You can’t read a financial website, newspaper, or investor newsletter without seeing the prospects of the cannabis and hemp markets.
In agriculture, farmers across the country are asking if these crops could be the next big rotating crop, combined with corn, soybeans, and wheat.
Jonathan Rubin, CEO of New Leaf Data Services and its Cannabis and Hemp Benchmarks divisions, says that while people are excited about these crops that are being used for industrial, medicinal, and recreational purposes, reality is already creating sobering moments.
U.S. Markets Erode
In U.S. cannabis markets, there has been significant price erosion in the last few years. Specifically, in the most mature, advanced markets like Colorado, Oregon, and Washington, where competition has had a chance to kick in.
The U.S. hemp market has experienced some price declines, but the market is just beginning, and prices can vary widely across different product categories, such as hemp biomass and hemp-based CBD isolate.
“And as most commodities see, the price moves toward the marginal cost of production. At some point there is a bit of a shakeout of those operating in the business, prices then bottom out, and then they start to fluctuate back up with that consolidation in the industry,” Rubin says.
In the U.S., the cannabis business is siloed because every state has its own legal requirements. For instance, growers are not allowed to have interstate commerce because cannabis is still federally prohibited.
“So, in the West Coast markets, as well as Colorado and Nevada, competition is doing what it is supposed to do in any market – creating efficiency, driving prices lower, ultimately benefiting the retail consumer,” Rubin says.
$200/Lb 4Q Decline Seen Coming
This falling price trend is expected to happen, the Cannabis Benchmarks operator says.
Recently, outdoor cannabis in Oregon traded at $100 per pound. The state’s volume weighted average price is $600 per pound. This compares with the cost of production level of $85 to $95 per pound for outdoor cannabis. Some greenhouse growers are planning on a cost-of-production level of under $100 per pound.
For reference, indoor-grown cannabis, perceived as the higher quality product vs. outdoor and greenhouse, is selling for about $1,500 per pound nationally, while greenhouse is about a third lower at $1,000 per pound, according to Cannabis Benchmarks’ data.
“Oregon’s prices declined 60% in 2018 vs. Colorado’s maturing market experiencing a double-digit decline of only 12%. That’s obviously a huge deal, 12%, when you compare it with soybean prices that have dropped 7% since the fall,” Rubin says. “However, what it indicates to us is that the pace of price declines in Colorado is slowing up. The market is getting to the point where it is self-regulating and producers are not building out all of the plant capacity they originally had planned. These producers are doing a better job of reigning in supply to match the demand.”
Prices are starting to stabilize.
This price action is expected to happen in Washington and Oregon, as well, with California sometime further out, he says.
“We do have an implied forward curve that represents what forward deals have been done as well as the price at which producers would be willing to transact today for delivery sometime over the coming six months. And the forward-curve price for the October-November period is roughly $975 per pound, for the U.S., compared to the current U.S. spot index price of $1,123 per pound,” Rubin says.
Oversupply Pressures Prices
Because of overexuberant planting, the price trend is being driven downward, Rubin says.
“In Oregon, the 2018 legal production was at least five times higher than the legal demand. So, when you are producing that type of oversupply something has to give,” Rubin says. Presumably a fair amount of that product went into the black market.
It’s important for people who are observing the cannabis market to understand that the black market and legal market are bidirectionally porous, he says.
“There are plenty of ways for illegal cannabis to get into legal channels and vice versa,” Rubin says. Black market and legal market prices are not independent of each other. They move with and impact each other.”
Elsewhere in the U.S., some of the smaller and more highly regulated cannabis markets, like Illinois and Connecticut, have more stable prices.
For instance, Connecticut cannabis prices have stayed in the $2,900- to $3,100-per-pound range for the past few years.
“It’s a small market with only four cultivators – it’s highly regulated. So, there is that dichotomy between the small tightly regulated medical markets vs. the larger recreational use markets that allow outdoor growing and experience seasonal price fluctuations,” Rubin says.
There are 10 states, plus the District of Columbia, that allow recreational (also known as adult) use of cannabis. It’s interesting to note that there are caps on each person’s per-month purchases. For medicinal use, the U.S. has 40 states that have legalized cannabis.
