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Yes, Canada: There Could Be A Cannabis Shortage

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Canada’s cannabis industry insiders are warning that despite its claims to the contrary, Health Canada is underprepared when it comes to the supply — and demand — for cannabis after it’s legal on Oct. 17, 2018.

How much cannabis will Canadians want post-legalization? Three different studies offer some theories: a 2016 study by Health Canada and Deloitte picked the brains of 5,000 statistically average Canadians, and concluded Canadians will buy a minimum of 600,000 kg annually. In its Sept. 20. 2017 report, Mackie Research Capital one-upped Deloitte, forecasting that consumers will need around 800,000 kg. And a 2017 report from the Office of the Parliamentary Budget Officer projects that we’ll need 655,000 kg – for the recreational market alone.

Whatever the true number turns out to be, it’s a formidable amount of cannabis to produce. And Canada is the new global king of producing pot – even now, months before the recreational use market opens its flood gates.

Licensed producers have been growing and selling medical cannabis strains since 2001, now in dried flower and oil forms — not just to Canadians with a doctor’s prescription, but to countries all around the world with their own medical marijuana programs, totaling about $1.2 billion in sales last year. We count Germany, Australia, New Zealand and many other countries among our international customers who value Canada’s medical grade bud.

We also grow more of it than anyone else. Look at our top three licensed producers: Aphria, Aurora and Canopy Growth. Aphria is on track to churn out 255,000 kg annually, while Aurora could top out close to 450,000 kg, especially given its state-of-the-art facility Aurora Sun in Medicine Hat, Alta. At more than 1.2 million square-feet, the mega-facility promises its endless rows of cannabis plants more than enough room to stretch their leaves. As for Canopy, after recently tripling its licensed production capacity to a whopping 2.4 million square-feet, and announcing plans to boost its peak capacity to 5.7 million square-feet, it commits to an annual delivery of more than a half-million kg of cannabis.

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Cannabis companies are furiously laying out the groundwork for immense scales of production – and therein lies the problem. If adequate, built-out capacity doesn’t quite exist yet, then authorized sellers across the nation will have no chance at supplying consumer demand with any consistency at all come October 17.

Cultivation facilities are still coming online

“The problem is that capacity is late coming onboard,” says Hamish Sutherland, CEO and president of cannabis operations and investment firm White Sheep. “The production capacity in this country is not yet at a stage where if all the consumers were to go to a legitimate outlet, the supply-demand balance is not yet there. Not remotely close.”

Sutherland is the former founding chief operating officer (COO) at Bedrocan, the fifth cultivator to earn its licence in the country. His current firm, White Sheep, operates multiple medical and adult-use cannabis companies. (Hamish himself was responsible for building and running a 52,000 square-foot facility, having successfully passed 50 surprise inspections from Health Canada.) White Sheep, with Sutherland at its head, also invests in cannabis cultivators and consumers, planting their thumb in the ever-expanding Canadian cannabis industry’s pie and ensuring that the firm will play a major role in its ongoing development. It’s Sutherland’s business to know the canna-business inside-out – and he doesn’t like what he sees.

“If the entire Canadian consumer market were to stop buying from illegal sources and go to a legal dispensary, there is absolutely no chance Canadian producers can keep up,” he says. “Mettrum in Bowmanville; Agrafarm in Orangeville; Tweed Farms in Niagara-on-the-Lake; Tweed in Saskatchewan. That’s it. BC Tweed doesn’t count. BC Tweed 2 doesn’t count. Their facility in Alberta – not built. Their facility in New Brunswick – not built. Their facility in Newfoundland – not built.”

“The guys at James Wagner who just went public this week. When you read their stuff, they have ‘365,000 square-feet’ of grow but actually, no – they have 15,000 and a plan for 350,000 additional. When you look at TGOD, they talk about their 1.8 million square-feet and, in fact, they have 7,000 square feet. You have Supreme that calls themselves 7 Acres and what they have is 40,000 square feet – they have one acre. They haven’t built the rest of the rooms out and licensed them.”

