Cannabis ESG Risk is a Buzzkill for Investors
This post summarizes and augments a longer article just released in the Journal of Impact and ESG Investing (here). [Updated: November 29, 2022]
While modern-day, billion-dollar cannabis companies may claim high marks on avoiding Environment, Social, and Governance risks to themselves and their shareholders and even championing these issues in the world at large, there are snakes in the garden. Certainly, the complexion of cannabis companies conjures up some positive ESG attributes. Among these are advocating for promoting ‘natural’ medicines, decriminalization and decarceration of non-violent offenders, and ostensibly representing socially progressive and ecological values more broadly. And, there are a host of more generic and potentially positive things any industry can do along the lines of diversity and inclusion, transparency, honorable corporate ethics, and climate change risk assessment and preparedness. Some cannabis companies talk about these issues as well, but, in many cases, a hard-ribbed look at execution tells a different story, particularly when it comes to environmental impacts.
Light years away — or maybe not so far — in a teachable current event, and to the surprise of many, (cannabis-puffing) Tesla has just been thrown out of the S&P500 ESG Index. Why? Because, while Mr. Musk presumably gets high (marks) on “E” in terms of its products (efficient/electric cars, solar energy systems, and batteries), he flunks out on “S” (racism and poor working conditions in his factories), and “G” (poor codes of business conduct). Just as Tesla has even been dinged even for environmental missteps (lack of transparency about its own carbon footprint and other forms of pollution), so too can cannabis companies sport warm and fuzzy rhetoric and yet not walk the talk.
The cannabis industry has yet to come to grips with the tension between its productive and counterproductive ESG-related activities.
Many have stumbled.
Investors are noticing.
Cultivated and consumed by humans for millennia, cannabis has only recently burgeoned into a $35-billion global industry, and that’s excluding even larger revenues via illicit markets ten-times that size. Closer to home, it’s America’s largest cash crop.
Along with this “green rush”, the industry has gone high-tech, while attracting substantial capital, and that has had implications for resource use. National legalization would further open the floodgates. While many producers have moved from the black to the legal market, the ESG dimensions of their business practices remain in the shadows. Evidence of practices that make a positive impact on sustainability for society more broadly is equally hard to pin down.
Environmental impacts are among the most distinctive and material ESG considerations for this particular industry. While the sometimes egregious impacts of outdoor cultivation — especially under the black market — have been well-documented, little attention has been paid to also significant impacts of carbon-intensive indoor cultivation. In 2020, 42% of cultivators grew cannabis exclusively inside sprawling windowless factory farms — often several times the size of a Walmart — and use as much energy as a data center.
For the legal and illicit cannabis markets combined, my estimate of a decade ago placed the corresponding annual energy use and greenhouse-gas emissions equal to that of three million cars nationally with a whopping $6 billion annual energy bill. Given rising demand, the numbers are likely higher today, and that original analysis did not include the full array of emissions.
Meanwhile, proper outdoor cultivation has vastly lower environmental impacts. This suggests two fundamentally different pathways along which this industry may develop, and for ESG analysts and investors seeking positive impact to consider.
The messy intersection of cannabis, ESG, and impact investing
Following are key factors creating ESG risks in the cannabis industry, while influencing the attractiveness of cannabis firms to investors wanting to support companies advancing social and environmental sustainability:
- Environmental — Issues include pollution from pesticide use, water use, land-use change, waste production, volatile organic compound (VOC) releases to the air, solvents used to produce extracts, and, last but not least, energy use and associated greenhouse-gas emissions. There are anti-competitive dynamics that tip the playing field in favor of environmentally detrimental indoor cultivation, while, ironically, warehouse grows are encroaching onto farmland where more climate-friendly outdoor cultivation could occur. Meanwhile, high energy use substantially elevates operating cost and contributes to companies’ financial, regulatory, and reputational risk. And, as many industries are seeing, climate change impacts stand as yet another risk: events such as drought, power outages, wildfires, and other natural disasters jeopardize cannabis crops. Meanwhile, the sheer expense of resource-intensive processes such as cannabis cultivation creates intrinsic business risk.