Potential for Corn Belt Farmers?
Just this week, the Iowa Department of Agriculture announced that once the USDA approves the state’s proposed regulatory plan, an individual farmer can legally grow up to 40 acres of hemp.
Farmers must have a license from the Iowa Department of Agriculture and Land Stewardship to grow hemp.
So, what is the realistic likelihood of the hemp and cannabis product becoming a third crop for U.S. Midwest farmers? The short answer is that hemp has a better chance of being a rotating crop, Rubin says.
Farmers across the country are indeed asking about crop switching or crop rotation, using hemp or cannabis, he says.
“When you look at the cannabis farmers, many started as a cottage industry, if you will. Many were black market growers who then became legitimate and legal. But when they were black market growers, they weren’t implementing operational best practices, supply chain management, agricultural tools, and technologies. Instead, their main focus was how to avoid a Drug Enforcement Agency raid,” Rubin says.
It was only when they became legal growers that they started to embrace big farming scales of economy.
This is in contrast to the new entrance on the hemp side, where growers came from big, commercial farming operations and started with that understanding of commercial scale.
“I think there is a more natural transition from the traditional corn, soybean, and wheat grower to move into hemp. It’s more aligned with the processes and best practices that they already have in place,” Rubin says. And when these markets move into financial instruments for hedging, crop loss and crop insurance, my sense is that all of those peripheral needs around managing the business will happen in the hemp side faster than they will on the cannabis side.”
Additionally, licensed hemp acreage in the U.S. was estimated at 26,000 acres in 2017; 78,000 acres in 2018; and is speculated to be 200,000 acres or more in 2019, according to surveys conducted by Vote Hemp.
Industry watchers say that most hemp farmers are planting only a fraction of their licensed acreage, as they learn more about the costs and availability of seeds, harvesting equipment, methods of drying, and access to extraction capacity.
Investing In The Industry
Tony Khanuk, a cannabis/hemp investor, agrees that although hemp was a legal crop in the 1900s, but federally banned since then, its return will still be fighting its connection to cannabis.
“Hemp was once lumped in with cannabis as the two plants are genetically related. Now, we are coming to a moment in history where it’s an inflection point in essence,” Khanuk says. “You’re seeing the growth of an industry going from the bottom up. It’s percolating up, from nowhere. That is amazing. But there will be bumps because a lot of farmers in the U.S. don’t have experience growing hemp.”
Current hemp growers are meeting headwinds with how much cannabidiol (CBD) product that they can extract from a plant, Khanuk says.
CBD is the medicinal extract from the cannabis or hemp crops.
“Farmers are finding it hard to glean enough CBD oil from the plant and are burning up a large amount of biomass in the extraction process. It’s a very small amount of oil that they are harvesting. Right now, some farmers are losing 50% of their crop due to inexperience. Some are still attempting to figure out the distance needed between each plant before they reach full maturity. So, there are a lot of things these farmers are learning on the fly,” Khanuk says.
Industry watchers say that demand for CBD consumer products is currently driving the hemp market. Whereas in the mid- and longer-term, demand for fiber and grain will drive the hemp market, experts say.
As a result, more hemp farmers are planting CBD hemp. This plant takes on a bush-like shape, or is Christmas tree-like, whereas industrial hemp is much taller and more bamboo-size, with very long stalks.
Right now, extracting CBD oil from the hemp plant is the gold standard in the industry. The other material that you would use in construction, clothing, rope, etc., has fallen by the wayside.
“A lot of people don’t realize how disruptive those products will be to other industries in that same utility space,” Khanuk says. “You really need to look at Europe, where hemp was never banned and has continued its course.”
In the U.S., growers are getting CBD hemp plant extraction rates of 1%, 2%, and 3%, but 4% or higher is the mark to hit right now. Basically, each time you purify, your yield shrinks. Depending upon the extraction technology, the quality of the oil varies.
Where extraction gets sticky is when extractors attempt to extract CBD from the cannabis plant, and the level of THC in the extract goes above the federally mandated 3%. At those levels, the extract itself would need to be destroyed or remediated depending on state laws.
