March 29, 2022

California Legislation Pushing for Cannabis to Cross State Lines

Interstate Traffic
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California has recently proposed a set of bills to address issues arising from federal cannabis prohibition, with one measure appearing to be an explicit challenge to the U.S. government’s current stance of simultaneous toleration for state-legal cannabis regimes and refusal to legalize nationally. Two of the bills under consideration are: AB 2568, which would provide that it is not a crime for individuals and firms to provide insurance and related services to persons licensed to engage in commercial cannabis activity; while SB 1293 would allow a credit to cannabis licensees in the amount equal to the amount of business expenses the licensees could not deduct or claim credit for on federal taxes.

The most direct challenge to the U.S. government’s current stance on cannabis, however, is SB 1326, which would authorize the Governor to enter into interstate agreements authorizing medical and / or adult use commercial cannabis activity between entities licensed under the laws of other states. California’s Medical and Adult Use Cannabis Regulation and Safety Act (MAUCRSA), the enabling legislation providing the framework for legal commercial cannabis activity in the state, “specifies that its provisions shall not be construed to authorize or permit a licensee to transport or distribute … cannabis or cannabis products outside the state, unless authorized by federal law.” The bill would strike the phrase “federal law” and replace it with “state law” in the original MAUCRSA, thus opening the door for interstate trade.

To help clarify whether California is attempting to throw down a gauntlet that would force a reckoning over the contradiction of state legality and federal illegality, Cannabis Benchmarks spoke with California cannabis lawyer Dale Schafer. Schafer’s view of cannabis law is formed from his decades of work as an attorney in the industry and the work of his organization, Weed for Warriors, which seeks to ease veterans’ access to medical cannabis through the Veterans Administration. While Schafer acknowledged the inertia of the now-rescinded Cole Memo – which stated generally that the U.S. Department of Justice would not enforce federal cannabis prohibition against compliant state-licensed businesses – he cautioned “the federal government is lurking out there,” suggesting the current situation is a shaky foundation on which to build interstate trade.

Schafer said the package of bills seemingly in defiance of federal law are “a big stick for states to wield” and may “effectuate policy change,” though the multiple and varied interests in keeping the cannabis industry in legal limbo may well keep the bills from passing. He could envision other states – Washington, Oregon, Nevada, and Hawaii – joining in a class action suit against the federal government to force a resolution when and if California finds itself in the federal crosshairs, particularly on passage of SB 1326, the interstate trade bill.

Schafer’s 10,000 foot view of the California cannabis industry sees key players in government financed sectors, law enforcement especially, as blocking any attempt to put a federal imprimatur on the cannabis industry, as it would affect law enforcement funding. The federal prohibition / state legal dichotomy has forced the industry to “live under precedents” – like the Cole Memo – based on “foundations that can be blown up any day.” He thinks the interstate commerce bill, SB 1326, is especially likely “to start a battle with the federal government.” He notes 2021 remarks from Supreme Court Justice Clarence Thomas – “a prohibition on intrastate use or cultivation of marijuana may no longer be necessary or proper to support the Federal Government’s piecemeal approach” – were “a greenlight to attack” the federal government’s positions on most cannabis restrictions.

Schafer believes if the dissonance between state and federal law is presented in such a way as to support state law with “objective reasonableness,” the federal government will lose. He also noted that “California is the only state big enough to take on the federal government,” citing its place as the fifth-largest economy in the world. He continued that California may, if these strategic bills are passed, “have a position the federal government can’t ignore.”

As for the current state of the cannabis industry in California, Schafer sees licensed businesses “circling the drain” due to the cost of compliance with the state’s environmental laws, expensive licensing fees that lock out experienced cannabis farmers, and prohibitively high cultivation taxes. As well, Schafer sees the pervasive power of illicit cannabis underlying many of the issues in the legal market.

Regarding proposed bills to get rid of the cultivation tax or place a five year moratorium on the same, Schafer does not believe they will pass. He cited the influence of law enforcement in politics and says the bills aimed at the cultivation tax are also likely to be opposed by California labor unions whose leadership tend to be “conservative.” His clear sense is that unless law enforcement is directed and funded away from drug enforcement, they will continue to oppose efforts to fully support the state’s cannabis industry and oppose moves to reconcile state and federal cannabis law.

