Californians will be voting on legalizing marijuana for adult use this November and there is already a stampede of entrepreneurs rushing to the market to take advantage of the expected "green rush." Entrepreneurs need capital and are raising money from willing investors. But what do their business plans and financial objectives say about wholesale prices over the next several years? Will they go up with demand or down with increased competition?
Though California is very different than any other legal marijuana market, looking at what has happened to prices in Washington State and Colorado since legalization can give an indication where cannabis prices will go.
"Legalized marijuana is getting very cheap very quickly," says the Washington Post based on looking at two years of data in Washington State.
After a transitory rise in the first few months, which Davenport [Rand researcher] attributes to supply shortages as the system came on line, both retail prices and wholesale prices have plummeted. Davenport said that prices “are now steadily falling at about 2 percent per month. If that trend holds, prices may fall 25 percent each year going forward.”
It's the same story in Colorado where wholesale marijuana prices dropped 1/3 in the first five months of 2016. According to data from the online wholesale marketplace Cannabase, the average monthly asking price per pound for recreational flower dropped to an average of $1,402 in June from $2,106 in January.
It should be noted that data collection in the cannabis industry is notoriously difficult with different data sources generating varied results. The Colorado data above is for recreational (not medical) cannabis and represents asking prices as opposed to final sales. But the trend in both states is clear, wholesale cannabis prices will drop regardless of the additional costs that regulation places on production.
Based on the above two examples, it's likely that prices will also drop in California following legalization (ignoring initial shortages of supply that are possible in the early days following legalization). But there are a number of factors that make it difficult to predict exactly how far prices will drop.
Factors that push up prices:
- Increased demand (especially with passage of AUMA)
- Supply shortages (possible in short-run)
- New taxes (at city / county and state levels)
- Significant regulatory costs
- MMRSA-required distribution layer
Factors that drive down prices:
- Increased competition
- Reduced costs from end of prohibition
- Efficiencies of scale
- Over supply of production
- Competition from black market
Other than the possibly of price shocks from temporary supply issues, it is hard to imagine that the price of cannabis in California will do anything other than follow the trends of the other legalized states and continuously drop. The only real question is what will the floor be. If one makes the assumption that there will be sufficient competition to drive marginal profit to the cost of capital (nearly zero) then equilibrium will be around the cost of growing and trimming a pound of marijuana.
It is highly likely that ever-improving cannabis growing technologies (from better greenhouses to automation) will increase quality and yields while driving down costs, and that whatever financial gains can be made from these will be ultimately eroded by competition. This is not to say that investors should steer clear of cannabis investments (quite the opposite in our opinion) but investors should give great weight to looking at the pricing assumptions given to them by entrepreneurs and seek out companies who will be leaders in production efficiencies (especially at scale) as opposed to victims of it.