Another sticky point for current hemp growers is that once the crop is harvested, it has to be dried out.
“A lot of the farmers growing hemp don’t have the capacity to dry their crop,” Khanuk says. The hemp plant for industrial use is 7 to 8 feet and can grow as tall as 12 feet or more, once matured, depending on genetics and other factors. Some are only getting a 2% yield on full flower oil out of these plants. So, even though the plant is huge, you are not getting a lot of CBD oil out of it.”
In the end, a grower needs a ton of biomass and a ton of drying capacity and a sophisticated extraction process. It’s a labor-intensive process to grow and process hemp, the Chicago-based investor says.
Producing Cannabis, Hemp Takes Experience
Nothing trumps experience when growing hemp and cannabis, Rubin says.
“The more harvests that growers have under their belt, the more they know how to dial in their growing practices. I think vertical integration should be approached with a degree of caution. In the long-term, it’s hard for a vertically integrated operation to be really good at all aspects of the business such as growing, processing, and dispensing,” Rubin says.
“In addition, if there is a crop failure due to mold, mildew, or pests, there is no way to bring product to the market,” Rubin says.
“I don’t think that the long-term future for cannabis in the U.S. and Canada is nearly as big as it will be for hemp. For instance, there is a reason bananas and coffee are not grown in the U.S. and Canada. Regarding cannabis, Columbia, Jamaica, and other regions that have lower production costs due to more fertile growing conditions and lower labor costs are potentially better positioned to compete as more markets open up, globally. So, 20 years from now, it’s hard for me to imagine much cannabis being grown in the U.S. or Canada,” Rubin says.
Cannabis Reckoning For Canada
While the U.S. has regulations that don’t allow cannabis producers to sell across statelines, that is not the case in Canada.
The Canadian market is a national market. Cannabis can flow freely across the provincial borders.
“While it’s only a fraction of the size of the U.S. cannabis market, Canada has a large market that sparks competitiveness quicker. As a result, the price erosion that we saw in Oregon and Colorado is going to happen faster in Canada,” Rubin says.
“The number of operations will get dialed in, lowering prices. More importantly, there is already an oversupply of both finished (on the store shelves) and unfinished (product waiting to be packaged) inventory. Monthly demand for cannabis flower is 6,700 kilograms. At that rate, the current supply represents 20 months’ worth of demand. Then, when you look at the five largest licensed cannabis producers, their production expansion plans call for well over 1.0 million more kilograms. That translates to more than 13 years of consumption,” Rubin says.
When you add the 20 months of finished/unfinished amount of inventory to a potential 13 years’ worth of supply that could be built out in the next 12 to 24 months, unless a producer decides to scale back, prices will decline very rapidly on the oversupply scenario, Rubin says.
“The solution is extract, extract, extract the oil then export, export, export,” Rubin says. “However, that is a limited opportunity, because there are more fertile places to grow cannabis. How are Canadian farmers going to export at a price to meet those prices being offered by other export suppliers?
“Unless there is a cutback on capacity, a reckoning could be coming for the Canadian cannabis market,” Rubin says.
Investing Interest Surges
“Everybody wants to invest in this (cannabis, hemp) space,” Khanuk says. “Right now, it’s a crapshoot for investors because everything is up in the air. Unless you are actively growing it (hemp), extracting it (CBD), or know people you can trust who are doing it, you are going to be in a catch-22. Somebody can tell you one thing and be growing something else entirely.”
An investor should go out to a farm and see exactly how many acres the grower has in production, whether the product is being tested by an independent lab, and whether pesticides are being used, says Khanuk.
“A lot of the stuff out there could be snake oil, due to lax testing regulations at the federal, and in some cases, state level,” Khanuk says. “Boots on the ground should be your investor mantra. The big question the investor has is this real cannabidiol and in what concentrations. Considering that the USDA is not testing the product, and growers are not required to test, it’s a huge problem from an investment standpoint.
“In the end, it’s a booming industry with caveat emptor as the byword.”
“They talk about a line in the movie The Graduate where Walter Brooke whispers the word ‘plastics’ to Dustin Hoffman. It’s the same thing, here, but in this case that word is ‘hemp,’” Khanuk.
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