Double Dealing: Legal, Illegal Blurring in the California Pot Market

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This photo, provided on condition of anonymity by a marijuana grower, shows the tops of cannabis plants in Northern California on November 24, 2021. As California enters its fifth year of widespread legal marijuana sales, the competitive market an undesirable trend. Industry experts say a growing number of license holders are also clandestinely operating in the illicit market – working on both sides of the economy to make ends meet. (AP photo)

AP

On a remote farm, greenhouses stand in regimental order, sheltered by a row of trees. Inside are hundreds of man-tall cannabis plants in precise rows, each emerging from a pot fed by spirals of irrigation hoses. Lights powerful enough to turn night into day blaze overhead.

In the five years since California voters approved a broad legal market for marijuana, thousands of greenhouses have sprung up across the state. But these hide a secret under their plastic roofs.

The breeder, which operates the cultivation north of Sacramento, holds a coveted state license that allows the company to produce and sell its plants. But it’s been virtually impossible for the grower, in a struggling legal industry where wholesale cannabis bud prices have fallen by as much as 70% year-on-year, taxes are hitting 50% in some areas, and customers are finding far better deals, Profits to be made thriving underground marketplace.

So the company has two identities – one legal, the other illegal.

“We’re basically subsidizing our white market with our black market,” said the farmer, who agreed to speak to The Associated Press on condition of anonymity to avoid possible prosecution.

Industry insiders say the practice of operating in legal and illegal markets simultaneously is all too common, a financial reality caused by the difficulties and costs of doing business with what they call the most regulated product in America.

For the California grower, the clandestine illegal sales take place informally, often with a friend within the close-knit cannabis community calling to make a purchase. The state requires legitimate businesses to report what they grow and ship, and it’s entered into a vast computerized tracking system — known as “seed-to-sale” surveillance — that’s anything but airtight.

“It’s not too difficult” to work outside the guard rails of the tracking system, the grower said. Plants can vary widely in their production, allowing for leeway in reporting while there is little opportunity for on-site inspections to verify records. The system is so lax that some legal farms put up to 90% of their produce on the illegal market, the grower added.

The passage of Proposition 64 in 2016 was seen as a turning point in the quest to legitimize and tax California’s multibillion-dollar marijuana industry. In 2018, when retail stores opened up, California became the world’s largest legal marketplace and another stepping stone on the path that advocates of federal legalization hoped to take after landmark legislation passed in Colorado and Washington state in 2012.

Today, most Americans live in states with at least partial access to legal legal marijuana — 18 states have broad legal sales for those 21 and older, similar to alcohol laws, while more than two-thirds of states allow access through medical programs.

Kristi Knoblich Palmer, co-founder of leading edibles brand KIVA Confections, lamented that corporate migration to the illicit market is hurting efforts to create a stable, consumer-friendly marketplace.

“Having this system that now seems to be failing to get people to do things the old way is not helping us achieve our goal of professionalizing cannabis and normalizing cannabis,” she said.

In California, no one disputes that the huge illegal market continues to eclipse the legal one, even though the 2016 law boldly stated that it would “take out the black market.” Democratic Gov. Gavin Newsom, who was lieutenant governor at the time the law passed, called it a “game changer.”

But California’s legalization drive has faced challenges from the start. The state’s illegal market thrived for decades and was anchored in the fabled “Emerald Triangle” at the north end of the state. No attempt had been made to turn such a vast illegal economy into a legal one since the end of Prohibition in 1933.

In October, California law enforcement officials announced the destruction of over 1 million illegal crops statewide, but said they were finding larger illegal growers. In Humboldt County’s cannabis heartland, many illegal growers are moving indoors to avoid detection. Investigators make arrests and issue search warrants every week, but with so many underground cultivations, “we may never eliminate illegal cultivation,” Sheriff William Honsal said in an email to the AP.

California’s illicit market is valued at $8 billion, said Tom Adams, chief executive officer of research firm Global Go Analytics. That’s roughly double legal sales, although some estimates are even higher.

In September, a cannabis company sued state regulators in an Orange County state court, alleging that so-called burner dealers had used shadowy “straw men” to obtain licenses to buy cannabis wholesale and then sold it in the illicit market to to avoid taxes.

No state claims to have eliminated illegal operators. US Rep. Earl Blumenauer, an Oregon Democrat who is co-chair of the Congressional Cannabis Caucus, said he sees little prospect of undermining illegal markets without federal legalization, which has stalled in Congress, although Democrats are in control about Congress and the White House.

The thriving illegal markets in California, Oregon and elsewhere are a “product of dysfunction, lack of resources and not having a regulated national market,” he said.

Like the California grower, many companies make some transactions in the illicit market to make ends meet, but others have abandoned the legal economy or never bothered to enter it.

While California’s legal market tightly controls how and where pot is sold, the illegal industry is easily accessible, providing access to a vast and profitable national market.

“Licensed players are the good guys. But it just never feels like we’re being treated like we’re on the right side of history,” said Knoblich Palmer.

California’s quest to establish itself as a pre-eminent player in the legal cannabis economy has never felt more threatened, and talk of a Boston Tea Party-like rebellion against state policy is spreading. In a December letter to Newsom, about two dozen industry executives said the state was crippling the marijuana economy.

“California’s cannabis system is a nationwide travesty, a public policy lesson in what not to do,” the business leaders wrote. Newsom has signaled that he is open to change.

The anonymous grower said the strain of competition in the regulated economy just doesn’t make sense for many long-standing operators that emerged in the pre-Proposition 64 market. There’s a common mindset – “Why bother?” – when the illegal economy is booming and law enforcement has little to fear.

In Los Angeles, for example, with licensing fees, real estate costs, attorneys, and inspections, opening a retail store can cost $1 million or more — if you can get a license at all. Promises from social justice programs that would support businesses run by people of color targeted during the drug war have gotten off to an uneven start.

For the struggling legal market, “that’s a challenge when quality, price and convenience work against you,” said Adams, the cannabis analyst. “The illegal market has all three.”

One irony in the legal market is that wholesale prices have plummeted, shaking the supply chain. A year ago, a wholesale grower could get about $1,000 a pound. Now that has dropped to $300 as the market is saturated.

Add $150 in cultivation taxes to a £300 and that’s a staggering 50% rate.

Part of the problem for the industry is that about two-thirds of California cities don’t allow legal sales or cultivation — local governments control when or whether to create legal markets, and many have banned it or failed to establish rules. Even in places where this is the case, cities have been slow to allow legal products to be sold because there are fewer than 1,000 brick-and-mortar stores in a state of nearly 40 million people.

Meanwhile, wholesale prices for underground buds are significantly higher. The legal market with limited outlets is being flooded with marijuana from big corporations.

Few know the industry as well as Jerred Kiloh, dispensary owner who also runs the United Cannabis Business Association, a Los Angeles-based trade group.

“No one is making money anywhere in the (legal) supply chain,” he said, noting that his own sales have plummeted. Kiloh sees few bright spots in the law that has created California’s legal market, aside from a quality-assured testing program and programs to erase criminal records for marijuana.

With Proposition 64, “we did everything wrong,” he said.

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