By Zach Fox

Colorado's marijuana industry is growing up, and five startups are laying the groundwork to commoditize the drug and one day enable futures trading, similar to oil or agricultural futures.

Without a doubt, the entrepreneurs face a long road. All five businesses freely admit that it will take several years before cannabis commodity trading approaches viability. Nonetheless, they see now as the time to win market share.

The companies say they are unable to offer any sort of futures contract because cannabis continues to be classified as a Schedule 1 drug by the U.S. Drug Enforcement Administration — the agency's most restrictive classification, placing marijuana alongside heroin.

Instead, the companies essentially act as wholesale brokers, allowing growers to post listings and retail shops to bid. After gathering reams of data from thousands of transactions, the startups envision establishing price indexes that could be used as a benchmark for futures. As a crop subject to the whims of Mother Nature and market demand, commodity traders see a potential need for a cannabis commodity exchange.

"Traders have joked about having a marijuana exchange for decades, ever since I've been in the industry," said Phil Flynn, an account executive with PRICE Futures Group. "In a way, having a marijuana market is no different than having a corn market or an alfalfa market."

Wholesale marijuana sales have exploded in recent months in Colorado, the entrepreneurs say, following the Oct. 1, 2014, expiration of a state law that had mandated vertical integration. Prior to the law's expiration, marijuana companies had to be 70% vertically integrated, meaning retail shops would have to grow at least 70% of the product they sold.

Since the law's expiration, Colorado has received new applications for both grow-only and retail-only operations, said Ron Kammerzell, deputy senior director of enforcement for the Colorado Department of Revenue.

"I think over time it will be interesting to look and see if we start to look a little bit more like the liquor industry, where we have the three tiers: we have the retail stores, we have the wholesalers and we have the manufacturers," Kammerzell told SNL.

As of Dec. 31, 2014, the state reports 505 medical marijuana retail licenses and 748 medical marijuana cultivation licenses, although, because of vertical integration, there is significant overlap, with dispensaries often holding both retail and cultivation licenses. And in the city-county of Denver, there are nearly as many marijuana stores — 200 — as there are liquor stores — 229.

But the startups have visions that stretch far beyond wholesale brokerage. While some of the entrepreneurs told SNL they see themselves as the Chicago Board of Trade or New York Mercantile Exchange, George Stein, managing director of executive search company Commodity Talent LLC said data and news company Platts might be the better analogy.

Oil futures have a long history, dating back to 1878 with the establishment of the Pittsburgh Oil Exchange. Speculation ran rampant, with volume reaching 2 million barrels of crude oil traded on exchanges in 1884. But Standard Oil Trust would shut down futures trading the next decade, in 1895, having so thoroughly dominated the oil market that it could set prices for the entire industry. After years of monopolistic price-setting, a 25-year-old journalist in Ohio, Warren Platt, looked to introduce transparency into the market and launched a monthly news production focused on oil prices in 1909. His company would become McGraw Hill Financial Inc. subsidiary Platts, a market leader in establishing price benchmarks for futures trading.

Screenshots of the trading platforms for Cannabase, Cannabis Commodities Exchange and CannaTrade (top to bottom). Cannabase, Cannabis Commodities Exchange and CannaTrade

It would take nearly 100 years for oil futures to return after Standard Oil shut down trading. NYMEX introduced a heating oil contract in 1978, and the London commodity market launched a gasoil contract in 1981.

While trading of the futures contracts started slowly, it picked up through the 1980s as the British government privatized its oil exploration company and increased volatility in oil spot prices. Many of the futures contracts were set based on the price indexes produced by Platts.

"You're only doing reporting. And out of that emerged, eventually, the futures contract on the international petroleum exchange," Stein told SNL. "So would there be a role [in the marijuana industry] for a third party to become, in effect, the reporting agency? That, historically, is how these things have developed."

The road to commoditization

New futures contracts require several qualities to be successful: many market participants to buy and sell the product; sufficient liquidity; a volatile price; and a quality that can be standardized.

Stein said the number of market participants seems sufficient, particularly considering that the number increases by the day, aided by the end of vertical integration.

"When you look at the grow facilities, it looks like a free-for-all right now," said Michael Elliott, executive director of the Marijuana Industry Group.

Elliott said he is concerned that cultivators with excess product will sell to the black market, which could be a setback for the broader legalization movement. Enter the wholesale startups, which say the emergence of grow-only and retail-only not only leads to an active wholesale marketplace but also allows cultivators to focus only on their best strains, enabling specialization and economies of scale — the underpinnings of a fully developed industry.

