Jeana Nordstrom, Capital Security
23 January 2020Analysis

Cashing in on legalised cannabis

Cannabidiol (CBD) product sales grew by more than 700 percent in the US in 2019, to around $5 billion. By 2023 sales are expected to reach $23.7 billion. Comparatively, about $620 million worth of CBD products were sold in 2018 in the US (based on 706 percent growth to $5 billion).

Edible products alone are expected to achieve $4.1 billion of sales in the US and Canada by 2022. The UK CBD market will be worth almost £1 billion (approximately €1.1 billion) per annum by 2025, according to Health Europa.

“Cannabis captives using blockchain, sophisticated underwriting and savvy investors will be the Amazon and Google-style darlings of the economy of 2028.”

Market research commissioned by the Center for Medicinal Cannabis estimates that the CBD market is currently one of the fastest growing wellbeing product categories in the UK. At the current rate it will be worth almost £1 billion per annum by 2025, making it equivalent in size to the current entire UK herbal supplement market.

By 2023 total retail marijuana sales in the US are projected to reach between $25 billion and $30 billion annually, a more than threefold increase from estimated annual sales in 2018.

However, the sector faces strong headwinds that could prevent this forecast growth. It is difficult for companies in the cannabis industry to secure banking and insurance relationships. With no underwriting experience and enormous investment cost, coverage in the insurance sector was almost impossible to find. That was until what we will call “Brilliant Brits” worked with us to come up with crop coverages.

In domiciles where cannabis has been legalised, the business had to be financed by a combination of cash payments and cryptocurrencies. But this could be set to change. In the US, the bill with the best chance of being enacted is the Secure and Fair Enforcement (SAFE) Banking Act, which would allow banks to do business with cannabis companies without fear of federal punishment. It cleared a key House committee in March by an overwhelming bipartisan vote, and received a hearing in the Senate.

Advocates say the bill has been delayed because politicians want the first piece of cannabis legislation to encompass social equity and criminal justice reform. Some see the SAFE Banking Act as an industry bill that doesn’t address equity.

Reasons for caution

Marijuana legalisation will usher in America’s new version of Big Tobacco. Already, private holding groups and financiers have raised millions of startup dollars to promote businesses that will sell marijuana and marijuana-related merchandise.

Cannabis food and confectionery is being marketed to children and are already responsible for a growing number of marijuana-related hospital emergency visits. Edibles with names such as Ring Pots and Pot Tarts are inspired by common children’s sweets and dessert products.

Today’s marijuana is considerably stronger than older strains. In the 1960s and 1970s, tetrahydrocannabinol levels of the marijuana smoked by baby-boomers averaged around 1 percent, increasing to just under 4 percent in 1983, and almost tripling in the subsequent 30 years to around 11 percent in 2011.

Marijuana legalisation will increase public costs. For every $1 in alcohol and tobacco tax revenues, society loses $10 in social costs, from accidents to health damage. The lottery and other forms of gambling have not solved our budget problems, either.

Few people are currently in prison for marijuana possession (only 0.1 percent of prisoners with no prior offences) and current alcohol arrest rates are over three times higher than marijuana arrest rates.

Statistics on state-level prisoners reveal that 0.3 percent of all state inmates were behind bars for marijuana possession only (with many of them pleading down from more serious crimes); 99.8 percent of federal prisoners sentenced for drug offences were incarcerated for drug trafficking. The risk of arrest for each joint smoked is one in 12,000.

Impact on the youthful brain

The brain has never given up its secrets readily. Researchers who have taken a keen interest in marijuana’s impact on the adolescent brain acknowledge that they can’t yet say whether the structural and functional alterations they’re discovering are a cause of pot smoking or a result of it. Nor is it clear whether the changes affect cognition.

A longitudinal study getting under way this year will eventually help answer these questions. But in the meantime, converging evidence suggests that getting high may pose a unique threat to young people.

The SAFE Banking Act

This bill generally stops a federal banking regulator penalising a depository institution for providing banking services to a legitimate marijuana-related business. Specifically, the bill prohibits a federal banking regulator from:

(1) Terminating or limiting the deposit insurance or share insurance of a depository institution solely because the institution provides financial services to a legitimate marijuana-related business;

(2) Prohibiting or otherwise discouraging a depository institution from offering financial services to such a business;

(3) Recommending, incentivising, or encouraging a depository institution not to offer financial services to an account holder solely because the account holder is affiliated with such a business;

(4) Taking any adverse or corrective supervisory action on a loan made to a person solely because the person either owns such a business or owns real estate or equipment leased or sold to such a business; or

(5) Penalising a depository institution for processing or collecting payments for such a business.