Schafer sees the road to full federal legalization as a series of incremental efforts to inch the country along the path, while changing the public’s perception of cannabis. He hopes the bill to eliminate the cultivation tax will pass and supports another bill that would fine landlords of illicit cannabis retailers $30,000 per day to help eradicate illegal storefronts. That said, he acknowledges stamping out illicit cannabis businesses is “a game of whack-a-mole” and believes the entire California cannabis industry is underpinned by the illicit market.

Schafer says California’s proposed bills could well be a strategic bid to force the federal government to reconcile its contradictory stance on legal cannabis. However, questions remain: First, as to whether the bills, particularly the interstate trade measure will pass. Subsequently, if SB 1326 is signed into law in California, will it garner a legal challenge from the U.S. government, or will the state be the first in the nation to sidestep federal regulation with state law?

March 1, 2022

Crashing Cannabis Prices Hit California Tax Receipts

California Cannabis Tax Receipts
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The California Department of Tax and Fee Administration (CDTFA) issued data this week on taxable sales and cannabis tax collections for Q4 2021. Taxable sales for Q4 were $1.26 billion, down 2.8% from an upwardly adjusted $1.29 billion in Q3 2021, suggesting any holiday bump in sales was diminished in part by falling cannabis prices. Year-on-year, Q4 2021 sales were up 1.1% from Q4 2020 sales of $1.24 billion.

Total cannabis tax revenue collected in Q4 2021 was $308.6 million, down 7.6% from an upwardly adjusted $333.8 million in the prior period. Q4 2021 total tax receipts include excise taxes of $157.4 million, cultivation taxes of $39 million, and sales tax of $112 million. Total tax collections for Q4 2021 were up just 1% from Q4 2020 total tax collections of $305.3 million.

Excise tax receipts fell 10.2% quarter-on-quarter in Q4 2021 following a downwardly revised 0.7% drop in excise taxes in Q3 2021. Excise tax is levied on both adult use and medical retailers based on the wholesale price paid, plus a mark-up rate set by CDTFA in the case of bilateral trades between two unaffiliated parties. Year-on-year Q4 2021 excise tax collections are up 3% from Q4 2020.

California Excise Tax Receipts

Sales tax data in the table below shows quarter-on-quarter increases in sales tax collections through 2020, except for Q4, when collections slipped following the pandemic sales boom that peaked in Q2 and Q3 2020, according to CDTFA sales data. California’s general sales tax is applied to retail purchases of cannabis by adult use consumers, but not medical patients, and varies by municipality.

2021 saw resurgent pandemic effects through Q2 2021; but unemployment fell across the year, federal subsidies ended, and cannabis prices fell. Lower sales tax collections in Q3 and Q4 2021 especially were exacerbated by sharply lower cannabis prices from the end of Q2 through Q4 2021. 2021 sales taxes collected from adult use retailers were $462.9 million, a 17.5% increase over 2020’s total sales tax receipts of $394 million.

CDTFA also provided Cannabis Benchmarks with a breakdown of cultivation tax receipts for Q4 2021. As California’s cultivation tax is a flat tax by weight for each product type, the data provides for quarterly and annual comparisons of the volume of product that entered California’s regulated market in recent periods. Tax receipts for flower, fresh plants, and leaves all fell in Q4 2021.

California Cultivation Tax by Product

Quarterly wholesale sales volume figures, extrapolated from CDTFA cultivation tax data, are shown in the table below. The cultivation tax is levied on product when it “enters the commercial market,” which is defined by CDTFA as when the product clears required testing.

California Wholesale Sales Volume

Year-on-year wholesale volume of products entering the market fell across the board, with Q4 2021 flower sales down 1.4%, leaves (trim) volume down 20.9%, and fresh plant volume down 9.1% year-on-year, suggesting that while purported production keeps growing, some amount of product is not making it into the market, instead being destroyed to avoid the tax burden or perhaps ending up in the illicit market.

