Cannabis is moving from the back alley to Main Street, and this will have profound implications for Ontario’s economy. The fact that the sale and purchase of recreational cannabis has been illegal before now complicates our ability to estimate demand, prices and government revenues from legalization. Still, we can look at other jurisdictions to estimate the future size of Ontario’s cannabis industry, and it’s not too early to assess the regulatory and market structure proposed by the Ford government.
Hints from Colorado
We took a look at population data from Ontario, as well as population and cannabis sales data from Colorado, which legalized medical cannabis in 2000 and recreational cannabis in 2014. While the specific regulations and legalization processes differ between Ontario and Colorado, the two jurisdictions do share a number of demographic, political and social characteristics that support our comparison:
- Colorado was one of the earliest US states to legalize medical marijuana, one year before Canada passed similar legislation.
- Ontario (14.0 million) has a much larger population than Colorado (5.5 million), but they have similar age profiles, with approximately 64 percent of their populations between the ages of 18 and 64.
- Ontario and Colorado have similar policies with respect to homegrown marijuana, allowing four and six plants per household, respectively.
- Colorado is relatively liberal in urban areas, voting in favour of Hillary Clinton over Donald Trump in the 2016 presidential election, but is more conservative in rural areas. This mirrors the general political tendencies in Ontario at the time legalization.
Both Ontario and Colorado are dominated by one large metropolitan area, but the overall population density of Colorado is about 50 percent higher than Ontario’s. The province’s lower concentration of residents coupled with its sheer geographic size (it is four times larger than Colorado) suggests Ontario will need many more legal cannabis outlets than Colorado. As of January 2018, Colorado had 509 recreational dispensaries and 505 medical dispensaries. If Ontario does not have enough stores, online sales will have to fill the gap.
So what happened to cannabis sales in Colorado after legalization in January 2014? Figure 1 shows monthly cannabis sales in Colorado from February 2014 through June 2018. Legal sales of recreational cannabis began around US$30 million a month but grew quickly to a peak of over US$100 million per month in April 2018, where sales seem to be levelling off. Interestingly, sales of medical cannabis have remained around US$30 to $40 million a month and don’t seem to have been affected by legal recreational cannabis sales.
These monthly recreational cannabis sales figures can give us some indication of how Ontario’s cannabis market might grow.
Recreational cannabis sales in Colorado in the first 12 months after legalization were approximately US$300 million, expanding to over US$600 million in 2016 and surpassing US$1 billion in 2017. In total, between January 2014 and June 2018, Colorado sold over US$3.3 billion in recreational cannabis products and US$1.78 billion in medical cannabis products. If we assume that consumption habits are similar in Colorado and Ontario, and Colorado’s effective tax rate of 20 percent is applied in Ontario, we need only to adjust for differences in population and currency/purchasing power. The level of taxation will affect prices and influence consumption, although it is yet to be seen how price-sensitive demand for cannabis products in the legal market will be.
In our analysis of the data, we increased the Colorado figures to account for Ontario’s much larger population, but we did not adjust sales figures for exchange rate differences because cannabis prices appear to be broadly comparable between Ontario and Colorado ($7 to $10 per gram) regardless of the currency used. If Canadian cannabis prices adjust, in a mature market, to fully reflect exchange rate differences, our sales estimates could be understated by 20 to 30 percent. The uncertainty of establishing a new market and the lack of well-documented demand and supply elasticities for cannabis limit our ability to obtain more specific estimates. For this reason, we believe that a conservative approach is justified.
We estimate recreational cannabis sales in Ontario of approximately C$930 million in 2019, C$1.59 billion in 2020 and C$2.38 billion in 2021. These figures closely mirror the estimates of the Parliamentary Budget Officer (PBO) of C$1.6 to C$2.4 billion in cannabis sales for Ontario. Based on the current trends in Colorado, we expect cannabis sales in Ontario to grow for the first several years after legalization; sales near C$3 billion and tax revenues near C$600 million are possible in a mature recreational cannabis market. The speed at which the market reaches this benchmark depends on the capacity of producers and retailers to meet consumer demand under the provincial government’s regulations.
The PBO has estimated that Canadians will spend between C$4.2 and C$6.2 billion on legal cannabis products in the first year after legalization. This amounts to a little less than is currently spent on beer each year. The exact size of the legal cannabis sector in Ontario is yet to be determined, but with annual sales that we expect to surpass C$1 billion by 2020, it is safe to assume that the economic gains of legalization will be substantial. A whole suite of new jobs and careers will be created, which will create spillover benefits for the rest of the economy.
Our sales estimates are obviously highly dependent on the market structure, tax rate and regulations that are ultimately implemented in Ontario.
The previous Liberal government decided to sell cannabis exclusively from the government-run Ontario Cannabis Retail Corporation and online via Shopify, forgoing the revenue that would be available from the sale of licences and incurring the start-up costs of establishing a new Crown corporation.