It was suggested that when at full capacity, and after acquiring Ontario-based grower MedReleaf for $3.2 billion, Aurora Cannabis could replace Canopy as the top-producing cultivator in the country, producing maybe as much as 570,000 kg annually.

But that’s a year or two down the road, after their 800,000 square-foot facility Aurora Sky is finished sometime before October 17 and the aforementioned (and nowhere near complete) Aurora Sun comes online in the second half of 2019. Though its on-paper capacity is impressive, where it lacks is in-the-ground cannabis plants that are ready to be cultivated, prepared, distributed, and sold to consumers. According to its 2018 fiscal report, Aurora produced less than 1,500 kg of cannabis for the medical market in Q3, which ended March 31. As Aphria CEO Vic Neufeld said at the time, “Unless someone’s out there hiding 100,000 kg, we’re looking at a real shortfall.”

In Mackie Research Capital’s 2017 report, analyst Greg McLeish writes that “though a number of these developments are well underway or are in the final design phase, it can take two years for new facilities to be fully operational, so the majority of this new capacity will not come online until late 2018 or 2019.” McLeish acknowledges the associated technical dilemmas, as does CIBC in its 2018 report, Cannabis: Almost Showtime. In it, the authors write that figuring out how to build one of these massive facilities is “remarkably challenging.” But first, before any one of these burgeoning enterprises can put shovel to dirt, a ticker tape parade of bureaucratic red tape currently has more than 500 applicants stuck in a backlogged queue with little end in sight.

The licensing backlog

Like Sutherland, lawyer Trina Fraser is keeping a close eye on supply and demand. A partner with Ottawa business law firm Brazeau Seller, Fraser’s main clientele are licensed producers. Applicants who wish to grow legal weed must first brave Health Canada’s stringent and notoriously thorough application process, including a lengthy to-and-fro with a dedicated reviewer, an RCMP security clearance, and a final review by a cannabis committee – and that’s only to grow.

“You start off with a base licence that allows you to cultivate only,” Fraser explains. “Then as you want to expand the scope of activities that are permitted, you will apply to Health Canada for amendments to your licence, the main amendment [being] the ability to sell… You have to look at the actual licence itself to see what activities are actually permitted. There’s cultivation, processing, importing and exporting, selling, selling wholesale, selling to patients.”

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There are 113 licensed producers in Canada as of the date of publication of this story. More than half (61) call Ontario home, with 24 in British Columbia, eight in Quebec, and, zero in Nfld., the Yukon, N.W.T. and Nunavut. Less than half (52) are licensed to sell their product, and about 25 are able to sell cannabis oil.

Then there’s the backlog: more than 500 application packages are waiting to be picked up by a Health Canada reviewer. Getting a cultivation licence can take anywhere from six months (though CannTrust earned theirs in just 129 days and AgMedica in 189 days); getting a seller’s amendment tacks on an additional average of 341 days to that wait time. Add to that the RCMP security review, which happens simultaneously but sometimes takes 12 to 18 months, meaning that applicants may be ready to move onto the next stage if it were not for their delayed clearance. More and more applicants are getting added to the pile, too, as Health Canada saw a 150% increase in applications received at the beginning of 2018. Those applicants aren’t expected to see their products on store shelves until at minimum spring 2019.

Fraser says some of Health Canada’s decisions early on in the evolution of the licensing program are the source of the bottleneck.

“There’s been undoubtedly, since day one, a backlog that Health Canada just has not been able to get through. It’s not been an adequately funded or resourced office within Health Canada, so we have never had any service standards for processing these applications.”

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Sutherland agrees.

“There are countless technical challenges and compliance issues and professional management ones that impede the ability of companies and the managers and employees therein to do their jobs.”

How has Health Canada gotten into this mess? For starters, the application process is immense in scope and detail. First, you submit your application package.