Liquidity also does not appear to be a significant issue. The most experienced startup in the wholesale cannabis industry, The List Exchange, reported nearly 1,700 pounds of marijuana for sale on its site on Jan. 7; as of Feb. 19, the supply was down to roughly 515 pounds. While roughly 500 units listed for sale might not seem sufficiently liquid, Stein noted futures contracts could use a smaller denomination. Further, he said commodity markets can limit trading hours to a portion of the day to ensure liquidity.

The price of cannabis certainly is volatile. Industry veterans refer to October as "croptober," the time of year outdoor harvests mature, typically sending prices down in the fourth quarter. Conversely, prices tend to spike in April as shops gear up for the widely recognized smoking holiday of April 20.

Roberto Lopesino Seidita, who launched The List Exchange in March 2011, said the wholesale price of cannabis peaked in December 2013. Dispensaries correctly anticipated a crush of demand and scrambled to stockpile product, driving prices north of $4,000 per pound. A year later, prices now range between $1,600 per pound and $2,500 per pound, depending on quality. And therein lies the central problem with cannabis as a commodity: highly variable quality and lack of standardization.

"The problem is that marijuana isn't corn. It's not fungible," said Sam Kamin, a law professor at University of Denver who has been tracking the marijuana industry. "If someone says, 'Why am I paying X and this wholesaler is charging Y?' you might say, 'Our stuff is a lot better than theirs,' but there's no way to prove it."

For now, product gets tested for potency levels. However, virtually everyone in the industry seems to agree that concentration levels of the psychoactive compound tetrahydrocannabinol, or THC, is only one factor when evaluating quality.

"Most people when they go in, they look at the label, 'Oh, 22% THC, that must be great.' But an indica [strain] and a sativa [strain] can both have 22% THC; why do they produce vastly different effects?" said Sohum Shah, COO of Cannabis Commodities Exchange, one of the newer startups.

The five wholesale marijuana startups seem to fall in three categories: two millennial-founded, technology-focused companies with slick design concepts; two relationship-driven companies founded by former dispensary owners; and one company founded by a Wall Street veteran that claims the financial sophistication the market will demand.

Shah's Cannabis Commodities Exchange is quintessentially millennial. Launched in April 2014, the company's Denver office resides in a brownstone-style building in the trendy Highlands neighborhood, a hilly community just outside downtown, packed with foodie restaurants and mixologist cocktail bars. The company's site is free and open to the public, but only marijuana-licensed businesses are allowed to list product or bid on active listings. Still, those businesses do not pay a dime. The company envisions monetizing its data after achieving sufficient volume to produce an index.

Shah said the company expects to tackle the standardization problem via advanced lab testing. Shah said the identification and classification of terpenes, a form of organic compounds, will unlock how and why certain strains produce different effects. Also, Shah said the company will use a review system to offer buyers insight into the quality of the seller's product.

The other millennial-founded company is Cannabase, which launched Jan. 1, 2014. With a somewhat contrarian tack, Jennifer Beck, CEO and co-founder of Cannabase, eschews the idea that it is a commodity exchange in infancy, marketing itself instead as a data and technology company. The company has three products: a mapping feature where consumers can search for dispensaries, a social network platform for consumers to interact with dispensaries and a private marketplace for wholesale transactions.

"The power of Cannabase isn't that we're competing on an app level — it's that we have the intelligence of a platform," Beck said. "Each of the pieces here works together in a way that helps bring an underground industry above ground."

Beck said the company is deploying a "freemium" model, granting free access to early adopters. She said the company will charge roughly $200 per month for dispensaries to maintain a "storefront" on Cannabase's social media platform, and it also envisions data service offerings.

Moving to the relationship-driven startups, Lopesino Seidita describes his company, The List Exchange, as a marijuana concierge service, locating product for those buying or placing sales for those with excess. The company, which also lists marijuana-related business for sale, charges dispensaries $300 per month to $1,000 per month, depending on the level of service. A former dispensary owner, he set out to improve a wholesale market that consisted of dispensary employees traveling to competing dispensaries with backpacks full of marijuana.

The List Exchange has just three employees in the United States, some of whom visit dispensaries regularly with samples of wholesale product. Lopesino Seidita said the company addresses the standardization problem by posting 60-megapixel pictures of the product for sale alongside each listing.

The List Exchange, which he says is highly profitable, could eventually become a commodity exchange, but Lopesino Seidita said the company, for now, is simply a wholesale broker looking to become a data service provider. Lopesino Seidita said he is aggressively seeking a partnership with an analytical company to bring sophistication to his process.

"We're at that step one, of, 'OK, I can go and ask the question.' But I realize I need help in how to design those questions, the boots on the ground to ask those questions and everything that stems from having access. So I see this as I've created an awesome door into the center of cannabis, but I'm also humble, realizing that I can't ever possibly bring all the services, or be all the services that can come through that door," he told SNL.

