How Canada Blew Its Chance to Be The Cannabis World Leader – Part 1

Dear Fellow Retail Investor,

Back in my hippie days (I’m old), I remember buying a bag of weed that reeked of mold.

Obviously I couldn’t complain to the Better Business Bureau about it.

But I was able to exchange it for a fresher batch.

(My source knew he risked a word-of-mouth backlash if he didn’t make things right.)

Now – some 40 years later – most North Americans don’t have to sneak off to some back alley for cannabis.

That’s especially true in Canada.

The reason, of course, is that back in 2018 the Canadian government legalized recreational marijuana.

Today it’s nearly 2 ½ years later.

Yet Canada is still just the second country (along with Uruguay) where pot is completely legal.

You’d think by now Canada would be a global cannabis leader.

That hasn’t happened.

Instead, Canada showed the world exactly how NOT to roll out legal weed.

Case in point – the province of Ontario.

Ontario reneged on its “no limit” on cannabis retail licenses

Cannabis was legalized for adult use in Canada on Oct. 17, 2018.

A month later, the Alcohol and Gaming Commission of Ontario (AGCO) announced it wouldn’t limit the number of retail distribution licenses.

That made sense, as capping pot licenses risked underserving rural areas of the province.

But just a few weeks after the announcement, the AGCO decided to cap the number of licenses to 25…

For the entire province!

That was obviously insufficient, as Ontario – Canada’s most populous province – is home to 14.7 million people.

Former Ontario Finance Minister Vic Fedeli (who’s now the province’s minister of economic development) said the cap was due to a shortage of legal weed.

He blamed the federal government for the shortages, which impacted far more than just Ontario. 

Take Alberta, for example.

That province received just 20 percent of a late 2018 order from federally licensed producers.

In Quebec, shortages forced pot shops to cut their retail hours to 4 days a week.

And in other jurisdictions, online retail sales were restricted.

You can bet many Canadian cannabis consumers turned to the black market as a result of these shortages.

They were completely avoidable.

See, Canada had years to prepare a smooth rollout.

(Prime Minister Justin Trudeau announced the federal government of Canada intended to legalize adult use cannabis back in 2015). 

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Limiting the number of legal pot shops was just the beginning…

Consider applications for government cultivation.

As of May 2018, Health Canada was taking an average of 341 days to approve one.

(Health Canada is the department responsible for Canada’s health policy.)

Aphria, Inc. (Nasdaq: APHA) would wait much longer.

The Ontario-based grower wound up waiting more than 18 months for a cultivation license for its Aphria Diamond facility.

How Canada Blew Its Chance to Be The Cannabis World Leader – Part 1

To say the delay worsened Canada’s pot shortage would be an understatement.

See, Aphria Diamond was set to produce a whopping 140,000 kilograms of weed a year at the time.

And the facility was pretty much raring to go in early 2018.

Greenhouses there only needed to be retrofitted for cannabis production (at the time they were used for growing vegetables).

Aphria expected little trouble getting license approval.

But obviously they were wrong.

Health Canada’s sluggish approval process was far from the only thing that ruined Canada’s chance to lead the world’s new cannabis industry.

Anatomy of a pot shop horror story

Through its infinite wisdom, the AGCO announced in December 2018 that a lottery would determine who could apply for retail cannabis licenses.

Over 17,000 people entered this lottery.

One of the lucky 25 winners was Stephen Frey, who had no experience in the cannabis industry.

No matter – with all the buzz about legalization, he figured he’d profit in short order.

Boy, was he in for a surprise.

For starters, his congratulatory letter warned that he had just 7 days to submit his application.

It had to include…

Proof of a CA$50,000 letter of credit
CA$10,000 in non-refundable fees
And a guarantee he’d be open for business by April 1, 2019… a little over two months away

And if he failed to open in time, he’d have to pay thousands of dollars in fines.

Frey’s problems sprouted like mushrooms over the next few months

For one, he had great difficulty obtaining the letter of credit.

(Banks didn’t want to fund “risky” marijuana businesses.)

Finding a suitable storefront proved equally difficult.

When he finally did secure one, his landlord charged him 30% over the going rate (just because he was selling pot).

Renovations to the building cost him CA$400,000.

The next hurdle was securing product.

This also proved challenging.

The problem was the only source cannabis distributors could legally buy weed through was the state-run Ontario Cannabis Store (OCS).

As a new cannabis business, Frey was entitled to pre-order a one-time shipment of up to 100 kilograms of weed…

At a cost of CA$1 million…

Which – get this – he’d have to pay upfront!

That was more than he could afford, so he ordered half that amount.

Now he had to scramble to hire staff…

Buy display cases…

And buy furnishings in order to beat the April 1 deadline.

He worked 18 hours a day to try and make that happen

But despite all that effort, he was unable to open on time.

Result – a CA$12,500 fine.

The province then gave him a new opening deadline of April 15.

But he was unable to meet that one… so he was fined another CA$12,500.

Finally, on April 20 Frey was able to open

Happily, he was flooded with customers.

But they were draining his inventory much faster than expected.

That forced him to close two to three days a week within a month of opening.

As you can imagine, the buying public was unhappy about that.

Many said they were being forced to go to the black market.

(Are you noticing a trend here?)

Frey tried to order more product, but came up against yet another government obstacle.

He could only buy 25 kilograms per week.

Frustrated and desperate, he pleaded with the government to sell him more.

Their response – he should have pre-ordered the full 100 kilograms.

