Colorado Has a Radical Plan to Save Its Billion-Dollar Marijuana Industry From a Federal Crackdown

By Sean Williams Markets Fool.com

The marijuana industry has been on a roll lately. Just last year, five states legalized medical cannabis (two of which did so entirely through the legislative process and without putting a measure on a ballot), while the number of recreational marijuana states doubled to eight. In fact, had a recreational marijuana measure not been defeated in Arizona by just 2 percentage points, it would have been a clean sweep for cannabis in the November elections.

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The success of the pot industry is directly correlated with the rapidly changing perceptions surrounding it. Gallup, which has conducted surveys on how many respondents would like to see cannabis legalized nationwide for almost 50 years, found that only 25% favored its nationwide legalization in 1995. As of 2016, this approval rating had jumped to 60%, representing an all-time high.

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A separate and more recent survey from the independent Quinnipiac University found 59% national support for recreational marijuana and only 36% opposition. When it came to just medical marijuana, an overwhelming 93% of respondents would like to see it legalized.

The federal government digs in its heels

Standing in the way of this popular opinion are the U.S. Drug Enforcement Agency (DEA) and Congress. In August, the DEA denied two petitions that requested it reschedule or de-schedule marijuana from its current Schedule 1 status. The DEA declined with the reasoning that there was inadequate safety and benefits data available, as well as improper oversight for a drug that can be easily abused. As a Schedule 1 drug, marijuana is labeled illegal and having no medical benefits.

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Congress, on the other hand, is caught in something of a catch-22. Lawmakers want lots of additional benefits and risk data that can only be found through running clinical trials, yet these trials are nearly impossible to run since obtaining marijuana for medical research is exceptionally difficult with the drug bearing a Schedule 1 designation.

But this may not be the worst of it for the marijuana industry.

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In February, White House press secretary Sean Spicer said that the Trump administration would not remain as lax in the federal regulation of cannabis as the Obama administration had been. The good news is President Trump has been unwavering in his support of medical cannabis, meaning the 28 states that've legalized medicinal pot are likely safe.

Recreational cannabis is a different story. Spicer intimated that a federal crackdown should be expected on the recreational marijuana industry, though what's not known at this time is to what degree. Spicer's comments could simply imply tougher regulations that ensure legal weed stays out of the hands of minors. Then again, it could involve a full-scale reversal of the hands-off approach under the Obama administration, leading to enforcement of federal laws against recreational cannabis. With ardent marijuana opponent Jeff Sessions recently appointed the U.S. attorney general, the chances for pot's growth to come to a crashing halt are seeming more likely by the day.

Recreational-marijuana states scramble to protect their cash cow

If (and this is a big "if") the federal government does choose to completely roll back the freedoms of state-level recreational pot, it puts more than just the cannabis industry in a bind. States like Colorado, Washington, and Oregon have come to rely on the tax and licensing revenue generated from the recreational marijuana industry to fill gaps in their budgets.

For instance, Colorado wound up selling more than $1.3 billion in legal marijuana in 2016, a more-than-30% increase from the prior-year period, when legal cannabis sales fell just shy of the $1 billion mark. Overall, $875 million in Colorado's sales came from recreational marijuana, with the remainder coming from the medical side of the equation.

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However, there's a major difference in taxation between the two. Medical pot is only taxed at 2.9% in Colorado whereas recreational marijuana bears a 17.9% tax. Having its recreational weed business banned would cost Colorado well over $100 million in annual tax revenue, at least $40 million of which goes to fund its schools.

Colorado's legislature is therefore developing a plan that could help protect its marijuana crops from being seized should the federal government present it with a worst-case scenario.

A bill that was proposed last week and passed in the state's Republican Senate by a 4-1 vote would allow Colorado's approximately 500 licensed recreational marijuana growers to immediately reclassify their cannabis as medical instead of recreational. The bill would allow this change to be "based on a business need due to a change in local, state or federal law or enforcement policy."

The upside of such a bill is that it would protect from seizure the more than 800,000 marijuana plants that were being grown in Colorado's retail system as of this past summer. The downside, though, is that it would still strip Colorado of highly valuable taxable income because the tax rates on medicinal pot are substantially lower than recreational. In other words, it would be a victory in name only for Colorado.

Other states are discussing similar methods to protect their marijuana industries against a potential federal crackdown.

Image source: Getty Images.

The waiting game continues

For now, the uncomfortable waiting game continues for the marijuana industry and investors who are eager to get in on an industry expected to grow by more than 23% per year over the next decade, according to investment firm Cowen & Co. Though cannabis represents an incredible growth opportunity, two factors should keep investors away from marijuana stocks for the time being.

For starters, most marijuana stocks are losing money, and they'll probably continue to do so for the near future. The seven-largest companies combined hardly generate any revenue, and just one is profitable over the trailing year, and by a small amount at that. The marijuana industry is far from established, and businesses that continue to bleed red will eventually succumb to the pressure from fundamentals-focused investors.

More importantly, no one's exactly sure what the Trump administration might do to the recreational pot industry. There's obvious concern with Sessions as attorney general that a worst-case scenario could come true, which would be devastating to a lot of marijuana stocks.

Simply put, until we have more answers, your money should stay far away from marijuana stocks.

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