Today Canada becomes only the second country in the world (after Uruguay) to legalise the use of cannabis for recreational purposes. In doing so, they became the first G-7 nation to lift prohibition when they removed the Cannabis Ban Act of 1923.

In its place is Bill C-45, or the Cannabis Act, which was passed in the Senate (in June of this year)  by a majority of 52-29. The act creates a strict legal framework for controlling the production, distribution, sale, and possession of cannabis.

The world is watching, the markets are frothy and everywhere you go, people are talking about it. But the real question is, what does Canada’s greatest ever national experiment look like on day 1?

Let’s start with what’s allowed?

On Day 1, adults over the age of 18 (I’ll come back to that) will be able to purchase and possess up to 30 grams of cannabis (this is just over an ounce). In addition, they will be able to grow up to 4 plants in their homes.

And what’s available?

For the first 12 months, only flower (dried cannabis) and low-potency oils will be allowed. Whilst people may produce and consume edibles in their own homes, extracts and edibles will not be available, pre-packaged, during these first 12 months.

And finally, what’s government’s role in all of this?

The federal government’s role is to regulate the production of cannabis. It is the role of the Provinces to then oversee distribution. But it’s not as simple as that.

Essentially, the federal government is leaving it to the various Provinces to make their own decisions regarding home grow, legal age and how the retail market should work. And herein lies the complication.

Quebec and Manitoba – for example – are not allowing homegrown plants at all.

Montreal (which will have 12 retail stores operating on Day 1 and 20 by the end of the year) will allow cannabis to be consumed in any place that smoking is still allowed.

The other provinces have banned any public consumption.

Some of the provinces are allowing private retail shops to operate, whilst others (like Quebec) are running retail as a public monopoly with government-controlled stores.

Ontario, the largest Province by population, is not having any brick-and-mortar stores, for the first 12 months, at all. Instead, it will only allow for home delivery via the Ontario Online Cannabis Store (OCS).

And while the Fed has said the legal age for consumption is 18, already, British Columbia have raised that to 19 – to match the legal age for alcohol consumption – with other states looking likely to follow suit.

So what should we expect to see?

The Black market will continue to blossom

The producers have simply not had enough runway to stockpile for this level of demand.

This takes time. And during that time, the black market will continue to thrive. The best current estimates put the total supply at approximately 1/3 of the total demand.

In August, Statistics Canada released a report estimating the size of the recreational market to be in the region of 926,000 kgs per annum. This was almost double Canaccord Genuity’s 450,000 kg estimate.

Canada has (to date) issued 120 licenses under the ACMPR to producers, to try and meet this demand. They just haven’t had enough time to stockpile. Bear in mind that most of the production capability is still being built!

 

Aphria recently released their Q1 2019 results and their gross margins were under pressure mainly as a result of significant increases in fulfillment and handling operations.

Canopy recently experienced a massive crop failure at one of their B.C. facilities. Although the company has yet to respond to what actually happened, it would seem that delays in Health Canada approval for additional cultivation space could have played a part.

And it appears that Aurora is also going to come up short. Aurora Sky is not yet fully online and this is going to impact their ability to supply the right quantities in order to fulfill their Provincial supply agreements.

As has often been quoted, “there will be no shortage of cannabis come recreational legalisation, just a shortage of legal cannabis.”

Sales are going to be much lower than initially projected

We already know there are going to be shortages. Now, on top of that, it’s also going to be very difficult to purchase. There are just not going to be enough retail stores available on the day.

Recreational retail will not be an opening day event, but rather a process that will evolve over a couple of months. It will take time for Canada to grow into its recreational framework.   

In California, according to WeedMaps, only 19% of the cities have retail shops. Retail is not a given, even when operating in a legal environment. People are very polarised on the issue. And Canada is no different.

There are going to be fewer than 200 retailers open for the first couple of weeks. Sound like a lot? It’s not. That’s only two hundred stores to service what many believe will be around 15% of the Canadian population.

So getting it is not going to be easy. And there just won’t be enough of it to go around.

“There will be failures, there will be shortcomings, and there will be short shipments,” said Vic Neufeld, CEO of Aphria, one of the largest and highest-valued cannabis companies in the world.

The fact of the matter is that no matter how fast they have scaled, the Canadian Producers will not be able to meet the demand.  They just didn’t have enough time. And this is going to impact their sales and revenue numbers. They will be lower than projected. No doubt

You won’t see dry shelves on day 1, but rather, it’s when it comes to the second or third order, that the retail stores are going to suffer.

Even though there are vaults with thousands upon thousands of kilograms of cannabis, sealed and ready for recreational use, it simply will not placate the levels of insatiable demand.

After all, this is the “shiny new toy” for almost every consumer looking to take the edge off in some way, shape or form.

Pricing will be critical

One of the fundamental paradigms behind the lifting of prohibition, is government’s evolution from the prosecutor of an illegal drug, to regulator of a legal commodity.  It’s called “seed to sale” and is the process whereby government tracks every gram from the time it is planted to the time it is purchased in a retail environment.

This allows the federal government to ensure quality is controlled, inventory is kept out of the black market, and of course, that it gets every dollar of tax, owed to it, along the way. And the taxes add up.

The federal government collects an excise tax of 10% or $1 per gram, whichever is higher. This is then split with 25% going to the Federal Government and 75% going to the Provinces. The Provinces will additionally also be able to charge local taxes.

However, there is only so much of a premium people are prepared to pay to get cannabis legally. After that, they would prefer to go back to the black market. It’s the black market that creates the price ceiling.

A month or two into legalisation, California decided to reduce the state tax for this very reason. Lower taxes and compliance’s for the producers combined with lower state taxes on the retail purchase, led to slightly lower prices, which in turn start driving traffic to the legal retail market.

The retail experience will vary 

The Province’s role in this is to oversee distribution. But they all seem to have a slightly different view on this.

Each Province is required to purchase its cannabis wholesale from a federally licensed producer. These are known as supply agreements. Once they have purchased their cannabis, they have options on how they can distribute it to the retail market.

Their first option is physical retail outlets.

If they choose to have these, then they can choose between government-run retail outlets, or allowing private companies to operate them. British Columbia and Alberta are allowing for private retail from Day 1, with Ontario only allowing for private retail from April 2019.

And they have the option to distribute online, with door-to-door (ID checked) delivery. There can, however, be no form of self-service or vending machine style sales. Advertising is not allowed and corporate branding on the packaging is extremely limited.

Given the lack of preparation on the part of the various provinces, the inherent supply issues facing the producers, and the pricing structure still untested against the black market, the short-term future for recreational legalisation does not look good.

But in the end, the upside is phenomenal.

Canada’s recreational market is estimated to be worth around $6 billion per annum. A market that could easily generate nearly $1.1 billion dollars in 2018 alone.

And once edibles are legalised (an event many are calling “Peak Legalisation”) in late 2019, the market will really be set for massive growth.

In the future, there will be 1000’s of stores, access to a very wide variety of edibles and extracts, and a robust market generating hundreds of billions of dollars. But for now, we are here.

The day that changed the cannabis game. The day that marked a tipping point in the global lifting of prohibition. The day where promise and reality finally got to meet.

Day 1.

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