Outrun Change

We need to learn quickly to keep up with the massive change around us so we don't get run over. We need to outrun change.

Update on marijuana regulation – #15

Only a few articles I’ve noticed recently on the state legal sales of recreational marijuana. In case you are just noticing my articles on the topic, my interest is to watch the natural experiment of whether overbearing, heavy-handed regulations strangle a brand new industry.

1/15 – KOMO news – Too much pot: Growers struggle with glut of legal weed This is essentially a story on implementation issues in Washington state. Initially there was a shortage of state-legal marijuana, now there is a glut. Since last summer, growers have harvested 31,000 pounds (I have no idea how that count is determined).

Article says many users are staying with the lower taxed medical marijuana.

In Washington there are 270 licensed growers providing 85 licensed stores. The huge volume of regulatory hoops to jump through for retail stores is slowing the opening of new outlets while there are minimal restrictions on growers. In Colorado, the article says growers must prove a demand for their product before getting licensed.

Prices, per the article, are running $23 to $25 per gram an ounce, which is twice the price of so-called medicinal marijuana.

In Colorado there is more demand than supply and in Washington more supply than demand, according to the article. The state laws only provide protection for sales in the state under the state’s regulation. That, combined with the federal ban on interstate transport, makes it exquisitely dangerous to move marijuana from Washington (excess supply) to Colorado (excess demand). Were freedom to come into play, growers would fill up a truck and hit the road for Colorado.

Overall, this article reflects the implementation struggles more than the crushing effect of regulation. Several factors will smooth out the supply and demand:

  • more stores soon to come on line (another 100 in next few months)
  • general stabilization of the industry
  • adjusting to the heavy supply right after the harvest which will need to held and sold during the year (harvest is in the fall and article suggests there is one crop a year, although I have no idea what that means; there is only one apple harvest a year but apples are in the produce section year round)

When the supply chain settles down we will have a clearer picture of the disruption caused by regulation.

1/24 – Forbes – IRS Further Limits Deductions For State-Legal Marijuana Facilities – This is a bit off-track from the issue of overbearing regulation, but still interesting.

For a business that is illegal, only the cost of goods sold (COGS) is deductible for federal tax purposes. That means rent, general, selling, administrative, and depreciation costs (G&A) are not deductible. This creates huge tax liabilities on small profits.

To work around this, state-legal-federally-illegal recreational and so-called medical marijuana sellers are aggressively calculating the inventoriable portion of their G&A cost into inventory. Thus the otherwise nondeductible G&A is rolling into the COGS calculation.

Last week, the IRS issued a Chief Counsel Memorandum (short version: internal position paper) pointing out that a combination of several laws means that costs that would otherwise be nondeductible may not be rolled into inventory and then turned into a deduction when calculating COGS.

Yet another attack from the federal-illegal side of this state-legal experiment.

1/26 – Breitbart – Legal Marijuana Sales Grow 74 Percent in 2014 – A combination legalization advocacy and investment firm (how ’bout that for a creative business model?) asserts that legal sales of marijuana grew 74% in 2014, from $1.5B to $2.7B. Sales in Colorado were $805M. Investors are moving into the market

2/4 – NBC News – A Marijuana First: Pot Vending Machines Dispense Weeds – A vending machine dispensing marijuana buds is available in so-called medical marijuana dispensaries in Seattle. Swipe your medical marijuana card (or just your driver’s license, if the article is technically correct in its statements), pay with cash (or bitcoins), and you are on your way. Since there is no clerk involved, presumably you could borrow your buddy’s card or license.

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11 thoughts on “Update on marijuana regulation – #15

  1. Jim,
    Are you sure you quoted correctly when you stated prices are $23 to $25 per ounce?
    I think it is more like $23 to $25 per gram, not per ounce. That would be a bit more than $700 per ounce, which is what I have read on the internet.
    I don’t think having only an annual production will affect the availability of pot at any given time of the year. I think pot doesn’t spoil so it shouldn’t be a problem to store it for resale during the year after the harvest.
    I also think the IRS deduction rules are insane….

    • Hi Mark:

      Ounce? Gram?

      Oops. Let’s see…at 28.3495 grams to the ounce, that the difference between $652-$708 an ounce or $23-$25 an ounce.
      I can’t tell the difference. So much for my well refined auditor’s skill at reasonableness tests.

      Um, yeah, what I really meant to say was per gram. Would you believe me if I said it was just a typo?

      Didn’t think so.

      I laughed at myself on that one. I’m trying so hard not to take a public position on whether legalization is a good idea or not. Also trying so hard to avoid saying I don’t know anything about the product or market or portion sizes or potency. Yet my complete cluelessness shows through anyway! How funny.

      I fixed the article. Thanks for pointing that out.

      More seriously, I don’t get the oversupply issue discussed in the article. Nonperishable product can be stored. Would need to have rather high security, but that is a small cost of doing business if the average harvest was 108 pounds.

      The part left out from the article is the distinction between grown-in-the-field-under-open-sky marijuana and the hothouse version. Tone of the article is that open field harvest is the only product on the market. I do know that isn’t correct.

      I can understand a slight oversupply for a little while, but don’t see why there would be such a disruptive glut.

      My guess? This is merely an initial implementation issue. The first season of a brand new industry is going have lots of glitches.

      Seriously, thanks again for pointing out the error.

      Jim

      • Jim,

        I figured you had made an error there.