- Social — Issues include irresponsible use and unintended health impacts among adult consumers (or if illegally used by children), potential impacts of boom-and-bust industrial development on communities, good-neighbor considerations such as light pollution and nuisance odor releases, at least 23 health and safety and hazards for cannabis workers, plus blurry lines and unintended enhancement of the illicit market by legal producers. While cannabis has some known health benefits for consumers, links with chronic psychotic disorders have also been described by 70 peer-reviewed articles summarized by Miller and colleagues, and a new article in The Lancet finds that higher potency products are associated with disproportional adverse mental health outcomes. There are clearly differences of opinion on benefits more broadly within the medical research community. The climate change impacts of cultivation can cause public health risks. Facilities using fossil fuel generators that emit unhealthful pollutants have been sited in lower-income urban neighborhoods, while intensive (and increasingly robotized) warehouse development is causing loss of housing and jobs. As producers inevitably expand to developing countries with looser regulations, fair trade considerations will likely also come to the fore.
- Governance — Issues include inadequately racial balance in company ownership and workforce, disclosing and mitigating diverse ESG risks, unethical engagement with regulators, and efforts to greenwash product offerings and the associated legal risks these actions can trigger. Despite the claims by companies to be champions of environmental justice, in reparations for disproportionate incarceration of minorities for non-violent cannabis crimes, in 2021 less than 2% of the jobs in the cannabis industry, which employs almost as many people as there are plumbers, were held by black people. Meanwhile, in 2019, about 80 cannabis industry lobbyists were registered in California alone. The indoor wing of the industry has demonstrated resistance to regulations attempting to improve energy efficiency, while, according to a new report from the UN, often ignoring existing environmental regulations. The risks are compounded by cannabis continuing to be classified as a Schedule 1 drug federally. For example, as a result, the EPA, FDA, and USDA do not regulate pesticide use in the industry and the FDA rarely approves medical research needed to ensure safe and beneficial use of cannabis. Federally-funded research on the industry is hamstrung more broadly.
Despite this busy risk landscape, some observers almost reflexively give cannabis high marks on ESG, even going as far as characterizing it as the “perfect social-impact investment”, while others are more cautious. Some ESG funds already feature cannabis, their managers appearing not to have systematically assessed the relatively unique and disproportionately large risks. Positive recommendations in the investor media appear piecemeal and myopic, e.g., one report advocates for a major synthetic fertilizer company because the product is used in presumably desirable hydroponic cannabis cultivation (with no evidence of the stipulated environmental benefits given) and involvement in exoneration of prisoners incarcerated for cannabis crimes, the latter of which is certainly an ESG-aligned activity but not sufficient on its own to deem a company to be comprehensively governed by comprehensive ESG risk-reducing principles. The few corporate ESG reports that are available often loosely describe diversity, equity, and inclusion efforts or gifts to local charities, but include only scant metrics or mention of efforts to address environmental matters arising directly from their business operations. According to one source, the majority of institutional investors are on the fence as to whether to anoint cannabis stocks as sustainable and socially productive. One contrarian entity has even launched an “Anti-ESG” fund that focuses on gambling, alcohol, selected pharmaceutical firms … and …. wait for it … cannabis.
At least three ESG risk rating services have more seriously examined cannabis-related companies, but only a small subset of 181 traded cannabis companies have been assessed (Figures 1 and 2). Via the Morningstar Sustainalytics platform, ratings are available for 16 cannabis stocks, indicating “High” to “Severe” ESG risk in most cases. In 2018, Sustainalytics rated the “Big Four” largest cannabis firms as “weak” on energy and emissions management along with other ESG indicators.
Four of these companies have also been evaluated under The S&P Global Corporate Sustainability Assessment platform, scoring between 6 and 39 on a scale of 0 to 100 (higher being better). However, three received a zero rating in the Environment sub-category and were rated “low” to “very low” in terms of data availability (transparency), with only one receiving a “high” rating.
Fifteen of the companies were also rated under the International Shareholder Services (ISS) ESG platform, scoring between D and C+. Their accompanying scores for degree of alignment with the United Nations’ Sustainable Development Goals (SDGs) were mostly negative, indicating business practices running contrary to sustainable development. These scores ranged from -8.4 to 5 for the group (mostly negative) on a scale of -10 to +10.
