The cannabis industry is in a tough and unique situation. While some states permit full recreational use of marijuana, federally, it remains illegal as a Schedule 1 substance. Not only does that create confusion for investors, businesses, and consumers, it also means that there are still many obstacles preventing the sector from realizing its full potential.
While decriminalizing marijuana could be an important first step in changing federal law, the industry truly needs complete and outright legalization to thrive. And until that happens, it's going to struggle. Here are five ways that marijuana being illegal federally is causing problems for the cannabis sector.
1. Banking is a challenge
Big banks largely avoid doing business with the cannabis industry because marijuana companies aren't legal businesses in the eyes of the federal government and doing so would expose them to liability. This doesn't mean cannabis companies aren't able to obtain any banking services, but it's a challenge given the potential risk. This is why lawmakers introduced the Secure and Fair Enforcement (SAFE) Act last year, which would protect banks from legal trouble related to doing business with the pot industry. But despite passing the House last September, the bill hasn't moved any further.
Access to banking is crucial for the marijuana industry for many reasons, one being that lack of banking services results in businesses keeping more cash on hand, which makes them a target for criminals. In 2019, Denver, CO reported a three-year high for cannabis-related break-ins. And during this summer's protests, many cannabis businesses were targeted by looters, with some businesses reporting millions of dollars in losses. While many might assume insurance will help businesses to recoup losses, there's problem number two to consider.
2. Getting insurance isn't always possible
As with banking, cannabis companies often can't obtain insurance coverage in the traditional way because insurance providers also avoid the industry because it's federally illegal. When insurance is available, it can be too expensive.
The pot industry's also vulnerable because it depends on the success of crops, and recent wildfires have exacerbated these problems for cannabis producers, destroying not just their crops but their businesses. According to the Oregon Liquor Control Commission, 12 of the 20 licensed cannabis operators that were in burn zones were wiped out entirely and were complete losses, and those numbers could rise even higher.
Without insurance coverage, there's next to no recourse for these businesses.
3. Complex hemp rules create lots of ambiguity
In late 2018, the federal government took one positive step for the cannabis industry by passing the Farm Bill, making it legal to sell hemp-based products. States would still need to come up with their own hemp programs (and the vast majority have -- more than 40 states allow for some sort of hemp production).
Under the hemp rules, as long as tetrahydrocannabinol (THC) levels remain at 0.3% or lower, the government considers the product hemp. Anything above that is classified as marijuana. That seemed like a clear ruling -- until the Drug Enforcement Agency (DEA) recently released interim rules relating to that, suggesting that even if a product momentarily rises above that threshold, such as during the extraction process, then companies are in possession of an illegal Schedule 1 substance.
If marijuana were legal, this complication wouldn't exist since it wouldn't matter if the THC content were above 0.3%. But even hemp is now looking a lot riskier as a result of the DEA's rules, which aren't yet finalized. A company like Charlotte's Web (OTC:CWBHF), which was once seen as a much safer cannabis investment since it sells hemp-derived CBD products, has seen investors unload the stock this year. Year to date, its shares are down more than 60%, far and away worse than the Horizons Marijuana Life Science ETF (OTC:HMLSF), which contains pot producers and is down around 32%. That's in stark contrast to 2019 when Charlotte's Web outperformed the index, falling only 31% while the ETF declined by 39%.
4. Expansion isn't easy
One of the biggest hurdles for cannabis companies is that federal laws prevent marijuana products from crossing state lines. Even though marijuana may be legal in states like Oregon and Washington, companies can't ship the products from one state to another. If a marijuana company wants to do business in both states, it would either need to acquire a company with operations in the other state, or it would need to start operations there from scratch. Neither option is cheap.
Charlotte's Web, which doesn't face those obstacles, is able to ship its products across the country to states that permit hemp, whether it's to the more than 21,000 retail locations its products are in, or directly to consumers. For companies selling and producing marijuana, however, that's not a reality, and it saddles those businesses with added expenses, making it more difficult for them to turn a profit.
5. It makes it unattractive for other industries to get involved
Despite the industry's attractive growth prospects, there hasn't been a big influx of companies from the pharmaceutical or consumer packaged goods industries racing in to tap into all this potential. The biggest names thus far have been alcohol giant Constellation Brands, with its $4 billion investment in Canopy Growth (NASDAQ:CGC), and tobacco maker Altria Group, which purchased a $1.8 billion stake in Cronos Group (NASDAQ:CRON) in 2018.
Other, more risk-averse businesses remain on the sidelines. Berkshire Hathaway executives Warren Buffett and Charlie Munger believe it's a mistake for one of their favorite businesses, Coca-Cola, to get involved with marijuana. In a 2019 Fox interview, they said that marijuana "would be detrimental" to Coke's "wholesome image."
Although attitudes are changing on marijuana, with more than 30 states legalizing marijuana for medical or recreational purposes, it's clear that not everyone's on board with it. And even if companies were willing to take on the risk of reputational damage and getting involved in an industry that's federally illegal, they'd face challenges from not being able to ship products across state lines. That would mean companies with robust networks like Coca-Cola wouldn't be able to take advantage of their existing distribution channels. That alone may disincentivize larger businesses from getting involved with cannabis and helping the industry grow.
Federal legalization of marijuana is key to all these issues
Until marijuana is legal federally, the majority of these issues are likely to remain problems for the industry. Decriminalizing marijuana isn't going to address all of these problems, nor will bills focused on certain aspects like banking. Investors have to take these challenges into account when investing in pot stocks and be cognizant of the risks. If and when marijuana becomes legal in the U.S., these issues will dissipate and the cannabis industry can start realizing its full potential. But until that happens, the government's still standing in the way of the industry's growth.