The demand for recreational marijuana has increased considerably. Most industry observers predict that there will be a recreational marijuana shortage in 2019. What is causing this shortage?
Supply and Demand
Health Canada, the department responsible for issuing production licenses for marijuana growers, more than doubled the number of production licenses in 2017. Unfortunately, this has not balanced the supply/demand ratio. Regional supply imbalances in provinces that only allow sales through government-run retail outlets and unmet cultivation targets from producers are thought to be the culprit.
Often, what is on paper does not pan out in real life. This is true for the Canadian marijuana industry. The amount of paid-for production capacity is more than enough to meet demand for 2019. In fact, companies have been spending hundreds of millions of dollars in order to boost production.
The Marijuana Policy Group
A Denver based company called the Marijuana Policy Group (MPG), has provided analysis and policy advice to the Canadian government and private clients. They found that Canada’s publicly traded licensed producers have funds available to produce 1,370 tons of cannabis for this year and the next. MPG believes that this supply is actually three times more than needed to serve the legal cannabis market in the coming year.
The supply and demand problem leads to two key questions:
- How much of Canada’s 992 tons of black market marijuana can it bring into the legal market in the next two years?
- How successful will producers be in meeting their cultivation targets?
MPG predicts that Canada will take approximately 40% of the recreational cannabis black market share. This equates to almost 400 tons of marijuana in the first year. For producers, this means that they only have to meet 35% of their cultivation capacity in order to meet market demand, MPG estimates.
According to Miles Light, co-founder and partner with MPG, “Licensed producers are well capitalized in Canada, making it easier for them to ramp up production in the first year. Supply may be limited initially but should ramp up sharply after a few months…Legal demand won’t be 100% of the market. Some portion of that will be supplied by home growing, and some is going to be supplied by the same black market that exists today. Then you have what’s being already supplied in the medical market.”
Currently, Canada’s licensed medical cannabis production is almost 83 tons per year.
Where Is the Cannabis Shortage?
MPG predicts that any shortage of cannabis will not be from production and cultivation of cannabis, but rather from market distortions. Retails and wholesalers who sell the marijuana after it is produced are thought to be responsible for the market shortfall.
Light predicts, “You’re unlikely to have a systematic shortage or bottleneck in cultivation, but there may be bottlenecks further down the supply chain, especially in distribution and retailing.”
What is the reason for this “bottleneck” effect? Provinces such as Ontario and Quebec have opted for government-run retail monopolies creating a shortage of sales outlets. Ontario and Quebec account for two-thirds of the overall population in Canada. Even with this large percentage, there will only be around 70 adult-use marijuana outlets in 2019. In comparison, there are 1,066 government-run liquor stores and 250 illegal marijuana dispensaries in these two provinces.
Regional market imbalances may be seen regionally. Some areas may have too much marijuana and other areas may not have enough. In contrast, provinces that allow for private-sector retailors will see many entrepreneurs help the bottleneck by opening outlets with a larger selection of products and a wider range of prices. According to Khurram Malik, partner with Jacob Capital Management in Toronto, regional retail networks will be key in alleviating the bottleneck in distribution.
This equates to an inventory surplus in the market before there is excess supply. According to Malik, if there are only 50 stores in Ontario when 500 are needed, there will be an “inventory glut” before the market sees any supply surplus. This surplus will benefit smaller producers, who will be able to produce at a higher utilization rate.
The Big Picture
The larger issue is going to be the variety of products available for sale. What are consumers going to demand? What are they willing to buy? Will the products sold in the regulated markets satisfy the demand of consumers?
The initial in-demand strains of marijuana, which includes edibles, will not be a part of the initial legalization rollout. President of the Cannabis Commerce Association of Canada, Ian Dawkins, explains it best by comparing cannabis sales to alcohol sales.
He surmises that a government run liquor store would not be very successful if it only sold three kinds of rum. Instead of settling for a limited choice, Canadians would be “lining up at the border to ship in the U.S.” Dawkins is a principal consultant of British Columbia-based Althing Consulting.
He also predicts that the best way to approach the supply problem is to quit focusing on total weight. Instead, he believes that the shortage will be in particular sub segments that larger licensed producers (LPs) do not understand.
Some LPs, however, are attune to market demands. Canopy Growth, a major licensed producer that trades on the Toronto Stock Exchange under the symbol WEED, is offering a diversified product offering by recognizing that the demand will not be for one particular product, but a wide variety of marijuana products.
This means that successful companies must offer cannabis varieties grown by a diverse set of producers. More customers are attracted to a store when there is a wide variety of products for sale. This holds true in all retail outlets across every type of product sold.
Therefore, in order to meet the high demand for recreational marijuana, Canada must:
- Ensure that there is adequate production of marijuana to meet market demand
- Allow for private companies to fill in for government run shops when there is an area that has bottlenecked
- Lift restrictions on private companies to allow them to compete in all provinces
- Offer a wide variety of products by resourcing from many different producers
- Listen to market demand and adjust as needed
Canada stands on the precipice of recreational marijuana legalization. Ensuring that all Canadians have access to and choice of recreational marijuana will determine how successful it will be.