Here's Why California's Cannabis Black Market Won't Go Away

As we all know, Prop 64 legalized cannabis for adult use in California. Voters gave it the green light in November 2016, paving the way for legal, licensed dispensaries to open their doors beginning in January 2018. Many Californians celebrated by flocking to dispensary doors and soon afterward consuming their first taste of legal, adult use cannabis. But that’s far from the end of the story.

Because Prop 64 gave local governments the power to decide their own regulations — or bans — with regard to cannabis businesses within their jurisdiction, California became riddled with a patchwork of partial legalization throughout its hundreds of independent localities. While certain places like Los Angeles, Sacramento, San Diego, and the Bay Area are now home to a number of licensed dispensaries and delivery services, other areas still exist in a state of de facto prohibition. And the illicit market does well in places without legal options.

Some lawmakers have tried to remedy the situation, with legislation like the now-shelved  Assembly Bill 1356, which would have mandated that municipalities where the majority of residents had voted in favor of Prop 64 lift their bans on legal cannabis businesses. And so many cities across California remain without legal dispensaries. 

It may come as a surprise that the illicit market flourishes in states with an established, legal market, but there are a few likely reasons for this. 

Some say that price is the driving factor behind it all: Consumers, if given a choice, will opt to pay less for what they perceive to be a similar product — and the unregulated market in California is cheaper because producers and sellers don’t have to pay the 15 percent state excise tax or the variable local taxes, nor do they have to invest in testing or other regulatory hurdles involved in licensure. 

Others say that it’s more about product availability and accessibility: Consumers have established their preferences and shopping routines and may choose a retailer that, while technically unlicensed, offers what they want in a convenient platform.

For some, the answer as to why the illicit market is thriving has more to do with relationships: If consumers have an established rapport with a small grower who is unable or unwilling to get licensed because of the high cost and labor involved in licensure or because the jurisdiction in which they operate is not issuing permits, that consumer may stay loyal—particularly because decriminalization has lowered the risks of doing so. 

There’s yet another factor involved when consumers buy cannabis on the illicit market, or what's often referred to as the "traditional market": They may not even know they’re doing it. Jackie McGowan, a cannabis industry consultant with K Street Consulting, told Civilized that there’s yet to be a clear way to guide consumers to licensed storefronts. “And if you can’t tell the difference, which one would you choose?” she asked. “The cheaper one, right?” Particularly in cities where dispensaries and delivery services are already up and running, it’s relatively inconspicuous for unlicensed retailers to hang a sign or hire a driver and start selling. Without the burden of licensure, they can charge less and take market share away from legal businesses. Of note, Governor Newsom signed a bill on July 1st raising the fine for illegal cannabis sales to $30,000 per day. Where enforced, this could provide more serious deterrence.

Drawbacks

Not long ago, a San Diego resident who we'll call Adam (his name is withheld to protect his employment status) consulted Weedmaps, an app similar to Yelp but for weed businesses, and found a local retailer to deliver high-potency edibles for a fair price. “They contacted me, asking if I was law enforcement,” he told Civilized. That first interaction seemed odd to him, and was compounded by the fact that when the driver showed up, he asked Adam to get into his car. The edibles Adam bought looked like candy that had been coated in oil, he recalled. Maybe it was cannabis oil, but he said that the effects of those edibles were a far cry from the high-potency product he was expecting.

Adam’s wife Nicole (her name has also been withheld because she's a public school teacher) recalled a time the two of them visited a retail shop in Chula Vista, California. She was looking for a familiar vape brand, she said, but “they were offering me all kinds of mystery products." These products were unmarked, she added, with no ingredients listed. "The people who worked there didn’t seem to know anything about them, like whether they were farmed sustainably or organically," she said. "They seemed uncomfortable that we were asking all these questions and emphasized the products’ low prices, instead.” Though the couple is cost conscious when it comes to cannabis, these two experiences made Adam and Nicole more cautious about where they shop. 