While ESG ratings signal internal risks that companies face, ESG reports also emphasize proactive outward-facing activities that companies take to reduce the external impact of their activities. Only eight cannabis-related companies appear to have issued ESG reports as of early 2022. Only four of these were among the top 27 cannabis companies by market cap ($35 billion aggregate valuation), indicating low levels of transparency in this industry. The available reporting exhibits widely-ranging levels of detail, completeness, and quality.
On the environmental front, these reports tend to provide qualitative discussion of energy, emissions, water use, and solid waste, but few quantify the amounts. Some of the documents provide data only for selected company facilities or locations. Energy use and greenhouse-gas emissions are rarely comprehensively considered or quantified. A challenge for third-party ESG analysts and impact investors is that measured energy data are difficult to come by through other channels, as even the legal side of the industry remains highly secretive about its use of energy and other resources, keeping their data under wraps. Third-party aggregators also tend to constrain access in a proprietary manner. Disclosed datasets often omit key activities or fuels.
In their initial ESG report, Canopy Growth, with 3,221 employees, exemplifies the value of transparency and data disclosure. It’s the most meticulous and quantitative report in this group. For the year 2020, Canopy reported 59,000 metric tonnes of CO2-equivalent emissions from their cultivation operations (Scopes 1 and 2 only), and 68 million gallons of water use. Canopy’s reporting also appropriately quantifies what are referred to as “fugitive emissions,” in this case represented primarily by unintended leakage of heating-cooling system refrigerants, known to be far more potent than the greenhouse-gas carbon dioxide. These emissions represent almost 10% of Canopy’s total releases, a non-trivial contribution and yet a type of greenhouse gas rarely if ever previously reported by this industry. This ESG report provides limited useful context for Canopy’s resource-consumption data, e.g., energy use, emissions, or water use per unit of floor area or final product, which would make possible multi-year tracking and benchmarking to other reference points to indicate whether the facility is operating with poor, average, or best practices. Notably, while Canopy credits greenhouse-gas emissions reductions of an impressive-sounding 239 tonnes CO2 to efforts made in 2020, this represents only 0.4% of the firm’s total reported emissions. Solid waste volumes were not disclosed in the report.
The only known disclosure of solid waste production by a commercial-scale indoor cultivator (Rubicon Organics) suggests 30 kg of waste per kg of dried commercial cannabis flower, or a total of 326 tonnes for the year for this one firm. More broadly, according to one source, single-use cannabis product packaging resulted in one-billion pieces of plastic trash in 2020 industry wide, bound for landfill, oceans, and roadsides.
Put in perspective, indoor cannabis cultivation requires significantly more energy input than most products (measured in terms of energy as a percent of total production costs). On an energy-per-weight of the final product, it is on a par with that of even the most energy-intensive industrial materials (cement, zinc, copper, and aluminum). From an individual consumer’s perspective, the average per-capita cannabis consumption (assuming indoor cultivation) represents from about 15% to 60% of the total energy-related household carbon footprint in Rhode Island and Colorado, respectively (the states with the lowest and highest per-capita cannabis consumption). Perhaps the trials and tribulations facing ordinary indoor “vertical farming” of vegetables — with investments not panning out as the reality of energy costs sinks in — is a harbinger for cannabis.
The annual carbon footprint of indoor cannabis consumption also eclipses that of many other consumer products and energy-intensive activities (Figure 3).
Nope, energy-efficiency and renewable energy won’t solve the problem … and no one want’s nuclear weed
I never thought I’d come across an energy problem that couldn’t be solved by a strong dose of energy efficiency and renewables. But, the intractable structural problem for energy-intensive indoor cannabis is that only 5% to 10% of all energy needs (even less in the case of more space-efficient vertical cultivation) can be generated by placing solar arrays on a typical facility’s rooftop, even in places with ideal solar resources. Prototype facilities using extensive insulation, rooftop daylighting systems supplemented with high-efficiency LED electric lighting, and carefully controlled energy-efficient cooling systems, have achieved energy demand reductions of perhaps 50% (and there’s no room for solar panels on a greenhouse roof). Few sites would have the luxury of sufficiently large undeveloped adjoining land area, the cost of which (not to mention that of the solar arrays) would be difficult or impossible to justify (Figure 4). Cannabis industry associations deserve credit for recognizing and advocating for net-zero energy goals, but they have not acknowledged the practical impossibility of doing so indoors.
