Wednesday, January 1, 2014

The state of legal Marijuana in Washington

In November of 2012 the voters of Washington state approved a citizen initiative #502 to legalize the production, processing and sale of marijuana for recreational use.   Over the next year, the Washington State Liquor Control board held a series of public comment periods and hearings and consulted experts and stakeholders in the existing medical marijuana business and formulated a set of rules and regulations which were finalized in December of 2013.

Initiative 502 provides for the licensing of three marijuana businesses; a producer, who grows the plants, a processor who packages or adds value to the plants via incorporation in food or processing into hash oil, and a retailer who provides a point of sale for Marijuana for the general public.  

The number of licenses for producers and processors is unlimited but the total size of all grows is capped at 2 million square feet of canopy space.  The number of retail outlets is capped at 334.  

The Liquor control board has stated that in the event that more retail applicants are received than there are licenses available that they will have a lottery to award the licenses.  In the event that more than 2 million square feet of canopy (leaf) space is applied for, that they will reduce the space allocated proportionally for all applicants.  

Applications vastly exceed WSLCB expectations
Using the latest data available (12-31-2013) the total number of retail applicants is  1,313; the applications are not evenly distributed; some locations are very popular, some less so, mostly corresponding to the population. 

Using the same data, the total number of producer licenses applied for is 2,114.  Each producer is required to indicate the size of their grow in "tiers".  Tier 1 is less than 2000 square feet.  Tier 2 is 2000 to 10000, tier 3 is 10000 to 30000.  

If each license applicant applies for the maximum space in their tier, the total canopy space that has been applied for exceeds 2 million square feet substantially.   Here's the totals for each tier:  

Tier 1:   503 licenses applied for, 1.06 million square feet
Tier 2:   794 licenses applied for, 7.94 million square feet
Tier 3:   815 licenses applied for, 24.45 million square feet

Total canopy space applied for:  33.39 million square feet, and this number will probably increase as the license backlog is processed and added to the publicly available list.   Canopy space authorized:  2 million square feet.  

If the liquor control board allocates space as they've described each applicants proposed share will be reduced proportionally.  Since more than 16.5 times the allocated canopy has been applied for, it would seem reasonable for people to get 1/16.5 of the space they've applied for, or roughly 6%.  

So if you applied for a 2000 square foot grow, you'll get an allocation of 120 square feet -- about the size of a small bedroom, 12x10.  If you applied for a 10000 square foot grow you'll get 600 square feet.  A 30,000 square foot grow will get 1800 square feet.  

Grower requirements expensive
Each grower will be required to have cameras and security system which allows law enforcement or regulatory access 24x7, a  sight-obscuring 8 foot fence, a shipping quarantine area, signage and security plan.  In addition growers will have to carry commercial liability insurance, undergo background check and fingerprinting, prove the source of the funds they use to finance their operation and maintain an inventory system that is accessible to law enforcement at all times.   They will also pay a 25% tax on the gross amount of each sale, which will be at a minimum 25% from producer to retailer.  The retailers collect a 25% tax on sales to the public.   Growers will also be required to test their production with an independent lab and to conform to various requirements related to fertilizer, herbicides and pesticides used.  

Using these figures, I don't think that tier 1 growers (limited to 120 square feet) will pencil out; it is difficult to contemplate making enough profit on that small a grow to pay for all of the costs involved in operating.  

Tier 2 growers at 600 square feet have a shot at producing enough Marijuana to support a full time person, but again it becomes difficult to see how they'll actually make enough profit to cover the operating costs and taxes.  

Tier 3 growers at 1800 square feet will provide enough revenue to run a 2-3 person business.  

Prices expected to fall substantially
Marijuana prices in Washington state for medical marijuana have been steady at $11/gram.  The liquor control board's expert expects that price to fall to $5 a gram next fall.  At $5/gram, that's a retail price of $2,165/lb.  I would expect wholesale prices to be less than half of that, or $1080/lb.  Production costs/lb for indoor grown marijuana are between $650 and $800 a pound.   Indoor production is estimated at 2lbs per 1000 watt light and optimum conditions and no crop failures (mold, mites, human error), 3 crops per year.

Maximum gross revenue per tier:

Tier 1, 160 square feet, 10 lights produces 60lbs/year, $64,800
Tier 2, 600 square feet, 38 lights, produces 228lbs/year $246,240
Tier 3 1800 square feet,  112 lights, produces 675lbs/year $729,000

Projected profit per tier ($800/lb production cost)
Tier 1:  $16,800
Tier 2:  $63,840
Tier 3:  $189,000

In terms of gross revenue, even the largest Marijuana producer has less revenue than an average fast food restaurant, and by most business standards would be considered a very small business.  

Risks that producers face
As with any farming venture, you run a substantial risk of crop failure or human error that costs you either all or some portion of your crop.  You also have regulatory risks in this industry; the federal government, changes in state law and the producers will be forced to plant crops without having any idea who of the 800 applicants for retail will actually receive licenses.  Once the licenses have been awarded it will take some time to figure out which of those people will be successful, and how much marijuana they can sell, so there's a pretty substantial risk of substantial price fluctuations, both up and down.  

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