While the 2020 pandemic year saw steadily rising product volumes, in 2021 volumes dropped initially with Q1 2021 product volume falling across the board versus Q4 2020. The Q4-Q1 decline was likely also due to the seasonal characteristics of the production side of the market, with trading volume in the final quarter of any given year typically inflated due to the fall outdoor harvest. That said, 2021 flower and fresh plant volumes increased from quarter to quarter until Q4, while volume of leaves increased in only one quarter in 2021. It is clear cannabis volumes recorded for tax purposes have fallen with a corresponding drop in tax collections, yet cannabis prices reflect a market that is significantly oversupplied.

California Quarterly Sales Tax Receipts

Total cultivation tax collections fell in both Q3 and Q4 2021, as the table above shows, as oversupply issues continue to plague the market, driving prices lower so that some growers are not harvesting product because taxes and fees make it unprofitable to do so, according to Forbes magazine.

The downturn in Q4 2021 cultivation tax receipts and the volume of product entering the market is especially notable as the final quarter of any given year is the period in which the autumn harvest takes place. As noted, some crops were reportedly not harvested at all, while other growers may also be unable to move their crops or holding back inventory intentionally in the hope of better market conditions as the year progresses.

Again, California’s cultivation tax is only levied upon product that “enters the commercial market,” which occurs when it has been transferred to a distributor and passes the state’s required testing. As alluded to above, due to severe oversupply conditions that became apparent in the summer of 2021, distributors in Q4 2021 may not have been looking to aggressively take in new inventory as they usually would in the wake of the autumn outdoor harvest.

California Cultivation Tax Receipts

As noted, the significant downward price pressure that began last year became undeniable in the summer. Outdoor flower’s price peaked in March 2021 and began selling off in earnest in June 2021. Greenhouse product’s price peaked for the year in April and started a strong downtrend in late July. Indoor flower prices also peaked in March 2021 but did not begin their strong downtrend until the first week in September 2021. California’s Spot started reflecting the 2021 sell-off in late July.

Given the staggered dates of the sell-off across products, it is clear there has been price contagion from outdoor up through greenhouse and indoor flower. There was also a notable tightening of the spread between greenhouse and outdoor product that began in September 2021. The greenhouse / outdoor spread went from $439 in May 2021 to $135 at the end of December, suggesting there is more outdoor-like greenhouse product on the market than there is indoor-like greenhouse product. However, it still remains the case that the overriding issue is the vast oversupply in legal and illicit markets and price will remain under pressure until one, or both issues, are addressed.

February 8, 2022

What Can Other States Learn from the California Cannabis Experiment?

California Cannabis
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California is arguably the largest legal cannabis market in the world and, as such, lessons might be learned by states that have recently legalized cannabis. The most striking current economic features of California markets are the deterioration in wholesale prices, the legal tax regime, and the failure to eradicate, or apparently even put a dent in, the illicit market. The state may have continued along for many years with dueling legal and illicit markets and what is arguably a very expensive tax regime if it were not for the significant and ongoing price deterioration. The downtrend in price has highlighted tax issues, as well as the entrenched illicit market and its effects on legal cultivation and prices. California cannabis price pressures continue, foreshadowing dire consequences for small cannabis farms and processors of outdoor product, as well as retail outlets that see demand for sun-grown, smokable flower from their customers.

To get a better handle on what is driving California cannabis business, Cannabis Benchmarks spoke with Brian Hilliard of Norcal Consultants. His long term take on the California cannabis industry is that it will survive, but will be significantly changed in five years time. He sees “big alcohol, tobacco, and pharma buying up land” to produce massive quantities of (mostly) outdoor grown cannabis and driving the price for such plant material “down to $100 per pound” to fulfill the demand for extracted products they create. Along with further price deterioration, Hillard predicted a drop in quality as alcohol, tobacco, and pharmaceutical firms create cannabis products for mass distribution.

The extraction market has been a double-edged sword in California. On the one hand it has created another demand channel for outdoor grown product. However, outdoor flower prices have continued to deteriorate even as the new demand channel – extracted and manufactured products – expands, in large part because extractors are high-volume buyers that can secure lower rates relative to smaller purchasers of smokable flower. Hillard explained that farmers are often “waiting for five months to get paid” when they sell to retailers or processors, essentially consigning product for sale. Extractors, on the other hand, pay up front for sun-grown cannabis flower and other parts of the plant, so farmers can avoid the uncertainty and delays involved in “consigning” their crop. Hillard sees much of the demand for extracted products coming from Los Angeles and other big cities where style is as important as substance and finely packaged edibles, concentrates, and cartridges are challenging the dominance of smokable flower.