As specified by the bill, a depository institution shall not, under federal law, be liable or subject to forfeiture for providing a loan or other financial services to a legitimate marijuana-related business.

The bill moved out of the House Financial Committee in March and was sponsored by more than 200 lawmakers at the time of the vote. It is backed by a slew of national banking groups, including the American Bankers Association, the Credit Union National Association and the Independent Community Bankers of America, which have pushed Congress to act on the issue for some time. The National Association for State Treasurers, a bipartisan group of more than 30 state attorneys general, and the governors of 20 states, have urged Congress to pass the bill.

Getting by with a little help from their friends

Captive insurance has been a good friend to this newly emerging market. Cannabis captives using blockchain, sophisticated underwriting and savvy investors will be the Amazon and Google-style darlings of the economy of 2028.

Cannabis represents a significant opportunity for the insurance industry, which could issue over 25,000 coverages. The captive industry’s creative approach and strong underwriting background has already created comprehensive market coverage for this sector.

Some high-profile deaths and illnesses among people vaping cannabis has temporarily knocked the industry off its stride. But this only illustrates how important it is that captives continue collecting data about this industry, allowing it to carefully evaluate coverages and attachment points.

Reports suggest the fatalities may have related to the use of a synthetic vitamin E oil called tocopheryl-acetate, that tainted most seized vape carts. Vape pen makers report using it because it’s a cheap thickener, and the Food and Drug Administration is now specifically looking at forms of vitamin E oil.

A cannabis industry that was legalised and properly regulated would help prevent such incidents. Informed underwriters can protect users from substandard equipment and ensure cannabis products are not harmful for human consumption. Manufacturers will work with risk management to better protect themselves against losses.

Growers’ revenue

Cultivating for CBD can generate anywhere between $2,500 and $75,000 per acre, depending on the state, the circumstances and the cultivation method. There is a lot of money to be made, but also considerable choice, and a lack of reliable data about how to grow hemp, which are hurdles for farmers looking to get into this market.

Input costs for growing hemp in the north west were about $15,000 per acre, including, from highest to lowest, labour, seed, nursery usage—to start plants offsite that are transplanted in the field—and an offsite drying facility.

In south west Idaho it has been common to generate $2,000 to $5,000 in revenue per acre for other crops, and spend 50 percent to 80 percent on input. Hemp’s input cost per acre could drop slightly over time, as producers gain field experience and chemicals are developed and approved.

Successful growers have generated about $112,500 per acre in revenue growing for the CBD market last year. A good crop produces about 900 kg of hemp flowers per acre for CBD extraction. It takes about 18 kg of flowers to make 1 kg of CBD oil.

That comes to about 50 kg of CBD oil per acre. They split that with the processor and sold their 25 kg for $4,500. An ounce of oil was selling for around $125 as of early this year.

Even at its lowest price, hemp is significantly more profitable than soy at its peak price, or any other agricultural commodity, for that matter. The price looks set to drop going forward, as acreage increases around the US and some growers experience processing-capacity limitations.

Currently hemp grown for fibre and seed for grain generate much less revenue, meaning seeds and stems could be used more productively. The California-based Braille Institute is working with hemp paper products for braille labels, and the fashion industry has shown an interest in hemp products, which provide an edgy wallet-opener to a certain demographic.

There is plenty of scope for further innovation. Growers are finding that the use of cloned plants controls THC levels and removes the problem of male plants fertilising female ones. Females fertilised by pollen will produce 50 percent or less of the normal cannabinoid value achieved in a female flower-only plant.

Using technology from the petroleum industry, Florida-based hemp processing company Gravitas Infinitum has developed a system to extract a number of the 35,000 different usable extracts from hemp and cannabis, from bud to root bulb. Along with this technology, the firm is educating the growers to the nuances of hemp and cannabis.

In the 1800s Gold Rush the big money was made selling picks and shovels. In today’s ‘green rush’ there are similar fortunes to be made developing blockchain data and supply chain logistics. The groups with strong risk management, board of director diversity and governance, and savvy investors, stand to make a lot of money from the legalisation of cannabis. From this group could emerge the Amazon of the cannabis industry.

Jeana Nordstrom is a director of Capital Security. She can be contacted at: