The Coronavirus Pandemic has smashed into the global economy, with a kinetic force that is shaking developed economies to their core. It started in China, a key supply chain hub for much of the legal cannabis industry. The longest bull market in history ended abruptly as justified panic over the economic implications of the 21st century's first real pandemic became general. Governments around the world issued mandates that have effectively banned commercial activity. The cannabis industry is much more dependent on the whims of the state than are others. In that fact may be a silver lining for the industry, along with the perennial truth that people love their vices in troubled times.
Despite this, many cannabis businesses were already strained and likely already desperate for capital going into this crisis. Social distancing and international measures at crackdown will slow and interrupt the supply chain. Cannabis may have the recession-proof characteristic as a commodity but legal cannabis businesses cannot realize this quality for investors successfully if their supply chains are interrupted, and they run out of cash to purchase key inputs and pay suppliers. So, while headlines of sky-rocketing sales may tell an important, albeit, an incomplete part of how COVID-19 is affecting cannabis, the truth is that much of the existing cannabis industry will likely not make it out of the dramatic recession that is now ominously approaching. Cannabis companies will also not be able to count on the public support many other small businesses can. Will states like Illinois, Colorado and California that have designated cannabis essential during stay at home orders also provide financial support? Who will bear the cost of supply-chain disruptions? San Francisco was persuaded after hours to reverse a decision related to industry designation. How effective will cannabis businesses be at advocating for their interests to state and local government?
We now live in a world where the state of California is ordering gyms to close and has designated cannabis businesses essential. That designation has thus far been the most significant development for American cannabis in the COVID-19 crisis. However, beyond the short-term, how will the new dynamic affect prospects for the industry? In other words, what are the medium and secular term implications for the cannabis industry? The short-term consequences are pretty much the same for every industry; a general culling of the herd, those with better balance sheets and operations succeeding, more able and recognizable brands gobbling up less capitalized, established and recognizable ones, and general consolidation. It is likely that any appetite left within the Federal Enforcement apparatus to go after marijuana businesses will evaporate, given scarce resources and drastically changing priorities. It is reasonable to expect that the virtue of a growing industry that employs a lot of people (more than many that are far better represented on K Street) will outweigh antiquated moral concerns, which now seem so passé’….. so 20th century. The elimination of these attitudes in government circles is no small accomplishment. They have prevented things like Federal legalization and the natural affinity the state usually has for something that can add significantly to its coffers, particularly when local governments' tax revenue will shortly begin vanishing.
Cannabis Industry In Fear Of Pandemic: Is There a Silver Lining?
So, the cannabis industry is now facing a potentially existential threat from COVID-19. So is the restaurant industry. So are the airlines and cruise lines. So is the retail sector. The shake-up of the political scene is potentially one of the most bullish developments for legal cannabis since its inception.
Unlike the exclusively lousy news for restaurants and travel businesses, individual rays of light are shining through this situation, particularly for skilled and established cannabis operators with enough cash on hand to weather the storm. State governments are responding to the cannabis industry with regulatory flexibility, at least in the short-term. State officials in Colorado allowed a delivery industry to sprout up virtually overnight to serve high demand. Other states have been flexible by allowing dispensaries to bend regulations to embrace more pandemic-friendly SOPs. Most states who have medicinal cannabis laws have designated those as essential industries that can remain open. This was a massive win for the industry that was undoubtedly a stay of execution for many of the less-established operators who would have been otherwise unable to take advantage of the sales uptick.
Of course, the other ray of light that some industry experts take with more of a grain of salt was a temporary and dramatic increase in sales. Some attribute this to the same kind of panic buying and hoarding that is occurring at grocery stores and doubt that it is sustainable, or even very meaningful for the industry. A wave of industry-wide layoffs seemed to be commencing even before the crisis is accelerating, deflating the initially rosy narrative of "sky-high sales." Historically, there is ample evidence of the counter-cyclical or recession-proof characteristics that legal mind-altering substances tend to have, “vice” commodities outperform during downtimes. However, the uptick in legal cannabis sales could also be reflecting a more dire market sentiment; that many customers’ favorite products may not exist in a few weeks or months if the mandated shutdowns continue.
COVID-19 Cannabis Failures and Solutions Look Very Different Than In Other Industries
As they cannot rely on Federal assistance for keeping employees on, many cannabis businesses have already begun to make difficult decisions about employee and cost cuts. Still, these harsh decisions may result in leaner and tighter entities that are adequately capitalized.
Cannabis businesses also do not have the flexibility that many companies have to cut costs and tighten belts during tough times. Hiring and firing can be a cumbersome process. So can achieving economies of scale or taking a company from intrastate to interstate. If you throw in the ostracization from the banking system and many traditional sources of financing, then you begin to see why the particulars of building a cannabis company with a "fortress balance sheet” could be challenging. The willingness of investors may dry up even further after this crisis as failing cannabis companies, lacking any legal bankruptcy protections, will likely leave many creditors in the lurch.
However, there is an opportunity for companies to capitalize on and achieve unique competitive advantages that may propel them to great prosperity and success in better times. As the cannabis bear market began much earlier than the market shocks from coronavirus, hopefully, many cannabis operators have developed leaner, more versatile organizations that will be better prepared to meet this unprecedented economic shock.
The Bull’s Case For Cannabis: The Economic Argument Gets Legalization Over Finish Line.
