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Uh-Oh! California's Marijuana Growers Have a Major Problem

Growth in the legal marijuana industry has been practically unstoppable over the past couple of years, and the sales data shows it. According to cannabis research firm ArcView, legal weed sales grew by 34% in North America to $6.9 billion in 2016, and they're on track to grow by a compound annual rate of 26% through 2021.

This would equate to a North American market worth nearly $22 billion in five years, and there could be plenty of expansion yet to come. This sales growth, along with the rapid change in consumers' perceptions of cannabis, which includes an all-time high percentage of Gallup and CBS News survey-takers who want to see pot legalized nationally , have been the catalysts that have driven investors to marijuana stocks over the past year.

California is the marijuana industry's crown jewel

As things stand today, 29 states have legalized medical cannabis, and residents in another eight states have given the green light for recreational weed.

Among those eight states, none is more of a crown jewel for the marijuana industry than California. The legalization of recreational weed in California, which was approved in November 2016, is expected to yield at least $1 billion in additional annual revenue, which is great news for a state that somewhat regularly contends with a budget deficit. By the beginning of 2018, dispensaries are expected to be given the green light to sell recreational cannabis to adults.

For added context, Colorado wound up boosting legal pot sales (medical and recreational) by more than 30% in 2016 to $1.3 billion, but still fell shy of $200 million in tax and licensing revenue, meaning California's market could be five times, or more, the size of Colorado.

While this should be great news for California's marijuana growers, there's actually a major speed bump standing in their way.

California's growers could see their profits go up in smoke

According to Hezekiah Allen, the executive director of the California Growers Association, pot growers within the state are producing in the neighborhood of (drum roll)... eight times more weed than is currently being consumed. According to the Los Angeles Times, growers have danced around this issue by exporting their product to other states, which is forbidden by the federal government but has thus far worked for California's growers. However, and this is a big "however," beginning Jan. 1, 2018, exporting cannabis out of California becomes illegal under the state's new law, leaving California's growers with a small handful of choices.

Option one is that California growers could choose to cut back production, which according to Allen would be painful. Allen suggested that growers "are on a painful downsizing curve."

A second option is that cultivators could choose not to apply for a state license at all, which would mean leaving the cannabis industry altogether.

And the final option would be for growers to continue exporting their product, and thusly operating in the black market by violating state and federal law. Lori Ajax, the chief of the state's Bureau of Medical Cannabis Regulation, suggests that growers who don't apply for a state license will eventually face enforcement actions, but that may not happen right away, given that California is attempting to introduce a massive and new recreational cannabis industry.

What might this mean for California's pot industry? If too many growers decide to skirt the licensing process, or remain intent on exporting their product, it could reduce the number of consumers who choose to business in the regulated market. Further, black market pricing may undercut regulated pricing as a result of not having to pay state licensing fees, which would defeat the purpose of pushing businesses and consumers into the regulated market.

California's issues provide this critical reminder

If California's potential marijuana growers crisis is anything, it's a reminder to marijuana stock investors that the rollout of recreational marijuana in new states is unlikely to be flawless, even with Colorado, Washington, and Oregon serving as legal weed examples. The legal marijuana industry is still relatively nascent, and it's bound to have hiccups that could impede growth and allow lofty expectations to go up in smoke.

The potential issues California could encounter with regard to licensing its growers and corralling black market production and exports may also garner unwanted attention from Washington. For those who may not recall, now-former White House press secretary Sean Spicer commented in February that the current administration may take a tougher stance on federal cannabis regulation than the Obama administration. Though medical cannabis is likely to be off the table in those discussions, recreational pot is a front-and-center target, especially if individual states struggle to regulate their industries. Not to mention, Attorney General Jeff Sessions has his eyes firmly set on curtailing marijuana's expansion.

Marijuana businesses are also facing a number of inherent disadvantages that come with pot being a Schedule I substance. This includes an inability to take corporate income-tax deductions like normal businesses, as well as having little or no access to basic banking services, including something as simple as a checking account.

In other words, before investors get overly excited about the prospect of buying into marijuana stocks, they'd be wise to bring their expectations down quite a few notches. This isn't to say that the legal marijuana market can't continue to grow. However, it does suggest that marijuana stocks may not benefit as much as investors anticipate they will, which creates a dangerous and/or disappointing scenario for your money.


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