In order to change consumers' shopping habits and steer them toward licensed retailers, California's Bureau of Cannabis Control recently launched an educational campaign called get #weedwise to inform the public on health and safety concerns like mold, fungus, pesticides, and even fecal matter that can be present in illegal weed that circumvents state-mandated testing. There’s also a tool on the BCC's site to help consumers verify licensed cannabis businesses. But getting people to use this information in their decision-making presents another challenge. 

Terminology 

When talking about this issue, it’s helpful to parse out the terms. “Black market,” while still in common use, feels a bit outdated and pejorative to those who know the industry well. Alex Traverso, chief of communications at the Bureau of Cannabis Control, prefers the terms “legal” and “illegal” to distinguish those businesses that have gone through the regulatory measures to get licensed, and those that haven’t. 

Hezekiah Allen, president of Global Cannabis Innovators Corp, prefers the terms “regulated,” “unregulated,” and “criminal,” to draw important distinctions among those who operate in full compliance with the law, those who might prefer to operate in compliance but do not currently have the means to do so, and those who have no interest or intention to join the legal market and may in the process be committing violence or environmental crimes. 

McGowan uses the term “duty-free market” to describe any cannabis business activity outside the taxation and regulation regime. However, regardless of the term you choose, the fact remains that the unregulated market is alive and well, though it’s also changing. According to Traverso, the level of sophistication consumers expect — from the product itself as well as from retailers — is rapidly rising. “People want brands,” he told Civilized. “They want something that’s more of a lifestyle product — they don’t necessarily want to meet a guy on the corner who’s handing them a plastic bag.” 

Market Size

A simple Weedmaps search turns up several thousand retailers, but there are fewer than a thousand licensees in the whole state: a clear indication of how common illegal retail activity really is. Earlier this year, the LA Times reported that about 80 percent of the cannabis bought in 2018 in California originated on the black market — an estimate that comes from cannabis analytics firm New Frontier Data. The illicit market in the state was thought to be worth about $3.7 billion, which is more than four times the dollar value of the regulated market. 

Risks to Buying on the Unregulated Market

In addition to the sale of unmarked “mystery” products like those Adam and Nicole encountered, counterfeit products posing as known, legal brands is a problem among unlicensed retailers. California strictly regulates the quality of licensed cannabis, but it’s unlikely that what’s sold on the illicit market has been tested for pesticides, molds, or other toxins. “We want to make people aware of the fact that a lot of these products we’re taking [from unlicensed retailers] would not pass testing and are not good for them,” said Traverso. “People think they’re getting a deal. But at the end of the day, health is more important — and something they should be safeguarding.”   

Challenges to Eroding the Illegal Market

Hezekiah Allen believes that the biggest barrier for cannabis businesses seeking to enter the legal market is the two-track licensing system whereby the local city or county has to issue a permit before the state can issue its own. “Most cities and counties in California are not issuing permits," he said. "So most cannabis business people simply can’t participate.” In fact, only about a third of the state’s cities currently allow the sale of cannabis within their borders. 

Beyond that, money is an issue. It can cost hundreds of thousands of dollars to get licensed for a small grow — defined as 10,000 square feet or less. A small grower may yield about 300 pounds a year. Because it takes anywhere from $400 to $1,100 to produce a pound of flower that will itself garner between $500 and $1,500 a pound, margins can be small. Beyond the initial licensing, ongoing fees include those of annual renewals (starting at $1,000, depending on the size of the operation), taxes at $148 per pound, and the labor it takes to comply with reporting requirements such as water usage, the track and trace system, and sales. All that leaves many mom and pop cannabis entrepreneurs out in the cold.

