$46 Billion: Marijuana's Most Promising and Perilous Number

By Sean Williams Markets Fool.com

Though still an illegal substance at the federal level, marijuana is threatening to become one of the fastest-growing industries on record.

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In total, 28 states have legalized medical marijuana, including Pennsylvania and Ohio, whose legislatures passed a law legalizing cannabis for medicinal purposes in 2016. Legislative approvals had, until last year, been extremely rare. Meanwhile, eight states have legalized recreational, adult-use pot. This is up from four states in 2015 following the passage of recreational marijuana initiatives in California, Maine, Massachusetts, and Nevada in the November election.

Image source: Getty Images.

What's fueling marijuana's expansion?

The changing opinion of the public toward cannabis has been a major reason why it's flourished at the state level. National pollster Gallup found 60% support for the nationwide legalization of the drug in its 2016 poll, which was up from 25% in 1995, the year before California became the first state to legalize medicinal marijuana.

State-level governments have, in some cases, been a strong influence, too. Marijuana provides a new channel of taxable revenue for states that could be struggling to make ends meet. In California, for example, the passage of Proposition 64, which legalized recreational pot, is expected to add $1 billion annually in tax revenue once retail dispensaries are given the green light. Colorado, which was one of the first two states to have legalized adult-use marijuana, brought in $135 million in tax and licensing revenue on just shy of $1 billion in sales in 2015.

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Yet even these figures don't tell the full story of the marijuana market in North America.

Marijuana's promise and peril are tied to one important figure

According to a new 25-page report from ArcView Market Research titled "The State of Legal Marijuana Markets," which was provided in advance of its release to The Huffington Post last month, North Americans (defined as persons in the U.S. and Canada) spent $53.3 billion on marijuana in 2016.

Image source: Getty Images.

But here's the keynote figure of the report: just $6.9 billion of those sales were from legal channels in the U.S. and Canada. Even though this $6.9 billion figure represents year-over-year sales growth of a robust 34%, it still means that $46.4 billion in sales, or 87%, came from the black market. This $46 billion figure represents both promise and peril for the marijuana industry.

On one hand, there's real opportunity for states to end or significantly reduce this illegal activity by legalizing recreational marijuana. For instance, Colorado legalized recreational cannabis in 2012, and since then its black market has been reduced to only about one-third of its total sales, compared to 87% for the North American average. While it's a small sample size, the data would suggest that legalizing marijuana coerces consumers toward legal marketplaces.

Furthermore, ArcView CEO Troy Dayton doesn't believe it'll be too difficult for the legal marijuana market to keep up its exponential growth rate. In his words: "In contrast to comparable markets with fast growth from zero to tens of billions in recent decades such as organic foods, home video, mobile, or the Internet, the cannabis industry doesn't need to create demand for a new product or innovation -- it just needs to move demand for an already widely popular product into legal channels."

ArcView has estimated legal sales will grow to $21.6 billion by 2021.

Image source: Getty Images.

Then again, this $46 billion figure is a stark reminder of the challenges the pot industry is facing. For example, a legal but tightly regulated cannabis industry may struggle to offer a competitive price for pot products compared to the black market. Over the past year, marijuana prices have plunged thanks to bigger players swooping in and flooding the market with product. This isn't a trend that would be expected to survive over the long run. In other words, once larger players have eliminated most of their smaller competition, their incentive to bring supply and demand back into harmony, and to raise prices, would likely return, making black market marijuana substantially cheaper once again.

Another key point is that the inherent disadvantages created by the federal government for legal industries that play by the rules could continue to spur sales in the black market. As long as the federal government chooses to keep cannabis as a schedule 1 substance, pot businesses will be unable to take normal tax deductions. What's more, because financial institutions ultimately answer to the federal government, cannabis-based businesses have limited or no access to basic banking services, such as a checking account or line of credit. These disadvantages mean legal pot businesses get punished, while black market businesses still retain an estimated 87% of all marijuana sales.

This is the conundrum for many investors. There's a clear upward trend in legal pot sales, but there are no long-term guarantees that the black market will cede a majority of its market share to legal businesses, or that the federal government will make investing in the space profitable over the long run. Until we have that clarity, the enormity of the black market should serve as a warning to keep prospective investors safely on the sidelines.

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