Market Dynamics Worth Tracking Throughout 2019
Market Dynamics Worth Tracking Throughout 2019
By J.J. McCoy, Senior Managing Editor, New Frontier Data
With each new year comes a fresh reminder that the only constant is change, an axiom with particular relevance in the nascent and mercurial legal cannabis industry. As the calendar turns, these are among the hottest topics to track throughout the first quarter of 2019 and beyond:
The Farm Bill/CBD
Last month, President Donald Trump made history by signing the Agriculture Improvement Act of 2018 (i.e., the Farm Bill) into law, permanently removing hemp from the federal prohibition under the Controlled Substances Act of 1970 (CSA).
As noted by cannabis law expert (and New Frontier Data advisor) Bob Hoban of Denver-based Hoban Law Group, the new law marks a sea change after decades in which the U.S. Food and Drug Administration (FDA), mandated by the prohibition, refused any trace of hemp-derived cannabidiol (CBD) in foods, health supplements, or other products.
While not yet changing its official policy regarding regulations for foods and supplements (i.e., prohibiting unproven medical claims), the FDA noted there being new opportunities to introduce – and market – hemp derivatives to the nation’s food supply.
Meanwhile, now unfettered by the CSA, the total U.S. hemp industry looks to expand by 18.4% through a 5-year combined annual growth rate (CAGR) from 2018-2022. New Frontier Data’s Hemp Business Journal estimates that, in leading all hemp product categories, the hemp-derived CBD market will grow from a $390 million-dollar market in 2018, to a $1.3 billion market (or 3.3x) by 2022, representing a 27.2% 5-year CAGR.
Takeaway: Hoban concluded that while “FDA uncertainties may take some time to be resolved, this development should be viewed as an encouraging policy shift, further galvanizing momentum for retailers and other hemp industry stakeholders immediately and going forward.”
The Next Attorney General
Nominated U.S. Attorney General William Barr has publicly referred to ousted Attorney General Jeff Sessions’ January 2018 decision not to defer to the laws and policies of states that have legalized cannabis. Yet, Trump publicly disagreed with Sessions over cannabis reform policy, championing both medical cannabis and states’ rights to legalize it. Meanwhile, FDA Commissioner Scott Gottlieb recently made noteworthy if disparate comments about the subject, first claiming that “there is no demonstrated medical use of botanical marijuana” before also predicting “an inevitability that it’s going to happen at the federal level at some point soon.”
Takeaway: For now, the status quo holds, if with the contradictory statements putting a new spin on the adage that “anything can happen, and probably will.” Stay tuned.
The New Congress and Possibilities for Landmark Federal Legislation
In June 2018, Sen. Elizabeth Warren (D-Mass.) and Sen. Cory Gardner (R-Colo.) introduced the Strengthening the Tenth Amendment Through Entrusting States (STATES) Act, a bipartisan effort to protect states’ rights to legalize and regulate cannabis within their own borders.
The STATES Act has gained a total of 10 co-sponsors (five Democrats and five Republicans) in the Senate since it was introduced, and Gardner says it has enough support to pass a simple-majority vote. That said, in December Gardner was unsuccessful in trying to attach the act to a successful criminal justice reform bill. That effort was stymied by Senate Majority Leader Mitch McConnell (R-Ky.), who championed hemp in the Farm Bill but still staunchly opposes marijuana, even if his predecessor and former colleague John Boehner held a similar stance before becoming an advisory spokesman for Acreage Holdings.
Last week, the 116th Congress was sworn in with the new House of Representatives under Democratic control (235 of 435 seats), ironically characterized by the conspicuous absence of two defeated Republican representatives who had served as contradictory poles regarding cannabis policy: Dana Rohrabacher of California founded the Cannabis Caucus, while Pete Sessions of Texas had effectively prevented many proposals from ever getting out of committee for any action.
Takeaway: Keeping in mind the recent example of sports gambling as another “sin industry” gone mainstream, it is important to note that 2/3 (33) of the 50 United States now have legalized cannabis to some extent, and U.S. investors and companies have scrambled to enter the fray. As a lobbyist from the Massachusetts Recreational Consumer Council reminded, “the fact that Congress is proactively talking about bills to resolve banking, to keep this a states’ rights issue, and to provide equity to folks from areas disproportionately harmed by prohibition is all promising.”
The Rise of International Markets
Canada put the world on notice in October by becoming the first G-20 nation to adopt a nationwide program for adult-use cannabis. Tilray’s stock soared with the announcement of an export deal to the United States.