Larger-scale, grid-based renewable energy infrastructure is also not free of environmental risks, impacts or costs, and existing infrastructure was not planned and constructed to meet the prodigious energy needs of this emerging industry. Such developments create new and vexing environmental impacts. Prospects are also constrained by an inadequate grid, threats to cultural resources, and dependence on scarce critical minerals. Meanwhile, demand for energy by cannabis facilities is growing at such a rate that all of California’s existing wind energy (representing billions in investment), for example, could easily end up being in effect diverted solely to power cannabis cultivation. Lastly, new loads created by indoor cannabis facilities are now indirectly fueling the push to subsidize and otherwise prolong the uneconomic lives of existing nuclear power plants and even to build new ones. It is difficult to imagine cannabis investors — or consumers — being comfortable with the notion of “nuclear weed”. Indeed, avoidance of nuclear power was an impetus for early development of ESG thinking and remains so today.
Social and governance considerations often intersect with environmental ones
Corporate behavior often runs afoul of ESG goals, and cannabis appears to be no exception. Sadly, large indoor cultivators have lobbied against cleaner outdoor cultivation, as energy utilities divert ratepayer money to hefty subsidies — up to $1 million for moderately-sized facilities in some cases, euphemistically referred to as “rebates” — for indoor growers, in effect underwriting their energy demand growth while putting outdoor growers at an artificial competitive disadvantage. Meanwhile, the industry appears to have successfully lobbied for exemption from an increasing number of state and local mandatory energy use disclosure policies.
A key to improving the sustainability of any industry is enabling customers to understand their products and consciously direct their purchasing power. Yet, one study found that only 20% of surveyed budtenders at dispensaries in Portland, Oregon provided correct consumer information about the environmental impacts of cannabis products. Retailers also contribute to entrenching the dubious idea of outdoor-grown as an inferior product, often relegating it to the ‘bottom shelf’.
While presumably the exception to the rule, licensed indoor cultivators have been discovered using and illegally dumping non-permitted chemicals, violating worker safety guidelines, and using non-permitted fossil-fuel generators in urban warehouses while displacing low-income housing. In latter example, is a prominent example of how disregarding environmental considerations can be bad for business (and thus posing a major ESG risk). An entity hosting energy-intensive indoor cultivation in a 400,000 square foot building was forced to cease operations after ignoring regulations and using up to 11 megawatts of massive diesel generators in a low-income part of Oakland California, subsequently defaulted on a $50M loan.
On the positive side — and central to the notion of strategic ESG — improved practices can reduce business risk. Perhaps foremost among these is that the indoor cannabis businesses model is vastly more energy-sensitive than outdoor producers. One study found that energy expenses for indoor cultivators range from 30% to 60% of total operational costs, and others have reported energy expenses at $150 to $350 per pound of finished flowers versus $10 per pound for outdoor cultivation. In 2021, operating for indoor growers averaged $527/pound–with 16% spending $1,000/pound or more–far more than outdoor production.
Indoor cultivators face regulatory risks (e.g., carbon taxes), legal risks (greenwashing), and reputational risks (consumer opinion) in connection with their energy use and carbon emissions. Related choices can help or hinder a company, depending on their practices.
From “greenrush” to “greenwash”
Green-washing is a particularly thorny problem in the cannabis industry given inadequate third-party standards and highly limited transparency in the data and analytics behind public-facing statements.
Some examples are as simple as including a few token solar panels on a rooftop to make a false impression, emphasizing recyclable packaging while vastly greater amounts of non-recyclable waste from the cultivation process are landfilled, or utilizing illegitimate carbon offsets. Other examples include misleading claims about carbon “sequestration” in the product itself (this carbon is actually released upon combustion), assertions of running fully on renewable energy while in fact fossil fuels are being used, or warm-and-fuzzy emphasis on terroir, when the product is in fact produced under artificial suns atop synthetic growing media. Some companies boast about following regulations, as though it is an option, while others add scents to skunky exhaust air streams that contain unhealthful volatile organic compounds.