Although the California cannabis markets are undergoing changes wrought by oversupply and, in some cases, plateauing demand, Hilliard noted outlets outside of the licensed retail system are thriving in northern California, with well established “sessions” picking off medical and retail customers. Essentially, “sessions” are markets outside the regulated market, where mostly medical card-holding buyers meet sellers at pre-designated dates to buy and sell cannabis in a farmer’s market atmosphere. While “sessions” may not be strictly legal, they are well-established “bazaars” in major California cities, occurring three to five times per week in some cases.

Despite Hillard’s prediction for continued erosion of outdoor grown crop prices, he sees a perpetual market for “jewel box” cannabis, the best of the best of all grow types that discerning consumers will always seek out. In his mind, growers that can successfully distinguish their product from the run of mill, heavily marketed products will always have a place in the cannabis ecosystem. Moreover, he said the “traditional market” – meaning unlicensed operators – will continue to thrive as well, with veritable grower dynasties finding a way to survive amid a rapidly changing landscape. In fact, Hilliard said with the advent of the legal market “nothing has really changed” among the dynastic family businesses.

So what might other states take from the California cannabis experience? One sure lesson is that ever increasing supply means lower prices. Consequently, taxation schemes based on state revenue considerations rather than industry realities may have to undergo significant changes to bolster the sector when oversupply inevitably swamps the market. Moreover, eradicating illicit markets is nearly impossible with expensive licensing regimes essentially shutting out experienced growers by dissuading them from entering legal systems. And finally, that cannabis businesses will find a way to survive, sometimes without regard for legal market requirements, creating a non-virtuous circle that is very expensive, if not impossible, to curtail.

December 7, 2021

California’s Taxable Cannabis Sales Take Big Hit in Q3 2021

California Taxes Take Big Hit
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The California Department of Tax and Fee Administration (CDTFA) recently issued data on taxable sales and cannabis tax collections for Q3 2021. Taxable sales for Q3 were $1.24 billion, a steep 12.5% quarter-on-quarter decline from over $1.41 billion in Q2 2021. The quarterly downturn in sales is notable, as Q3 is frequently the strongest sales period of any given year for legal cannabis markets. Year-on-year, Q3’s taxable sales are down 1.8% from over $1.26 billion in Q3 2020.

Total cannabis tax revenue collected in Q3 was $322.3 million, of which excise taxes were $169 million, cultivation taxes were $42.4 million, and sales taxes from cannabis businesses were $111 million. The $322 million in total taxes collected represents a 6.6% decrease from the upwardly adjusted Q2 total taxes of $345 million. Total tax collections were down by 0.8% year-on-year in Q3. Quarter-on-quarter and year-on-year total sales revenue are lower due to lower demand beginning in the summer, as well as a significant drop in Q3 California cannabis prices.

Excise tax receipts were down 4.7% from the prior quarter in Q3 2021, after gaining an upwardly revised 10.7% in Q2 2021. California’s 15% excise tax is levied on retailers – both medical and adult use – based on the wholesale price paid, plus a markup rate set by CDTFA in the case of bilateral trades between two unaffiliated parties.

California Quarterly Cannabis Excise Taxes

As shown in the table below, 2020 saw strong and steady increases in sales taxes collected from adult use retailers – including a 29% quarter-on-quarter increase in Q2 2020 – with the exception of the final quarter of 2020, in which tax revenue fell slightly. 2021 sales tax revenues have fallen two out of three quarters, yet total revenue in the first three quarters of 2021 is $61.3 million higher than that of the first three quarters of 2020.

The average quarterly sales tax revenue in 2020 was $98.6 million while the average quarterly sales tax revenue to date in 2021 is $115.2 million. At this pace, 2021 sales tax revenue will outpace 2020 by some $66.3 million.

California Quarterly Cannabis Sales Tax

CDTFA also provided Cannabis Benchmarks with a breakdown of cultivation tax receipts for Q3 2021. As California’s cultivation tax is a flat tax by weight for each product type, the data provides for quarterly and annual comparisons on the volume of product that entered California’s regulated market in recent periods. Tax receipts for flower and fresh plants are up quarter-on-quarter, but revenue from leaves was down nearly 10% in Q3.