The other relationship-driven startup is CannaTrade, a unit of CannaSys Inc., which is a publicly traded company founded by CEO Chad Jennewine and CFO Daniel Rogers. The pair originally teamed up in 2009 to launch a dispensary called Greenwerkz. The dispensary grew to three retail locations and 17,000 square feet of growing space before they sold the chain in March 2014.

Jennewine and Rogers describe CannaSys as a technology incubator, with CannaTrade as just one of several products. The company has had the most success, so far, with CannaCash, which allows dispensaries to issue branded gift cards or a points-based loyalty rewards card.

Rogers told SNL that CannaTrade's main advantage stems from a focus on mobile, as opposed to a Web-based platform. CannaTrade allows dispensaries up to 10 trades per month for free, after which it charges $6.95 to $12 per trade, depending on the deal's size. Whereas their competitors stress winning market share, CannaTrade's founders are not as concerned. Jennewine told SNL that the company is "in a hurry, but we're not in a super hurry" because the wholesale market is still in its infancy.

"Quite honestly, your efficiency is going to come from continuing to have vertical integration. You're talking about being able to produce it internally from anywhere from $400 to $800 a pound, but on wholesale you're going to be paying anywhere from $1,500 to $2,500 a pound," Jennewine said.

Finally, there is Amercanex, founded by Steve Janjic, a Wall Street veteran who has years of experience in Forex trading. Since 2000, Janjic has been with six different employers, with stints ranging from six months to three years, according to his LinkedIn profile.

Unlike the others, who market themselves as data providers, Janjic said Amercanex acts, first and foremost, as a self-regulatory organization, auditing any dispensary that trades on its platform. To address standardization, Amercanex posts the seller's name, unlike competitors that anonymize the sellers.

Amercanex charges between $2,500 and $5,000 just for a seat on the exchange. In addition, Janjic charges 22 cents per gram on each wholesale transaction. Janjic said Amercanex, which has 10 full-time employees, hosts superior technology. He said that once marijuana is declassified as a Schedule 1 drug, major Wall Street players will swoop in and take over the commodity exchange market.

"[My competitors are] going to get crushed because they're not going to have the ability to build the brand then. To me, if I'm the first guy here when those guys come, I'm going to be absorbed into the marketplace," Janjic told SNL.

Shortest road to commoditization

Clearly, the standardization problem with traditional cannabis remains unsolved. It is hard to imagine standardization coming about via pictures of the product or eBay-style reviews of the sellers.

Even as data service providers, the startups appear to face a long road. To avoid running afoul state law, none of the startups are directly involved in the wholesale deals. While buyers and sellers connect on the digital platforms, the actual deal itself is required, by law, to take place on-site at the cultivator's location. The entrepreneurs readily acknowledge deal terms sometimes change at the last minute.

However, there might be a shorter path to commoditization for nontraditional marijuana known as "trim," a term used for the excess leaves created when harvesting the flower from the plant. Underscoring the standardization difficulty for traditional marijuana flower, harvesting procedures can drastically affect the price. Essentially, two plants can produce two identical flowers, but if a cultivator uses machines instead of hand-trimming, the aesthetics are damaged and the price drops, said Lopesino Seidita.

"If you take down 400 pounds, you can't hand-trim that; it's just too much cannabis," he said.

However, many industry insiders see the most explosive growth in non-smokable cannabis. Edible candies, baked goods, tinctures and marijuana concentrates known as Butane Hash Oil, or BHO, have exploded in popularity.

Manufacturers make these products from trim, which trades at roughly one-third the price of flower, at around $400 to $500 per pound on the wholesale market. Because manufacturers have need only for the THC content, aesthetics do not matter, and potency drives the price, potentially enabling standardization.

One of the buyers of a lot of that trim is O.penVAPE, a Denver-based company that produces vaporizers that use marijuana oil. Chris Driessen, executive vice president of sales for the company, told SNL that the company licenses its brand to distributors, meaning the parent company never deals with marijuana. But O.penVAPE's licensees will buy trim, manufacture the oil and sell it alongside the vaporizer. In Colorado alone, Driessen said, the company's affiliates go through up to 1 ton of marijuana per month. While the licensees maintain significant grow operations, they still typically source 30% to 40% of their product via the wholesale market, he said.

"Everyone underestimated what demand was going to be," Driessen told SNL. "You had dispensaries build huge grows thinking they were going to wholesale, and they couldn't even keep up with their own needs."

Now, with the end of vertical integration, bringing grow-only facilities, combined with rumors of significant build-outs at existing operations, there are concerns the pendulum is swinging the other way.

"There's so much production in this state. I'll be very surprised two years from now if the price of cannabis is remotely close to where it is today. My guess is it will be a fraction," CannaTrade's Rogers said.

For now, it remains a guess. Many hope he can soon make it a bet.