        If open field growing is the source of most of what is out there then I am really perplexed as to how growers can’t make money at $700 per ounce wholesale price (as I had seen on a TV program where growers were complaining they were going bankrupt when the glut had caused wholesale prices to drop to around $700 per ounce). Most vegetables, and even beef is grown for a few cents per ounce.

        Even if grown in a hot house, pot should be able to be grown for a very cheap price. I am really not getting why the cost of production is so high. It just seems very strange. I am sure when the big money gets involved as more and more states legalize it it will bring the cost way down. The small growers that are now growing most of the supply must know their time is limited.

        I am sure pot will eventually be legalized in all states sometime down the road…maybe not in our lifetime, not sure. There is just too much money involved, and too much (DEA, etc.) resources used to try to keep it illegal. Those agencies could then use all their resources to focus on more serious drugs like cocaine, heroin, etc.
        The genie is slowly being let out of the bottle and it will eventually be impossible to put it back in.

        We all know what happened when they made alcohol illegal….

      • HI Mark:

        Thanks for your comments.

        I’m still confused on the order or magnitude. I had thought the $23/$25 was retail when I read and then reread the article. One data point in the article is from one producer who:

        “…sold his first crop — 22 pounds — for just under $21 per gram: nearly $230,000 before his hefty $57,000 tax bill. He’s about to harvest his second crop, but this time he expects to get just $4 per gram, when he has big bills to pay.”

        I’ll do some math to make sure his numbers are internally consistent: $230,000 / $21/gram = 10,952 grams ; 10,952 grams / 28.4 g/oz = 385 ounces ; 385 oz / 16 oz/lb = 24 pounds. With rounding errors, that gets to his assertion of a crop yield of 22 pounds.

        So his yield is about $600 an ounce at producer level. That is consistent with the comments you cited of $700 an ounce at wholesale.

        If he gets $4/gram from his new harvest, his gross revenue will drop from $230K to $44K. If normal economic rules were in play (which they aren’t, which is why I am watching this issue, which means we can learn how much government regs distort the market!) then I would expect retail prices to drop severely.

        What have you read about retail prices prior to the ‘glut’? Links please! I scanned my articles and archives but can’t easily find the articles predicting what retail prices would do.

        One factor on the costs is the huge volume of paperwork needed to comply with state law. For starters, putting an RFID tag on every plant so the industry can track all product from “seed to sale”.

        Obviously this is an academic exercise to see what impact regulation has.

        Jim

  2. P.S.

    I am not giving my opinion as to whether or not pot should be legalized. I am just thinking what the federal government might be contemplating as far as where to best use their drug enforcement resources in the future, and also to cut their budgets.

  3. Sorry Jim, but I don’t have a link. What I saw was an interview on CNBC with a grower in Washington state. He said that prior to the glut there, pot was wholesaling for $1700 to $2200 per ounce, but was now down to $700 per ounce because of the glut.

    Another thing to take into consideration when talking about price per pound/ounce production costs is that those weights are for a dried product. That adds to the production costs. So a pound of pot might take a 10 pound plant (before drying) to produce, for example. It still doesn’t explain the high costs of production though. Tobacco is also sold as a dried plant and doesn’t cost anyway near hundreds of dollars per pound to produce.

    Anyway, I think eventually as pot becomes legal in more states the governments will tax and govern the business similar to the way they tax and govern tobacco, alcohol, etc. I think because pot has always been associated with the counter-culture and it is not a main stream vice at this time, governments are having knee-jerk reactions to the industry and over reaching with their governance and taxation.
    Maybe as the product becomes more mainstream and less (mystical) over the years, governments will relax their measures.

    • Hi Mark:

      Thanks for the extra data point: $1,700/$2,200 per ounce wholesale to $700. Do you recall the interview giving a timeframe for each of those data points?

      I did a few minutes research on the ‘net and found a few data points over the last year showing the drastic drop in retail price. Will post an article tomorrow.

      I agree we are in a transition time. On one hand, politicians see a pot of tax revenue in the distance, are drooling at the possibilities, and want to rake in fortunes. On the other hand, they don’t want to let things get out of control or see lots of people get irritated, so they layer on huge regulatory loads, driving up costs. Underneath all that is a possible shift in general culture consensus. Or maybe not.

      Thanks for sharing what you’ve read and heard.

      Jim

      • Sorry Jim, but I was only half listening to the interview and I kind of only focused on the price/glut situation. I was shocked at the cost of it though, and the cost of production.
        I will read the article about the drastic drop in price when you post it tomorrow.

        I am quite positive there will be a shift in general culture consensus about legal pot over time. Humans are quite adaptable to change. Look how much the former taboos of yesteryear are now mainstream today.

        “politicians see a ‘pot’ of tax revenue in the distance”…no pun intended…right Jim? LOL

      • Hi Mark:

        Good one! Actually, I was aiming for the deceiving illusion of a pot of gold at the end of the rainbow, with the word play that the politicians won’t get the millions and millions and millions they are dreaming of. But I’ll take the other pun as well. Wow. I coulda’ had a twofer!

        If it were generally known how much fun blogging is, there would be a ton more blogs around.

        Jim

  4. Pingback: Mr. “Worlds far away”, please let me introduce Mr. “Natural experiment in heavy-handed regulation”. | Outrun Change

  5. Pingback: Some data points on pricing in newly legal recreational marijuana. We can already see distortions created by regulation. | Outrun Change

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