Lower tax revenues for leaves – or trim – are perhaps an effect of waning pandemic demand. Seasonal factors may also be at play. With such material largely used by extractors and product manufacturers, those operators may have been waiting for the current quarter’s fall harvest to bring in more, cheaper raw material for their production lines.

California Cannabis Tax by Product

Quarterly wholesale sales volume figures, extrapolated from CDTFA cultivation tax data, are shown in the table below. The cultivation tax is levied on product when it “enters the commercial market,” which is defined by CDTFA as when the product clears required testing.

California Wholesale Cannabis Volume

Year-on-year wholesale volume of products put in a mixed performance with Q3 2021 flower sales volume up 6.5%, fresh plant volume up 11%, and leaves (trim) down just over 12%.

While the 2020 pandemic year saw steadily rising product volumes, in 2021 volumes dropped initially with Q1 2021 product volume falling across the board versus Q4 2020. The Q4-Q1 decline was likely also due to the seasonal characteristics of the production side of the market, with trading volume in the final quarter of any given year inflated due to the fall outdoor harvest. That said, volumes have generally increased from Q1 2021, with the exception of leaves (trim) in Q3, when the volume that entered the market fell 10.2% from Q2 2021.

Cultivation tax collections have remained surprisingly steady after the massive 40.9% jump in Q3 2020, which was likely spurred by expansive pandemic demand and increasing production capacity coming online. While cultivation taxes were marginally lower in Q4 2020 and Q1 2021, it appears the $40 million handle is here to stay until the next big figure at $50 million – an event that is likely to occur next year as explained below.

California Cannabis Cultivation Tax

Cultivation taxes are set to increase on January 1, 2022 in an inflation adjustment, a requirement of the Cannabis Tax Law effective January 2020. The new rates apply to cannabis product the cultivator sells or transfers to a manufacturer or distributor, according to the CDTFA.

California Cannabis Adjusted Tax Rates

The California spot market has undergone a steep sell-off in 2021, losing just over 34%, from its current annual high to the current low. The cultivation tax record indicates there has been very little change in the amount of cannabis being taxed in 2021.

Lower excise and sales tax collections are likely due in part to lower retail prices corresponding to the downturn in wholesale rates, especially in Q3 2021. Consumer demand and retail sales also softened in California in Q3, as in many other markets around the country. We might expect tax revenues from retail purchases to sink again in Q4, with spot pricing down 17.4% two-thirds of the way through the quarter. Additionally, October and November are typically slower retail sales months in legal cannabis markets.

August 31, 2021

California Retail Cannabis Demand Soars as Supply Expands Driving Wholesale Prices Down

California’s Legal Market Continues to See Strong Sales Growth

The California Department of Tax and Fee Administration (CDTFA) recently issued data on taxable sales and cannabis tax collections for Q2 2021. Additionally, Q1 2021’s figures were updated and completed after many businesses took advantage of an extension to remit granted by the state in light of the coronavirus. Overall, the data shows retail sales growth continued to be strong, while the amount of wholesale supply entering the licensed system in Q2 did not expand quite as much as retail demand.

Taxable sales for Q2 2021 reached almost $1.36 billion, up by over 11% from Q1 2021’s taxable sales of $1.22 billion. Q2 2021’s taxable sales were up by 24.5% year-on-year.

Total California Cannabis Tax Receipts Surge 26% Year on Year

Total taxes collected in Q2 2021 were $333 million representing a 9.3% increase quarter-on-quarter and a 26% increase in total cannabis tax revenue year-on-year. The expansive quarterly gains seen through the first pandemic period last year have tapered off in 2021, which may be due in part to people returning to work and having less leisure time. Additionally, the rather sharp 21.9% drop in the wholesale flower price observed by Cannabis Benchmarks from November 2020 – January 2021 may also have played a role in slowing sales and tax revenue growth.

In 2021, however, excise tax receipts began a slow climb that coincided with a gradual recovery in price, with January to June price climbing 15.3%. California’s 15% excise tax is levied on retailers and is calculated based on the wholesale price paid, plus a markup rate set by CDTFA, in the case of bilateral trades between two unaffiliated parties.