Some cannabis companies have been subject to legal claims for publishing false environmental information, using banned chemicals, and defrauding inspectors, while other legal risks are posed by running afoul of Federal Trade Commission (FTC) Truth in Advertising and Green Marketing guidelines.
Boom and bust? A reckoning may already be underway
The aforementioned risk factors may well indicate a boom-and-bust trajectory for the mechanized greenhouse and windowless indoor-cultivation segments of the cannabis industry. Or, with foresight, the industry may be able to achieve a less disruptive transition to genuine sustainable practices.
The business press has actually warned of risks to indoor growers since at least 2018. There are signs that some firms are already managing these risks by shifting towards outdoor cultivation. Between 2016 and 2020 the number of growers cultivating primarily indoors fell from 80% to 60% (with a corresponding 15% reduction in indoor canopy area under cultivation).
One of the largest traded cannabis companies, Canopy Growth, recently made a dramatic shift towards outdoor cultivation (to reduce costs), shuttering 58% of its indoor cultivation area (approximately 3 million square feet of relatively energy-efficient greenhouses).
Sustainable outdoor cultivation: The only play for impact investors
Unlike most industries, and despite decades of experimentation with indoor cannabis cultivation technologies and methods in markets with varying degrees of legalization — including in California since 1996 and Canada since 2000 — scalable solutions to the sticky energy and carbon problem have still not been demonstrated.
Fortunately, discerning impact investments aiming to support climate change mitigation and a shift to sustainable outdoor cultivation could capture very substantial greenhouse-gas emissions reductions and other environmental benefits. And, contrary to conventional wisdom, sustainable bio-intensive outdoor cultivation can actually use significantly less water and less land than state-of-the-art indoor practices, removing key arguments for indoor operations. Solid waste generation would also be vastly reduced, as indoor grows commonly use “once-through” artificial growing media and more plastics.
Even the U.S.-based National Cannabis Industry Association has said that “outdoor cultivation should be encouraged to the extent practical because of the significantly reduced energy intensity …”.
Each dollar invested in outdoor cultivation would mitigate far more greenhouse-gas emissions compared to costly measures achieving the same reductions in indoor environments.
In some ways, cannabis companies can claim to have an inherent social mission. Yet, the indoor-based segment of the industry is intrinsically unable to achieve energy and environmental benchmarks expected by impact investors, and has not shown consistent discipline in governance. Indeed, many current industry behaviors and practices run counter to ESG principles and there lacks a level of candor, transparency, and documentation needed to enable stakeholders to discern among companies and products, and to have confidence in claims of improved practices.
There is no small irony that this industry, rooted in the counterculture and associated with social and environmental values dating from the “back-to-the-land movement”, is lagging in these respects. Yet, those values still underpin the socially responsible investing movement, and could help steer the cannabis industry towards a realignment.
Impact investors must be highly discerning if their funds are to attain the desired outcomes. Far more rigor will be needed than offered in current ESG reports. In particular, greenhouse-gas inventories must be more comprehensive and explicitly documented. Meaningful metrics must accompany qualitative and abstracted descriptions of positive impact. Firms successfully prioritizing and documenting ESG-relevant metrics will merit rising capitalization and popularity, while others will experience reputational risks and divestment. Lacking better “self-policing” in this regard, it would not be surprising to soon see indoor cannabis producers programmatically excluded from ESG funds, rather than blanket exclusions that are beginning to occur.
The most critical environmental determinant of congruence with ESG criteria in general and decarbonization in particular is whether or not cannabis is sustainably cultivated outdoors, while also meeting parallel expectations for social and governance practices internally and as they impact society more broadly. In one hopeful example, a New York “sungrown” producer is also owned and staffed by people pardoned for prior cannabis offenses. Such companies could make lucrative impact investments.
Evan Mills is principal with Energy Associates, a retired Senior Scientist and current Affiliate with the Lawrence Berkeley National Laboratory, and a Research Affiliate with UC Berkeley’s Energy and Resources Group. He participated extensively in the work of the Intergovernmental Panel on Climate Change, which shared the 2007 Nobel Peace Prize with Vice President Al Gore.
Graphic design collaboration Francesca Mills.