By New Frontier Analysts
Six of the world’s largest agribusiness companies are currently working on merger deals that could reshape American and global agriculture. The most notable of the mergers is the proposed deal between chemical giant Bayer, and agriculture seed and pesticide giant Monsanto. This proposed merger is currently structured at $66 billion. To put perspective of the scale of this deal in terms of the cannabis market, Colorado’s cannabis sales were just under $1 billion for 2015.
Though these large agribusinesses have not yet entered the cannabis market and have little direct influence over cannabis at this point in time, it is worth viewing cannabis agriculture in light of these developments as it suggests the direction the market is headed, what economic forces might affect cultivators in the shot and long-term, and what might occur once these larger agribusinesses are able to enter the cannabis market.
The two primary economic forces credited for driving these mergers in agribusiness are a drop in net farm income year-over-year, and the exorbitant costs associated with new product development and approval. According to Bob Young, Chief Economist at the American Farm Bureau Federation, at a Senate hearing presentation on the Bayer/Monsanto merger, net farm income has dropped from $123.8 billion in 2013 to an estimated $71.5 billion for 2016, a decrease of 42% over four years. This drop in price is largely the result of an overproduction and oversupply in agriculture commodities markets. Young also estimated that between research and development, and regulatory compliance, the cost of bringing a new agriculture produce to market is $136 million and a 13-year process from development to approval. These high costs in turn drive up prices of the agriculture inputs that farmers, who are already experiencing lower revenues, relay on for cultivation.
To shift to the cannabis industry. Despite rapid overall growth in net income for the cannabis industry, individual cultivators are already experiencing tighter margins as cannabis unit prices experience a continued decline (According to Cannabis Benchmarks, the September 16th spot index price for a pound of outdoor cannabis was $916). This decline in unit prices stems from cannabis market liberalizations, leading to greater competition and greater supply in cannabis markets. As cultivators experience tighter margins, cannabis input producers including genetics, fertilizers, and pesticide manufactures will face downward pressure on prices effecting their overall margins as well.
In contrast to current drops in prices, the high costs of product development and product approval for market entry will not be drastically felt in the short to mid-term for cannabis cultivators or input producers. However, these costs are likely to be felt rather acutely in the long-term. The same barriers that prevent large agribusinesses from entering cannabis also provide a shield for the standard costs of product development as cannabis products are not yet required to meet the strict requirements that other drug and agriculture products face. The industry will eventually reach an inflection point when federal regulations that oversee safety and standards for cannabis are established (similar to those developing in state markets regulating packaging, testing, and dosage limits). This will increase costs of compliance for operators while signaling to major agribusiness that its safe for them to fully enter the market.
California serves as a great case study of these forces as it transitions from a large mostly unregulated environment into a formally regulated environment with the Medical Cannabis Regulation and Safety Act (MCRSA). Due to and the oversupply in cannabis production, the anticipated costs of regulatory compliance, and the market entrance of larger firms, it is estimated that only 10% of current cultivators will be able to make the transition into the regulated market.
In the short-term, market participation is going to continually increase and cannabis prices are going to continue to drop. Regulations seen in other agriculture segments will eventually be developed for the cannabis industry. As this happens, costs of compliance will increase, as well as large agribusinesses will be ushered into the market. With larger agribusinesses in the market, there will be even greater downward pressure on prices. With much lower prices and increased costs, profit margins are going to become very thin. This will in turn apply strong pressure for market consolidation for cultivators and cultivation input producers.
Though the cannabis industry is still ways away, market consolidation is inevitable. The path towards market consolidation for the cannabis industry is rather unique, with changes in the cannabis market occurring more rapidly compared with more traditional markets. Operators who are able to identify changes on the horizon will be able to navigate themselves down this path with greater success and hopefully survive while many will exit along the way.
New Frontier Analysts
Our data scientists drill deep with rigorous analytics to provide insight into key trends and market opportunities. We track the state of cannabis and its regulation in all major legal markets.