“It has to include,” Fraser says, “the completed form; security application forms for all of the people that are attached to your application and need security clearance; notices to the municipality and fire and police; and consent of your landlord if you don’t own the property. You need floor plans, SOPs, quality assurance reports…”

The process to acquire permission to grow legal cannabis in Canada is ultra-cautious, designed to weed out applicants who can’t comply with the standards. Is it possible that Health Canada is acting a little too cautiously?

Maybe, but they’re not taking any chances – not after what has happened south of the border.

Nine U.S. states have legalized recreational cannabis, while more than 30 now allow for medical marijuana, though these steps forward were not without some initial stumbles. Colorado faced a shortage after legalization in 2014; the same goes for Washington in 2015.

On the other end of the spectrum is the example of Oregon – a state with too much weed. The state sits on more than 1,000,000 pounds of over-capacity cannabis grown by its plethora of legal producers.

Because authorities issued far too many licences to growers, they are now stuck with barns full of rotting bales of cannabis that are going for the rock-bottom price of as low as $69 per pound. In light of the missteps these four states had to endure, states like Texas, Pennsylvania, Ohio, Michigan and Florida are limiting the number of licences they’re issuing to growers.

Is Health Canada issuing too many licences?

The authors of CIBC’s 2018 report also acknowledge the threat of oversupply in Canada, writing that the potential impending shortage initially “might cause growers to throw caution to the wind and lead to unbridled expansion.” In the lead up to legalization, Canadian producers are rapidly expanding their operations’ infrastructure, meaning that annual production rates for all of Canada may hit 2.4 million kg of cannabis or even higher – much more than we need. That’s not in the forecast until 2020 or 2021, when LPs finish up their ambitious construction schedules and get their greenhouses online.

As for the shortage, where will Canadians get their cannabis from in the interim?

“The black market will fill that gap, as it has done for the past 50 years,” Sutherland says. “The black market currently supplies 95% of the consumer market in this country. It’s big, it’s robust, it’s strong. It knows what it is doing.”

What about all the talk of cracking down on the black market? Surely that must be a majority priority, since authorities have frequently said they seek to be the only game in town.

Fraser says that the black market is the dynamic element that will, in the weirdest of ways, unofficially ally with Health Canada to keep Canadians consistently medicated. “Health Canada appreciates that we don’t have a meaningful ability to actually take over black market share so long as all we’re selling is dried cannabis and not-very-concentrated cannabis oil.”

But that’s not the official position of Health Canada.

“Based on current inventory levels and growth in production capacity, the industry is well positioned to supply product as consumers transition to the legal market,” Health Canada writes in an official statement. The statement also remarks they officials recognize they may need to speed things up a little, writing that Health Canada has “implemented a number of improvements to streamline the application process for issuing licenses and to enable increased production of cannabis.” Ultimately, Health Canada is presenting this emerging industry as a market that will take care of itself, though they will certainly be watching it very, very closely.

Despite Health Canada’s claim to the contrary, Sutherland is confident there will, in fact, be a shortage – and that supply will catch up to demand in about three years.

Until then, what can consumers expect? Well, don’t be shocked if there are periodic inventory shortages across all legal channels — something some members of the medical cannabis community is already familiar with. There could be “out of stock” signs on your favourite strains until the newly-grown shipments get distributed. And busier store locations could shut their doors prematurely due to drained inventory. (If you live in Ontario, there is a real possibility that some of the 40 stores promised for 14 million residents will not be ready to go for October 17.)

Though a rocky start to Canada’s great experiment with recreational cannabis is virtually guaranteed, consumers might take solace in Health Canada’s slow-but-careful approach.

“Thankfully,” Sutherland says, “Health Canada has taken the typical, cautious, paternalistic, Canadian approach. That is to ensure that there is an excess of risk management and an excess of caution and a wise balance of oversight… Canada is leading in the Western world as an entity providing that kind of oversight. You can go too fast and have complications, or you can go too slow and just bug people. We’ll catch up eventually.”

 

Source: Yes, Canada: There Could Be A Cannabis Shortage – Lift & Co.

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