Because getting compliant is so challenging, it's no surprise then that tax revenues from the first year of adult use legalization totaled only around $300 million, which is less than half of what was projected. According to McGowan, “there’s a long line of people patiently waiting for Prop 64 tax revenues to come in so that they can make use of those dollars.” For instance, the California budget allocates cannabis tax revenue to be used for administering the new cannabis laws, researching the effects of legalization and past criminalization, and a long list of social goods like youth education around cannabis, environmental restoration, and public safety. So even though high taxes are hampering the success of the legal market, McGowan says that the political will to lower those taxes is lacking.

Another reason why it’s hard to erode the unregulated market is that California cannabis growers have been supplying out-of-state markets for years. “So there’s a mismatch between market aspirations — businesses that want to scale large because this is the next ‘gold rush’ — and actual, in-state demand,” said Allen. The hard truth, he said, is that California needs to significantly scale back production in order to keep all its cannabis within the licensed market. But as long as federal prohibition persists, there will be black market demand. 

Traverso pointed to California’s unique history of a grey-area medical market pre-legalization to explain some of the difficulty: There was a thriving state-legal medical marijuana market for twenty years before voters passed Prop 64. Since the passage of Prop 215 to legalize cannabis for medicinal use in 1996, the state later passed Senate Bill 420, which set up a system of collectives and cooperatives through which cannabis could be sold — but not, technically, for profit. The complexities and legal grey area inherent in that system left a number of open loopholes and confusion — which the heavy regulation inherent in the new legal system post-64 (applying both to adult use and medical cannabis) was meant in part to alleviate.

However, because that traditional market was poorly regulated, it’s now a major obstacle to get people who were accustomed to the old system to comply with the many regulations and taxes imposed by the new law. “We don’t want to be overly punitive to people because this industry has suffered too much over the years with heavy handedness,” said Traverso. “So we try wherever we can to educate, and to be sympathetic to people who were operating for a long time with no regulations. We have to do our best to be open-minded.” 

Enforcement Efforts

Some jurisdictions, according to Traverso, are more active in enforcement than others. “Local control is what the people voted for with Prop 64,” he said, so local governments have a lot of authority, and everyone does things a little differently. “We want to prioritize going after the unlicensed people in places where there are legal operators because we want to make sure that those are successful.”

Legal operators do indeed feel the sting of business lost to unlicensed retailers. Javier Montes, vice president of the United Cannabis Business Association, told Civilized that it’s tough to compete because unlicensed shops have no accountability. “They open, are shut down and re-open within days. Some sell counterfeit products, which are obviously untested and unsafe. Illegal shops can sell for less because in many cases they do not pay sales tax or business tax, can operate at any hour of the day, pay employees under the table, and do not have to worry about insurance.”

People can file a complaint about an unlicensed business online at the BCC's licensing site. Then the cannabis enforcement division of Consumer Affairs can open a file, do surveillance work, and conduct an undercover buy to find out if the business is collecting taxes and checking IDs. They must build a case against the suspected illegal business and obtain a warrant before finally seizing product and even, on occasion, making arrests. “Unfortunately,” added Traverso, “it doesn’t happen as quickly as a lot of legal retailers would want.” 

Solutions to the Illegal Market Problem

Traverso believes that as the industry becomes more sophisticated and organized, legislation will come down the pike to fix problems — “whether that’s lowering taxes or trying to find a banking solution, or putting more resources toward enforcement,” he said. For its part, the BCC is willing to refine the regulations in order to smooth out bumps and allow more efficient access to legal status for businesses seeking it. Bans in various localities are also gradually being lifted, and more licenses are being issued. “It doesn’t happen overnight, but we’re continuing to work at it and things will continue to improve,” said Traverso.

According to McGowan, lowering the tax rate and studying consumers’ habits and preferences — especially those buying unregulated cannabis — are both key to overcoming this problem. “If we don’t know what consumers are doing, we can’t even begin to compete on an even playing field,” she said. Meanwhile, Allen takes a more philosophical approach: “We have to give up on the idea that we can prevent humans from consuming this product. If we acknowledge that adults should have access to cannabis… that will get rid of the unregulated market.”  

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