Ontario’s second pot lottery compounds problems

Frey’s saga shows how the AGCO lottery created a mess in Ontario’s cannabis rollout.

So what did the agency do to improve things?

It announced a second lottery!

The goal was to allow for 42 more pot shops to obtain licenses.

If you think terms for first lottery winners were onerous, get a load of the rules for the second:

And you had to promise your facility would be open by Oct. 1, 2019
You had to prove you’d lined up retail space
You needed to show you had access to CA$250,000
You needed to show you had access to CA$250,000

As the drawing was to be held on August 20, 2019, that meant winning applicants only had 6 weeks to open.

Sounds like a recipe to shut out the little guy, doesn’t it?

The Ontario-based High Life Cannabis Company (which is private) added to that perception.

The reason – locations associated with the firm somehow won 6 of those 42 opportunities to apply for retail store licenses.

No surprise then, that many people thought  the lottery was rigged.

Now, rules for that lottery limited applicants – which could either be companies or individuals – to one entry for each location.

I suppose the idea behind that rule was to ensure fairness.

But it did anything but – because the number of applicants who could submit for each location was unlimited.

It appears that High Life Cannabis and other groups took full advantage of this loophole.

For example, more than 600 entrants targeted addresses that had been listed on High Life’s website.

(Don’t bother checking the website, as these addresses were taken down long ago.)

One of those 600 entrants was named on 169 different applications!

Another was listed on 91.

Now to be fair, High Life itself was not listed on any of them. 

Private individuals submitted those.

So we don’t really know if High Life intentionally gamed the lottery.

But we do know that addresses related to High Life weren’t the only ones to appear on multiple lottery applications. 

For example, 3 separate locations in the small town of Innisful, Ontario (population 36,000) submitted 130 applications.

All 3 won

On average, every winning address was associated with 25 applications (according to lottery data). 

And 30 of the 42 retail locations drawn were on more than 10 separate applications.

By contrast, only 7 winning addresses were listed on single applications.

In an August 2019 Globe and Mail article, a lawyer working with cannabis companies that had entered the lottery blamed the CA$250,000 cash requirement for the inordinate number of winning group entries.

The paper didn’t identify this lawyer because he feared retribution.

Regulations also caused a shortage of retail pot shops throughout Canada

There were only 164 retail cannabis licenses in Ontario by September 2020.

That means nearly two years after legalization, there were only 1.1 cannabis store licenses per 100,000 people.

Obviously, that wasn’t nearly enough.

Shortages of retail pot shops also plagued other provinces.

Quebec had just 45 retail stores by August 2020 (putting it dead last in Canada’s retail store per capita department). 

So Ontario and Quebec – which together make up 2/3 of Canada’s population – only had about 200 legal cannabis stores between them.

Things weren’t any better in British Columbia.

The province had hoped to have 240 stores within a year of legalization.

But it only had 87 by then.

As you can imagine, those shortages did wonders for the cannabis black market.

In fact, for 2019 – more than a year after Canada’s cannabis rollout – the black market accounted for about 65% of all the recreational cannabis sold nationwide.

Government advertising rules gave the black market yet another advantage

Canadian rules about advertising legal pot are ridiculous.

Here’s a sample of what they prohibit:

Advertising cannabis through testimonials or endorsements
Portraying cannabis as being glamorous, recreational, exciting, vital, risky or daring
Using paid Google, Facebook or Instagram ads
Using outdoor signage
Showing cannabis products on a website
Communicating information about price
Giving away free samples
Using coupons

This is just a partial list.

Essentially, these stupid rules prevent legal outlets from using modern marketing and branding techniques. 

Now let’s turn to the issue of product quality…

“Friends don’t let friends smoke government weed”

That unflattering sentiment popped up on Reddit in late 2018.

The catalyst?

Reports of bug- and mold-infested weed from RedeCan, a licensed Ontario-based cannabis producer.

RedeCan’s contaminated product had been sold through the OCS.

(There are some incredible posts on contaminated government weed from that time on Reddit). 

RedeCan recalled the moldy pot and reportedly reimbursed customers.

But many of them complained they had to wait weeks for their refunds.

As for the bug-infested pot, RedeCan refused to offer refunds.

The reason?

The company said the bugs were beneficial (“similar to ladybugs”) and approved by Health Canada. 

Making people wait weeks for refunds on moldy weed…

And refusing to reimburse them for bug-infested weed…

Doesn’t exactly create consumer confidence, does it?

Then there’s Canadian pot taxes…

Yes, it’s true that Canadian taxes on cannabis are lower than those in the U.S.

But they still make legal pot in Canada much more expensive than black market weed.

That’s a big reason why about 40% of Canada’s marijuana consumers have bought black market pot since legalization. 

Bottom line – Canadian pot taxes are too high, and they’ll continue to drive people to black market cannabis.

High taxes… 

Contaminated weed …

Unrealistic licensing rules…

Huge upfront fees…

Ill-advised lotteries 

Absurd advertising rules…

All that’s just a partial list on how Canada blew its chance to be a world cannabis leader, and stunted the growth of some of the country’s most promising new cannabis companies. 

But the government isn’t the only culprit.

The country’s cannabis industry deserves some blame. 

I’ll explain why in my next Dear Retail missive. I’ll also share some important tips on investing in Canadian small-cap pot stocks. 

Stay tuned…

Until then,

Doug Fogel

Contributing Editor, Dear Retail

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