California Cannabis Excise Taxes

While there has been a good bit of volatility in quarterly tax receipts, the most significant take-away from the data is the steady year-on-year growth in California cannabis taxes. The pandemic ‘bulge’ in tax collections was not followed by lower tax receipts. In fact, in regard to the state’s general sales and use taxes, which are levied on purchases made by adult-use consumers, quarters following the pandemic-related surge in taxes gave back very little, sinking just 1.8% in Q4 2020 and 2.3% in Q1 2021. When extraordinary events spike market peripherals, a reversion to the mean value is far more common than a trend reversal in said peripherals, as demonstrated below.

California Cannabis Sales Tax

CDTFA also recently provided Cannabis Benchmarks with a breakdown of cultivation tax receipts for Q1 and Q2 2021. As California’s cultivation tax is a flat tax by weight for each product type, the data provides for quarterly and annual comparisons on the volume of product that entered California’s regulated market in recent periods. For the first two quarters of 2021, shown in the table below, tax receipts continue to increase, albeit at a slower rate than increases seen in 2020

California Cannabis Cultivation Tax

Quarterly wholesale sales volume figures, extrapolated from CDTFA cultivation tax data, are shown in the table below. The cultivation tax is levied on product when it “enters the commercial market,” which is defined by CDTFA as when the product clears required testing.

California Cannabis Cultivation Volume

Year-on-year wholesale volume of product sold climbed rather sharply with Q2 2021 flower sales volume up 22.2%, leaves (trim) up 33.6%, and fresh plant volume up 17.9%.

Wholesale product volumes depicted in the table above reflect increased production meeting expanding demand in 2020 amid the pandemic bulge; the period of time in which lockdowns were in place, unemployment was skyrocketing, the unemployed were helped with federal subsidies, and millions of workers were tasked with working from home. The jump in sales volume of all product types from Q2 to Q3 2020 is evident. However, while wholesale sales volumes for Q2 2021 are up year-on-year, they are below those recorded in Q4 2020 owing to the fall harvest supply surge that occurs in the final quarter of any given year.

Subsequent quarterly changes into 2021 show fewer taxes paid than in Q4 2020 coincident with less product volume entering the commercial market in each of the first two quarters of this year. From Q2 2020 to Q2 2021, cultivation tax receipts, shown in the table below, have climbed 31.5%, reflecting annual gains despite quarterly volatility.

California Cultivation Tax Receipts

Recent Tax and Sales Data Not Reflective of Current Market Landscape

How quarterly data will look for Q3 2021 will be interesting considering that currently-observed market dynamics appear to have changed dramatically from the prior quarter. As we noted at the outset of this section, sales and tax collection data through Q2 2021 paints a picture of a market in which retail demand is expanding at a greater rate than production. Indeed, our California Spot Index trended upward through Q1 and Q2 of this year, coincident with the data examined above. However, as we have noted recently, wholesale flower prices are falling and reports out of California indicate a buyer’s market.

The Eureka Times Standard recently reported on overproduction in Humboldt County and other areas weighing on price. Growers say the answer for overproduction of this magnitude is for the state to provide relief in the form of lower taxes and fewer licenses, but such changes will not stop overproduction from already-licensed large-scale growers across the state. The Humboldt County Growers Association is pinning their hopes on national and international legalization so that they might market locally produced cannabis across the country and around the world.

Cannabis Benchmarks California Spot Price Dives Below Long-Term Trend

Spot prices are for immediate delivery of a commodity; they contain no cost of carry surplus and generally reflect the cost of a commodity in the present and for immediate, or within several days, delivery of the purchased commodity.

Cannabis Benchmarks California Spot Index from the start of 2020 through last week is depicted in the chart below. Note the longer term trend, dating back to Spring 2020, has been broken by the current late summer sell-off. Indeed, as seen below, California’s Spot has reached a new year-to-date low as of August.

With outdoor and light deprivation harvests beginning, prices may continue lower. Although demand for freshly-harvested material could help steady price initially, as has been the case in some previous years, accounts out of California suggest an early harvest price bump may not be in the cards this year due to significant supplies from 2020 and this summer’s light-deprivation crops swamping the market.

California Cannabis Spot Price