This year will mark Canada’s production ramp-up in earnest, as cultivators race to scale their operations and more efficiently grow high-quality yields while jockeying for position toward distribution deals. The Czech Republic, for example, just signed up to sell Canadian product, joining Germany, Australia, and New Zealand among a lengthening list of clients turning to Canada for safe and legal medical-grade cannabis.
Meantime, now Israel will join Canada and the Netherlands in exporting medical cannabis.
Last month, Thailand became the first country in Southeast Asia to allow the use of medical cannabis, a remarkable development in a region notorious for hardline drug policies and strict penalties for drug-related crimes. It joins Australia, the United Kingdom, Ireland, and Germany and a dozen other countries since 2017 adopting medical cannabis markets.
In recent months, more than a dozen countries have legalized medical marijuana. New laws are pending in at least a dozen more as national regulators and even the World Health Organization (WHO) recognize legitimate medical uses for cannabis despite longtime bans under international treaties.
Takeaway: Last month the WHO cited the need for further research before postponing its release of much-anticipated recommendations regarding the international scheduling of cannabis. While no release date was given, United Nations member states remain scheduled to vote on the issue in March.
Pricing Fluctuations and Instability
California’s year-old launch of adult-use legalization has run into various obstacles both anticipated and unexpected.
According to the California Department of Food and Agriculture, the state’s growers produced up to 15.5 million pounds of cannabis while consuming just 2.5 million pounds (or 16%) of it, leaving a surplus equal to 13x of Colorado’s total production ripe for diversion eastward, where wholesale prices can fetch 3x higher.
Meantime, local regulatory debates in cities and towns that do not welcome cannabis businesses have been more common than expected, adding to low prices and extreme competition which will force many smaller California companies out of business.
In Oregon, too, prices for flower are expected to decline another 35% to 50% due to oversupply. According to New Frontier Data Senior Economist Beau Whitney, “Oil extracting companies are making a killing right now based on low wholesale prices for flower and trim. Their margins increased because cultivators are desperate for cash and selling biomass to the extractors at low, low prices. Other cultivators are growing only for extraction and not even selling into the flower market.”The result puts downward pricing pressure on cultivators who want to sell into the flower market. “Expect to see flower prices declines in California as well once the rules settle a bit,” Whitney added. “Right now, I could see outdoor in the near term going for less than $250 a pound, trending much farther below that in the longer term.”
Takeaway: Investors will want to be particularly wary of markets characterized by unlimited licenses and chronic oversupply. Whitney notes that Canada has more planned capacity than it needs, so it will see falling prices once that capacity comes online. “Once that hits, their only outlets will be the export markets in the E.U. and elsewhere,” he said. “Prices across the U.S. depend on the regulatory structure, but as prices go down out west, it will put downward pressure on the entire market.”
Further Mainstream and Market Acceptance
New York Governor Andrew Cuomo reversed his stance on cannabis after a study by the state’s health department estimated that legalizing cannabis there could annually generate $670 million in taxes, inspiring government leaders to apply it toward fixing New York City’s infamously deteriorating subways, among other pressing needs.
A study released by the New York City Comptroller last spring estimated that an adult-use market could be worth $3.1 billion for the state, and $1.1 billion for the city alone.
A formal comprehensive proposal is expected in Albany early in this year’s legislative session.
Similarly, increased M&A and consolidation activity seems assured for both the U.S. and Canadian cannabis markets overall. Prudent cannabis companies are already pursuing IP protection strategies and ascertaining transparent accounting records to make them more attractive for acquisition.
The appearance of cannabis companies listing on the U.S. and Canadian stock exchanges was a notable trend in 2018. It remains difficult for U.S.-based cannabis companies to access traditional capital due to federal government banking restrictions, so access to exchanges enables those companies to fund investment and raise capital.
“Overall, cannabis stocks reacted positively to major acquisition deal announcements in 2018,” noted New Frontier Data Investment Analyst Cesar Ramirez. “New major deals coupled with an increase in IPOs and global expansion by the bigger companies will help accelerate sector growth. IPO market is expected to increase as more recreational markets open up in the U.S. and around the world, which will likely generate similar returns to 2018.”
Takeaway: The cannabis sector 2019 outlook is overall positive and opportunistic, notes Ramirez. He is confident that “given the large number of deals in 2018, consolidation activity will be a big theme for the cannabis sector in 2019. The global equity market corrections in late 2018 caused a ripple effect on the cannabis sector as 2018 saw a -15.05% overall decline in US cannabis stocks [source: WeedEx U.S. Market Tracker].”
Ramirez expects consolidation activity to improve or remain stable in 2019, with the M&A market continuing to expand as companies enter the CBD market. As investors enter new markets more quickly through strategic takeovers, cross-sector deals will also contribute to the M&A market.