Don’t Worry About Excess Weed Supply. Freak Out About Excess Capacity.

For anyone who’s followed the coverage of Canada’s weed market, over the past months, you probably know that there’s currently way more weed in inventory than we have the collective lung capacity for bong hits.

But that excess supply isn’t the disease; it’s a symptom. The disease is excess capacity, and we’ve got a stage-four case. The most recent data available is five months old, but even then Canada already had way, way, way more cannabis production capacity than we will ever need. Just look at the graph above.

In June, there was enough licensed production space to harvest 1,670,000 kg of dried cannabis per year. The current demand in the WHOLE MARKET (i.e. the licensed and black market combined) is only 788,000 kg/year. That means that the current legal market capacity is more than two times what is needed to supply both the black and licensed markets. 

Even if the black market just goes away – poof! – and cannabis demand grows at 15% per annum (it won’t come close, but I’ll save the details of how I model market growth for a future post), some of that production space that was built, licensed, full of equipment, and ready to grow in June would lay fallow until at least 2025.

Moreover, the black market still exists. Combining Health Canada numbers with Stats Canada’s estimates of the total size of the cannabis market (details about this below), the legal market currently represents less than a fifth of the total cannabis market (17.4%). Put this all together and it’s very possible that a large percentage of the production capacity that was licensed in June will never grow a single plant.

As for any space licensed since then? It’ll just be worse. And I promise you: there was lots of space that got licensed. If capacity growth was what it was prior to June, we now have the capacity to grow thirty times more weed than was sold in the legal market (recreational and medical combined) in the year since legalization.

What does this mean for the future of the Canadian Cannabis market?

I’ll do future posts on how this will shake out for different market participants (vertically integrated majors, smaller producers, retailers & processors), but here is a quick summary:

Cannabis price/gram will continue dropping across the supply chain.

The extent of this drop will depend on what producers choose to do with all their production capacity. If the bigger players decide not to use large percentages of their capacity, this effect could be limited. Nevertheless, my current assumption is that output will increase substantially and prices will fall accordingly.

Major write-downs of production assets and goodwill.

Any asset that is likely to lay fallow for the foreseeable future will need to be revalued, resulting in large non-cash losses.

Substantial write-downs of processing and packaging assets.

There is no reason to think that misplaced optimism was limited to grow facilities. Processing capacity for oil production, beverage/chocolate/gummy production, vape cartridge production and everything else would have been planned based on estimates of kilos harvested in production facilities.

Fire sales and consolidation.

If any company can maintain investor confidence as this shakes out, the opportunities are huge. That’s a big “if,” but anyone with cash on hand when the panic sets in will be well set up for long-term success once the market stabilizes.

Details & Data Sources

To get the Canadian market’s capacity, I started with Health Canada’s published data on Licensed cultivation area (the last chart on this page). I then converted square meters to square feet (1 square meter = 10.7639 square feet) and used an estimate of 0.1 kg/square foot to get production capacity. That estimate of productive capacity/square foot is pretty commonly used and lines up pretty well with numbers reported by companies themselves in public reports (compare Table 1 and Table 2 here).

Licensed sales data also came from Health Canada. You can find links and details about computation in the Details and Data Sources section of my previous post.

The calculation for 2019 market size also came from Stats Canada data but required a little more leg work. It’s also far less precise than the numbers above because it requires estimations of black market sales, which are obviously more difficult to obtain.

I first took the three available quarters of data for 2019 for “non-medical (licensed)”, “non-medical (unlicensed)”, and “medical” cannabis from Stats Can’s report on detailed household final consumption expenditure and summed the three different categories to get the total cannabis market size. I then estimated the fourth quarter using an average of the three quarters available. This gave an estimate of $5.8 billion for the whole market. I then converted that to kilograms using Stats Can’s cannabis implicit price index, which told me that current overall price (which is a weighted average of illegal market, legal rec market and legal med market) are 78.2% of the 2012 baseline, which is $9.30/gram. That gives me a current price of $7.27/gram, which I used to find the market size in kilos of the 2019 Canadian cannabis market: 797,000 kg/year.