Cannabis Musings - December 27, 2024

Law-Talking Guy answers paid subscriber questions!

Friends – paid subscribers ($5 per month - Cheap!) have their questions answered by the Law-Talking Guy, which is a great reason for you to upgrade your subscription and support these Cannabis Musings. There are two reader questions so far this cycle, both of which have been lightly edited for clarity.

Question #1: Do you think hemp derived drinks will survive the next Farm Bill? The whole industry seems to see it as a savior, but it seems clear to me [the Subscriber] that Congress believes a loophole is being exploited. Certainly, many Red states feel that way. The industry's headline embrace of hemp beverages … seems nearly as wistful as expecting legalization to happen in early 2021 when Dems controlled Congress.

Back in May, we talked about how what happens with hemp under the new Farm Bill could have even bigger implications for non-hemp cannabis than rescheduling:

“If the 2024 Farm Bill were to change federal law’s treatment of hemp-derived cannabinoids, it could patshkeh the nascent “intoxicating hemp” (I still haven’t warmed up to that term) industry. If it were to leave the current definition of hemp alone, the existential threat to state-licensed, non-hemp cannabis posed by these products would continue to grow.”

Since that proclamation, we’ve seen the Farm Bill, which was supposed to have been refreshed in 2023 (it gets redone every five years), get extended for yet another year to late 2025 because Congress still can’t quite get there. That doesn’t mean that something can’t get passed earlier, but it doesn’t bode well for quick handling.

Also, since then, we’ve seen the House produce an amendment to the draft Farm Bill that would definitively close the loophole for so-called “intoxicating hemp,” and the Senate offer up its own version of the Farm Bill that also addresses the loophole (please don’t email me claiming that it’s not a loophole – it literally meets the definition of the term). Now, the Senate bill’s redefinition of hemp is more ambiguous than the House’s language, capping all THC at 0.3% dry weight, which would still seem to allow for some products like hemp beverages to still exist (because the dry weight would presumably still be on the entire finished product, not just the biomass). That’s why the U.S. Hemp Roundtable, a trade association for the industry, apparently has mixed feelings (at least as of mid-November) about the Senate’s proposed language.

There honestly isn’t a definitive answer to our Subscriber’s question, because it’s simply too early to tell how this plays out. However, I think it’s notable that both the House and Senate versions narrow the definition of hemp. To me, this means that it’s definitely on the radar, giving lie to my long-held, yet extremely obvious, thesis that Congress never intended for the 2018 Farm Bill to legalize psychoactive/psychotropic products (hence it being a “loophole,” because that’s where we are). It also suggests to me that it’s not unreasonable to think that the final Farm Bill will change the law in some fashion, but then again, maybe it won’t. We just don’t know how.

As for likening this to 2021, when the industry and investors were convinced that the Democrats were for sure going to legalize cannabis when they took the Senate that winter, I appreciate your cynicism, but I’m not sure this is the same. Legalization completely depended upon the Senate eliminating the filibuster, which was a really big “if”. Spoiler - that didn’t happen. On the other hand, there almost certainly will be a Farm Bill (in theory the country could continue to operate without one, but given the larger interests involved, that’s highly unlikely), so we don’t have that same kind of contingency. At this point, I think it’s more a question of how the lobbying plays out.

There’s chatter about lobbying from all sides on the issue. I have no good insight into whether and to what extent that’s true, but it makes total sense. There’s a lot of money on the line, not just for the hemp producers, but also for the alcohol distributors who have embraced the product (we’ve previously talked about their inroads into the industry, lobbying for distributor-focused federal legalization). But again, there’s so little insight publicly available to know how much of that is true and how much of that is fear-driven rumor.

As for non-hemp cannabis companies diving into the “intoxicating hemp” pool, yeah, that’s definitely a thing. Vu honik, dort fligen (“Where there’s honey, flies gather”). It’s a symptom of an industry that’s so tired of being beaten down that it looks for any potential scrap that’ll produce a win. I still wonder though about whether it’s worth investing heavily in a form factor that could be totally eliminated in the coming months, but I also said that back when we all thought the new Farm Bill could be done on-time in 2023. There does also seem to be some risk of flooding an ever-shrinking marketplace (as states continue to limit these products) with too many beverages and related products at once, but I’ve always felt that cannabis drinks make a lot of sense – they’re a very low barrier to entry, carry less social stigma than smoking flower, and have a controlled dosage. To me, it’s one of the ways this industry can expand its consumer base, rather than just pulling market share from the existing consumers as demand flattens in legacy states. So, I get the flock to “intoxicating hemp” drinks, but not totally.

Question #2: Do you think taxes are the reason the illicit market flourishes in California? Taxes are quite high and do make legal weed more expensive than its illegal competitors, but taxes are also very high on cigarettes and you don't see illicit cigarette production. What you get in the regulated market is so much better than what used to be available that I [the Subscriber] think anyone would be very happy with it if there was not an illicit market. Instead, I think it's largely a matter of enforcement. I think CA has poor quality government, lots of words on paper but little follow through.

Easy. Yes.

I mean, taxes aren’t the only reason, but they’re for sure a part. This is one of those areas in cannabis where I think that logic actually does prevail. The good folks at UC Davis’ Cannabis Economics Group have been researching these issues, and the data seems to prove out the thesis.

The selling point for licensed (non-hemp) cannabis has always been that consumers would (and should) prefer a broad array of safe, tested products with the knowledge that what’s on the label is in the package, in a transaction that isn’t taking place next to a back alley dumpster. The problem is that, so long as unlicensed cannabis remains materially cheaper, there will always be a segment of legacy buyers who won’t make the switch. That price gap can reasonably be attributed to taxes, a mishmash of regulatory and compliance costs (e.g., testing, packaging, security), and constitutionally-questionable state protectionist measures (i.e., you can’t cross state lines with the product).

How do you solve the problem? Well, federal legalization would help by leveling the playing field in many respects – lower operating costs, fairer federal taxes, better access to capital. You also could shrink the unlicensed market through police enforcement of existing laws, shrink the gap by lowering taxes and the cost of compliance, or both. Enforcement, however, is a sticky wicket – there’s a reasonable and understandable reluctance on the part of state governments (and the industry) to engage in an all-out war on cannabis and bring back all of the social ills that caused, but that’s been to the detriment of licensed companies who are barely keeping afloat (see, e.g., New York City until very recently). There’s no perfect way to resolve this dialectic, but it’s fairly clear that the current level of enforcement isn’t working for the licensed industry.

I’m also doubtful that most state regulatory bodies are interested in materially cutting down on regulatory burdens, and it’s too easy for states to keep taxes high on cannabis without political pushback. The industry has been begging for years for state governments to lower taxes and compliance costs, with sporadic success. So, again, we need federal legalization (the end of alcohol prohibition in 1933 is a fraught comparison, but not without merit). Period.

This is why we’re stuck as the only industry having to compete with a larger, more illegal market that’s been around for much longer. Me ken brechen! (“You can vomit from this!”)

Be seeing you.

© 2024 Marc Hauser. None of the foregoing is legal, investment, or any other sort of advice, and it may not be relied upon in any manner, shape, or form. The foregoing represents my own views and not those of Jardín.