The shake-out of legalised marijuana growers is underway

The New Zealand Herald reported this week:

A glut of legal marijuana has driven Oregon pot prices to rock-bottom levels, prompting some nervous growers to start pivoting to another type of cannabis to make ends meet — one that doesn't come with a high.

Applications for state licences to grow hemp — marijuana's non-intoxicating cousin — have increased more than twentyfold since 2015, and Oregon now ranks No 2 behind Colorado among the 19 states in America with active hemp cultivation...

It's a problem few predicted when Oregon voters opened the door to legal marijuana four years ago.

The state's climate is perfect for growing marijuana, and growers produced bumper crops.

Under state law, none of it can leave Oregon.

That, coupled with a decision to not cap the number of licences for growers, has created a surplus.

Oregon's inventory of marijuana is staggering for a state its size. There are nearly 1 million pounds (450,000kg) of usable flower in the system, and an additional 350,000 pounds (159,000kg) of marijuana extracts, edibles and tinctures.

The legalisation of marijuana in Oregon (and many other U.S. states) was supposed to bring on a boom time for marijuana growers. But, the removal of barriers to entry into the market caused a massive increase in the number of growers (and the quantities they were growing). Absent the legalisation aspect, this sort of boom-and-bust is common in agricultural markets, where barriers to entry are low (agricultural markets are among the closest to perfectly competitive).

Consider a perfectly competitive market for marijuana, as shown in the diagram on the left below. It's probably not quite perfectly competitive, because growers require licences, but it is pretty close. The diagram on the right tracks changes in growers' profits over time. Initially (at Time 0) the market is at equilibrium (where demand D0 meets supply S0) with price P0, and firms are making profits π0. Now say there is a permanent increase in demand at Time 1, to D1 (this increase in demand derives from the legalisation of the consumption of marijuana). Prices increase to P1, and growers' profits also increase (to π1). There are no barriers to entry (other than growers requiring a licence and some land, so this is a perfectly competitive market), so the higher profits encourage new growers to enter this market. Supply increases to S2 (more growers) at Time 2. Price falls to P2, and growers' profits also fall (to π2).

At this point in the story of the market shown in the diagram, profits are low so growers start to exit the market. And indeed, that is what appears to be happening:

"Word on the street is everybody thinks hemp's the new gold rush," said Jerrad McCord, who grows marijuana in southern Oregon and just added 12 acres of hemp.

"This is a business. You've got to adapt, and you've got to be a problem-solver."...

In Oregon, the number of hemp licenses increased from 12 in 2015 to 353 as of last week, and the state now ranks No 2 nationally in licensed acreage.

Growers are exiting the marijuana market and entering the hemp market instead, since most of the growing techniques are the same (so that makes the barriers to exit the marijuana market low, and barriers to entry into the hemp market also low). Once there are fewer growers growing marijuana, the price (and profits) should recover for the remaining growers. In the market diagram above, supply decreases to S3, with prices increasing to P3 and profits increasing to π3. But we should expect the market price for hemp to come under pressure shortly, from the increase in the number of growers in that market!

I've previously argued that this sort of cycle is likely happening in the New Zealand craft beer market, though I'm still waiting for the large-scale exits to happen. In that case, demand increases appear to be just high enough to keep the small craft brewers in the market. For now.