The Crisis in California’s Legal Cannabis Industry, Explained

On Election Day 2016, more than 57 percent of California voters gave the thumbs-up to Proposition 64, known formally as the Control, Regulate, and Tax Adult Use of Marijuana Act. Just over one year later, on Jan. 1, 2018, the first fully licensed cannabis “dispensaries” opened for business. The era of legal pot in the country’s most populous state was underway.

From there, the cannabis industry’s journey has not been a smooth one.

When Prop 64 was approved by the voters, the state expected that about 6,000 cannabis businesses would be licensed within the first years of the new industry. By the middle of 2021, only 1,086 had been approved, according to a Los Angeles Times report.

Three-and-a-half years after that first customer walked through the doors of Cathedral City Care Collective in Riverside County and made the first legal purchase of recreational cannabis, the newly formed industry is in trouble—so much trouble that in June, the state legislature approved a $100 million bailout for floundering dispensaries. 

The funds will be dispensed as grants to cities to hire experts and other staff that can help dispensaries, 82 percent of which still hold only “provisional” licenses, make the transition to fully licensed status. As currently set up by the state, that’s a lengthy, time-consuming and expensive process that can leave a small business owner smothered in red tape. The process can take most cannabis companies anywhere from two to four years.

And yet, if they fail to meet the state’s deadline of Jan. 1, 2022, they could be forced to close their doors. Gov. Gavin Newsom now says that he wants to extend that deadline by six months. At the same time, the provisionally licensed and fully licensed businesses face tough competition from a thriving illegal cannabis industry. 

According to data cited by the industry publication MJBizDaily, illegal cannabis operations rake in $8 billion in annual revenue, almost twice as much as the $4.4 billion generated by legal businesses. Given the regulatory roadblocks that legal cannabis businesses face, that disparity should not be surprising. MJBizDaily reports that an illegal grower needs just a few weeks and between $1,500 and $2,000 in rent and maintenance costs to set up about 2,000 square feet of cannabis cultivation. 

To create the same cultivation business legally would take at least two years and an investment of $1 million, according to the industry trade site.

On the retail side, illegal businesses can evade the state’s 15 percent excise tax on cannabis sales. Legal cannabis is also hit with a “cultivation tax” that depends on the weight and type of product. The illegal segment of the cannabis industry is only helped by the fact that, according to a New York Times report in 2019, the state leaves a large amount of responsibility for regulation to local cities and counties. With that kind of latitude, about 80 percent of California’s local governments decided simply not to allow legal cannabis businesses to operate at all.

Who bears the burden of dealing with the illegal cannabis trade in California? Sadly, but perhaps not surprisingly, that burden is borne most heavily by minority communities, according to a study by researchers at the University of Southern California. The study of 1,110 cannabis retailers—including 662 unlicensed shops—found that neighborhoods with only illegal operations had a higher proportion of Hispanic and African-American residents, and a lower percentage of white residents than those where only licensed cannabis businesses operated.

The fact that minority communities must rely on largely unlicensed sellers for their cannabis exposes them to higher health risks because they are buying an unregulated product. Nor is there anything stopping illegal shops from selling to minors, according to the study’s authors.

“Every day, unlicensed shops are providing Californians access to untested, untraceable and untaxed products on an alarming scale, threatening the health of consumers as well as the very existence of the legal cannabis industry,” United Cannabis Business Association President Jerred Kiloh told the Sacramento Bee.

The problems are so endemic that the $100 million cash infusion may have little impact, at least according to Steve Allan, CEO of the Parent Company, a firm that acquires cannabis businesses, in an interview with Bloomberg News. Allan called the sum “a drop in the bucket” compared to what would be needed to keep many struggling cannabis businesses in operation.

The illegal market that continues to thrive as legal businesses battle with the arduous licensing process comes with some very real human costs. In Los Angeles as of February 2021, there were only 184 licensed retailers out of more than 1,000 in the whole city, according to a report on California’s cannabis industry by Politico. Employees working at the illegal shops may not even be aware that they are unlicensed, Politico reported, putting them at risk of arrest without even knowing it.

After an initial phase of two years when the state focused on processing applications for cannabis business licenses, the state started stepping up enforcement against the non-licensed operators, both retailers and growers. In the two years after legal sales began, law enforcement agencies in California had seized 24 tons of black market pot, about $133 million worth, according to a Sacramento Bee report.

In early June, cops seized stashes of illegal cannabis valued in the “tens of millions of dollars,” in the Antelope Valley high desert, about 70 miles north of Los Angeles, according to an Associated Press report. They also said they planned to obliterate 500 illegal growing operations in the area with bulldozers, after discovering about $380 million worth of product and the infrastructure to support it. 

One growing operation uncovered in the June operation had 70 greenhouses across 10 acres and produced about $50 million in black market cannabis.

Those illegal operations appear to be operated by “unspecified cartels,” according to the AP report. Those same cartels, whose members are usually armed and presumably quite dangerous, are stealing water from nearby farmers in the middle of California’s drought emergency, according to reporting by Julie Cart of CalMatters.

And not only from farmers—throughout the state the cartel water thieves have created their own illicit water systems complete with dams, reservoirs and pipelines designed to siphon water away from homes, private wells, rivers and even fire hydrants, leaving firefighters with depleted supplies of water for battling flames. 

In fact, the California Environmental Quality Act which among other provisions requires that businesses—any business, including cannabis—can have no significant impact on regional water sources. Obviously water conservation is not a concern for illegal cartels that simply steal it. But for legal operators, showing full compliance with the CEQA typically takes a year or more. Newsom’s proposed extension of the deadline for coming into full compliance met with immediate objections from a coalition of environmentalists, led by the Sierra Club California, which in a letter to the governor slammed the proposed extension as “wholly inadequate to protect local communities and the environment.”

The fact that cannabis is not legally classified as a farm crop but instead as an “agricultural product” makes the approval process even tougher by imposing higher CEQA standards on the cannabis industry than on growers of other crops. 

The cannabis industry has been banking on passage of SB 59, a bill authored by District 12 Senator Anna Caballero, a Democrat from Salinas. The bill would extend the provisional license program for current holders not just for six more months as Newsom proposed, but for six years. But that bill is now stalled in the Senate.