A temporary uptick in sales during a period of uncertainty is a good thing for the industry. However, what more likely will profoundly affect the industry is the rapid pace with which COVID-19 is changing the political landscape and conversation around cannabis. America is facing down the barrel of potential economic depression. Health care has been resilient. Isn't the cannabis industry at least health care adjacent? It is likely, goes the bullish argument, that with this country facing the most significant economic upheaval of our time, policymakers will simply no longer have the luxury of artificially holding back the growth of an industry that currently employs five times more Americans than the entire the Coal industry. Particularly when Americans are voting with their wallets and saying resoundingly, "We the people, want our cannabis, especially if you make us stay at home.”
One of the most bullish possible developments for the American cannabis industry would be the Federal legalization of marijuana and its derivatives. Given the momentum of state-law overwhelmingly favoring legalization and taxation, it is unlikely that the current events will do anything except for weakening opponents to full-scale legalization at the federal level in the United States. The same economic reality that hastened the end of alcohol prohibition, in the bull's case, prevails here, and the Coronavirus outbreak results in a United States that is permanently less receptive to negative narratives about cannabis. The inexorable logic that wasting Federal resources on squashing an industry that is creating jobs and providing Americans a highly sought-after, semi-medicinal commodity during an unprecedented economic shock will prevail against the reactionary anti-pot forces that were already on the decline. While the financial pain and toil caused by this event are hard to look past, the acceleration of change that this event has rapidly caused in our political system is likely to be truly a once in a generation event. This fact may bear more on the future of legal cannabis than any other. As The Economist put it in its headline article, Everything’s Under Control last week:
IN JUST A few weeks a virus a ten-thousandth of a millimeter in diameter has transformed Western democracies. States have shut down businesses and sealed people indoors….It is the most dramatic extension of state power since the second world war. One taboo after another has been broken. Not just in the threat of fines or prison for ordinary people doing ordinary things, but also in the size and scope of the government’s role in the economy.
What does this rapid expansion of state power mean for the budding recreational marijuana industry? It means that the trend toward legalization will accelerate as the economic justification (the jobs the industry provides) becomes supreme to other existing concerns about federal legalization. The basic argument goes that as states lose tax revenue from existing resources, they’ll increase the vice tax and ask the Fed’s to legalize more forcefully to help these new and essential job-rich businesses.
The Bear’s Case For Cannabis: Economic Depression Crushes Demand For Legal Cannabis.
The Bear's case is essentially a variant of the tendency during economic panics of all correlations going to one. In other words, the macroeconomic shock to both demand and supply will simply be too much for an already fragile, on-the-ropes industry to bear. In other words, any demand that is obviously consistent and potentially even increasing, will not be able to be capitalized on by the legal weed industry because insolvency and supply chain breakdowns will permanently wipe everyone out.
In an extremely bearish assessment, an extended economic recession could significantly alter consumer behavior. The consumer could become so cash strapped that they migrate almost entirely back to black markets where costs and taxes are significantly lower. One thing that makes this narrative unlikely is that one effect on consumers, given that COVID-19 is a respiratory illness, is to seek quality products whose contents can be certified. Other short-term demand trends seem to nix this theory as well, such as an increase in average order size, greater sales of edibles and vapes, and other unsmoked variants.
Cannabis Businesses Are In For Volatility But Forecasters Beware
In January 1920, the US Government passed the Volstead Act and began America’s “noble experiment” with prohibition. Proponents of the law promised extensive benefits. From the end of the Civil War to Prohibition, drinking was so heavily ingrained in American life that the average American consumed 7 gallons of pure alcohol a year. Proponents of the now infamous 18th Amendment promised boons for all different parts of the economy; theorizing Americans would now entertain themselves in other ways besides drinking. Landlords, soft-drink makers, movie theaters and other places of public entertainment (whose profits were supposedly marred by the vice of drunkenness), waited on a bonanza that never came. What did come was the Great Depression, an unprecedented rise in violent crime, and a sky-rocketing demand for alcohol? The supposed benefactors of the law suffered; it turns out people spent more at their establishments inebriated. Public support for the law steadily diminished, and in the name of job creation and economic growth, one of the same justifications for its passage, the experiment with prohibition was finally repealed in late 1933 during the dog days of the Great Depression.
What are the lessons applicable to the current plight of the cannabis industry here? The number one lesson is that when a commodity enters and exits black market status, the effect on consumer behavior and ancillary economic actors who are affected by its commerce can be entirely unpredictable. The other is that economic necessity can instantly change regulatory and legal realities that otherwise may have taken a decade or more to achieve. The coronavirus has led to the most conservative American politicians supporting a version, albeit temporary, of Universal Basic Income. A month or two ago, this was considered too far-left for mainstream Democratic presidential candidates to embrace, including Bernie Sanders. Now also, conservative commentators are calling for the President to invoke the Defense Production Act to mandate private companies to produce things they otherwise wouldn't or state control over private production. This unprecedented crisis has suspended all physical laws of American politics and rendered the traditional ideological spectrum next to useless when evaluating potential legislative and regulatory outcomes.
Cannabis Market Potential Will Ultimately Be Defined By Governments
This, in the end, will likely be the most profound lasting effect of the pandemic on the cannabis industry; how the state's support or lack of it will define the parameters and scope to which it can grow. This is natural, as normal market forces can often take a back-seat to legal and regulatory changes that can instantly render thousands of businesses profitable or not. Regardless of anything else, one of the most significant drivers of cannabis companies becoming more profitable would be increased regulatory certainty. Hopefully, this situation will grease the gears of Federalism quicker than usual to give an industry that employs hundreds of thousands a much needed, and inexpensive, lifeline.