(This is the second installment of a two-part series examining the expected supply and demand of Canada’s cannabis market.)

If a recreational marijuana shortage materializes in Canada come 2019 – as most industry observers predict – don’t blame Health Canada, which more than doubled the number of production licenses it granted in 2017.

Instead, look to regional supply imbalances – possibly in provinces that opt to sell adult-use cannabis through government-run retail outlets – and producers who fail to live up to their cultivation targets.

On paper, at least, the Canadian marijuana industry has plenty of paid-for production capacity to meet demand by mid-2019.

Companies, in short, have been spending hundreds of millions of dollars to boost production to meet demand starting this summer.

That’s about three times more than MPG believes will be needed to serve the legal cannabis market in the first year. (The consultancy serves as an adviser to Health Canada, but this batch of data wasn’t compiled for a particular government.)

Two key questions will help determine Canada’s supply-and-demand situation in the months ahead:

How much of the black market – estimated at more than 900,000 kilograms (992 tons) – can Canada expect to bring into the regulated fold in that time?

How successful will licensed producers be in actually meeting their disclosed cultivation targets?

MPG reckons Canada will corral approximately 40% of the black market for recreational cannabis, meaning LPs would be expected to produce around 360,000 kilograms of marijuana in Year One.

The producers have to hit only 35% of their disclosed cultivation capacity to meet market demand in the first year, MPG estimates.

“Licensed producers are well capitalized in Canada, making it easier for them to ramp up production in the first year. Supply may be limited initially but should ramp up sharply after a few months,” said Miles Light, a co-founder and partner with MPG.

“Remember, legal demand won’t be 100% of the market. Some portion of that will be supplied by home growing, and some is going to be supplied by the same black market that exists today. Then you have what’s being already supplied in the medical market.”

Canada’s licensed medical cannabis production currently sits at about 75,000 kilograms a year, according to Daniel Pearlstein, an analyst with Eight Capital in Toronto.

Where shortages may occur

MPG sees any shortage of cannabis as the result of market distortions on the retail and wholesale end of the supply chain, after the marijuana is produced.

“You’re unlikely to have a systematic shortage or bottleneck in cultivation, but there may be bottlenecks further down the supply chain, especially in distribution and retailing,” Light said.

That’s because there may not be enough sales outlets, particularly in provinces opting for government-run retail monopolies, including Ontario and Quebec.

Those two provinces, for example, account for almost two-thirds of Canada’s population and will have around 70 adult-use marijuana outlets in 2019 – far less than their combined 1,066 government-run liquor stores — and the current crop of approximately 250 illegal marijuana dispensaries.

Market imbalances might be seen regionally, with some places having too much marijuana and other places not enough.

Conversely, analysts expect provinces with private-sector retail systems will see entrepreneurs address any retail bottleneck by opening outlets with a greater selection of products as well as a wider range of prices.

Khurram Malik – a partner with Jacob Capital Management, a Toronto-based financial advisory firm – said regional retail networks will be key.

“If you have 50 stores in Ontario where you need 500 stores, that’s not a supply glut, that’s a bottleneck in distribution,” he said. “There will be an inventory glut first before there is excess supply in the market.”

Any inventory glut in the industry will benefit smaller producers, who will find it easier to produce at a higher utilization rate, he said.

Larger issue

A bigger supply concern is the breadth of products available for sale in Canada come legalization: Will the products sold in the regulated market be what consumers want to buy?

That starts with in-demand strains of marijuana and includes edibles, which won’t be part of the initial legalization rollout.

Ian Dawkins, president of the Cannabis Commerce Association of Canada, drew a parallel to alcohol sales.

“It’s like liquor stores. You can’t just carry three kinds of rum and expect everyone to buy it. If you went into your local government liquor monopoly and they only carried one kind of whiskey, everyone would be lining up at the border to shop in the U.S.,” said Dawkins, also is a principal consultant of British Columbia-based Althing Consulting.

“Talking about supplying the market in raw kilograms is not the way you want to be approaching this,” he added. “The shortage is going to be in certain subsegments that the big LPs don’t understand and don’t have experience in.”

Canopy Growth, traded on the Toronto Stock Exchange under the symbol WEED, is one of the major licensed producers diversifying its product offering for that reason.

A spokesman pointed to the company’s CraftGrow platform, which offers cannabis varieties grown by a diverse set of producers.

“Looking ahead to rec sales, CraftGrow partners allow us to stand out to provincial bodies by bringing multiple producers to their shelves through a single transaction, which again makes us more attractive amongst the other available options,” said Canopy’s Jordan Sinclair.

“Variety is important in every market. By carrying more than one brand in the shop, we attract more customers.”

Editor’s note: The data took into consideration disclosed cultivation capacity for Canada’s publicly traded licensed producers. Marijuana Business Daily was also given funded production capacity for some privately owned licensed cultivators on condition of anonymity.

Matt Lamers can be reached at [email protected]

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