Newly elected Progressive Conservative Premier Doug Ford has decided to allow private retailers to participate in the market, but not until April 2019. For now, the provincial government, via the Ontario Cannabis Store (OCS), will operate online as the sole source of legal cannabis in the province. Starting next April, the OCS will act as the wholesaler to private cannabis retailers. While this plan avoids the costs of establishing retail stores and training staff, it maintains the provincial government’s role as the only wholesaler of legal cannabis products in the province.
There are several concerns with this plan. First, will the provincial government be able to effectively meet consumer demand using only its online sales platform in the months before the retail stores come on the scene in the spring? Second, will the government’s supply chain be as efficient and competitive as the private supply chains that will exist in other provinces? Finally, will retailers push for their own private supply chains come April 2019?
Adding to the policy-making challenge is the fact that a large number of private sector cannabis stores are already operating with the expectation that they will get a part of the recreational cannabis market. It has been reported that, in spite of hundreds of criminal charges and countless fines, Toronto has an estimated 65 illicit cannabis shops open for business at any given time. It is yet to be seen whether the Ford government will allow these businesses to formalize their activities and join the legal market. Following legalization, local municipalities will need to constantly monitor and shut down stores operating illegally. In addition, the proliferation of online black-market sellers, some with names as brazen as BuyMyWeedOnline.ca, will be a salient issue in the early days of legalization. Online sales also raise concerns about interprovincial sales, which have proven to be a highly contentious issue with alcohol. The comparably lower weight of cannabis products will make cross-border sales, via Canada Post, a very difficult activity to police.
Second, for beer, wine, liquor and cigarettes, the provincial and federal governments are fairly free to set a tax rate and let the market determine the retail price. However, for recreational cannabis, there is a well developed black market, and if legal prices go much above unregulated prices, legal sales and tax revenues will fall. So there is a soft upper boundary to the price of recreational cannabis, and operational and pricing inefficiencies will influence the profitability of the industry.
Third, supply chains between cannabis growers, processors and retailers will need to be developed. Currently, there is a large degree of optimism in the “marijuana patch” in Southern Ontario and elsewhere. Monitoring and following developments in this new agricultural industry should be a high priority for farm organizations and the Ontario Ministry of Agriculture, Food and Rural Affairs. The University of Guelph has already dipped its toe into cannabis research. Some of the euphoria at the farm level needs to be tempered by the fact that marijuana production is likely to be handled by a few large and well capitalized farms and firms.
The franchising model
The Ontario government seems to be adopting a “franchising” model for retail sales, where the government controls the number of cannabis licences sold or auctioned to private retail establishments. The licences would contain the rules and regulations deemed appropriate for licensees, but since cannabis is a legal product they should be focused primarily on public health and safety concerns. Government’s role would be to enforce and monitor the rules. Excise taxes are being set by the federal government, in consultation with the provinces.
The franchising model has a number of advantages compared with public ownership. The sale or auction of licences would generate immediate revenue and avoid all of the costs of establishing retail outlets; government would control the number of licences, and auction prices would help determine the proper value of a licence; and the private sector would determine the best locations for retail stores, subject to local zoning requirements.
Furthermore, if the government allows, the private sector would develop competing supply chains and would decide how best to market cannabis products. Finally, the private sector would make all staff training and hiring decisions, and the probability of a sector-wide work stoppage would be almost nil.
Some have raised concerns about moving away from a public ownership model. A first set of concerns is about the number of outlets: they could proliferate, or remote areas of the province might not be served. However, the franchising model allows the provincial government to control the number of outlets and to earmark licences for certain geographic areas if needed, without picking the exact street corner for a store.
There are also concerns that private retailers won’t be as vigilant about barring under-age buyers. However, the fear of steep fines and/or losing a licence should be motive enough to closely monitor private sales, and sales clerks making improper sales could be quickly sacked.
Finally, there are those who say Ontario will be sacrificing the profits that would have come from being the sole retail seller and wholesale buyer of cannabis in the province. However, the marketing of cannabis, in all of its many forms, is a far more challenging retail task than marketing wine and beer. Our view is that the sale or auctioning of licences can capture much of the revenues that might be available under a provincial retail store monopoly, while maintaining government’s role as a regulator. Whether the government should be the sole wholesaler of cannabis is an interesting question that deserves additional thought and research.
Regardless of the tax regime, market price and regulatory environment, the legalization of cannabis will have profound implications for Ontario and for Canada. Already, the prices of cannabis-based equities are growing exponentially and creating new investment opportunities (or pitfalls) for Canadians. In addition, several Canadian cannabis businesses have been granted licences to begin exporting to a number of countries that have recently legalized cannabis, either for medical or recreational purposes, including the Czech Republic, Germany, New Zealand and Australia. While exporting cannabis may be more complicated than shipping out corn and wheat, at the end of the day cannabis is an agricultural commodity with significant demand both domestically and internationally, and Canada is well positioned to benefit from both.
At the retail level, it remains to be seen how the general public will respond to the open consumption of cannabis. Governments are clearly hungry for the new revenue, and time will tell how adept they are at simultaneously regulating and developing this new market. The varying approaches that provinces take to marketing cannabis to final consumers may allow for interesting comparisons between alternative marketing systems.
This article is part of The Economics of Canadian Cannabis special feature.
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