Marijuana Prices Are Plunging in Colorado, and That Could Be Bad News

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Few industries are growing as quickly and consistently as legal marijuana, which is a big reason investors haven't been able to get enough of marijuana stocks in recent years.

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According to investment firm Cowen & Co., the legal U.S. cannabis market is expected to reach $50 billion in annual sales by 2026. On a more intermediate basis, cannabis research firm ArcView is looking for a compound annual growth rate of 26% through 2021 in North America, which would yield almost a $22 billion market by 2021. That rapid growth could be the ticket to substantial gains for investors willing to gamble on a substance that's still wholly illegal at the federal level in the United States.

Marijuana businesses have an uphill climb in the U.S.

But that doesn't mean "green" businesses have a cakewalk to success. Nearly all marijuana-based businesses face a plethora of challenges that are a risk to their profits, and in some ways survival.

For example, in the U.S., most cannabis companies are unable to obtain basic financial services, ranging from something as simple as a checking account, to a line of credit or loan. The reason? Financial institutions report to the Federal Deposit Insurance Corporation, a federally created entity. And since marijuana is illegal at the federal level, providing financial services to a pot company could be construed as money laundering, leading to fines and/or criminal charges against a bank.

In addition, cannabis companies face disadvantages come tax time. Namely, U.S. tax code 280E disallows businesses that sell federally illegal substances from taking normal corporate income-tax deductions. Though not all pot businesses are profitable, if they are, they'll be required to pay tax on their gross profit instead of net profit, leaving less cash left over to reinvest and hire more workers.

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Beyond just financial challenges, Attorney General Jeff Sessions is trying to squash the industry before it expands further. There's arguably no one more opposed to cannabis in D.C. than Sessions. Back in May, Sessions sent a letter to a few of his Congressional colleagues requesting the repeal of the Rohrabacher-Farr Amendment, which is what protects medical marijuana businesses in legal states from federal prosecution. 

News flash: marijuana prices are plummeting in Colorado

At seemingly every turn, cannabis companies face challenges. Well, it's time to add yet another.

According to a new analysis from The Economist, the wholesale price for a pound of cannabis in Colorado, the first state to begin legally selling recreational pot, has plunged from a peak of $2,000 in January 2015 to just $1,300 a pound today. Lower prices for dried cannabis are likely to mean lower margins, unless the cost per gram to produce marijuana has fallen by more than 35% over that same period.

Why the 35% drop in wholesale marijuana prices on a per-pound basis? The Economist attributes an expansion of supply and an increase in competition as a result of Sessions' mostly being all talk and no action. There's also some seasonality to this pricing, with peak pot prices observed during the ski season, when tourism picks up in the state. 

However, I'd contend that we're seeing something altogether different. My suspicion is that big businesses have been primarily responsible for weighing down pot prices in Colorado.

For those who may not recall, Colorado extended a moratorium on growing license issuances last year, which allowed those who'd already acquired a license to maintain control. This is especially true given that these grow licenses had no limits on the number of plants that could be cultivated on a grow farm. Additionally, nothing stopped big business from gobbling up as many licenses as they could afford in Colorado. The result is that just a few larger players wound up with a majority stake of the Colorado grow market. 

Now, if you're a big business and you want to eliminate your smaller competition, what do you do? Like Wal-Mart, you slash your prices to undercut the competition. Yes, this lowers margin, but you have deep pockets and your smaller competitors probably don't. Once you've sent them out of business or out of market, you've won the right to control more market share and command a higher price point for your product.

The way big business in Colorado is conquering smaller businesses is by flooding the market with dried cannabis. While this is a win for consumers in the short term, I suspect it's an anti-competitive tactic that'll substantially increase prices over the long run. While that'll be great for investors, it's not such good news for consumers.

This isn't just a concern in Colorado

Of course, big business' takeover of the pot industry isn't just something we're seeing happen in Colorado. Canada, which has been a source of great success for the green rush and investors, looks to be dominated by just a handful of larger businesses.

Even though Health Canada announced a change in policy this past May that would expedite the process by which growing licenses are issued and extended, it hasn't done much to stop just a handful of big players from taking over. Combined, Canopy Growth Corp. (NASDAQOTH: TWMJF), Aphria (NASDAQOTH: APHQF), Aurora Cannabis (NASDAQOTH: ACBFF), and MedReleaf (NASDAQOTH: MEDFF) could wind up with about half of all recreational-weed market share if Canada's parliament moves forward with legalization this coming summer. This veritable green oligopoly should be able to command exceptional pricing power initially, and over the long term.

It also doesn't appear as if smaller businesses can stop these giants. Canopy Growth Corp. has been an active acquirer, gobbling up Mettrum Health earlier this year to boost its access to medical patients throughout Canada, as well as instantly expand its grow capacity. More recently, Aurora Cannabis made a big bid to acquire CanniMed Therapeutics   in what would represent the largest pot merger ever.

Meanwhile, Aphria and its peers are working on mammoth projects that'll dwarf the competition. Aphria's $100 million-plus phase IV project will offer 1 million square feet of growing capacity when complete in January 2019, and will be capable of around 100,000 kilograms of annual dried cannabis production. 

As much as pro-legalization enthusiasts would like to see small businesses thrive and growing to remain local, big businesses has caught wind of the profit potential of the green rush, and they seem more than willing to throw their weight around to get a big chunk of the market, even if it means trampling small businesses in the process.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.