production. Lower production, combined with stronger-than-expected export prospects,

will lead to higher milk and dairy product prices next year.

The September Milk Production report shows slight milk production declines in both July and August. The number of cows in the national herd has shown a month-over-month decline since January, and the year-over-year decline in cow numbers more than offset the incrementally rising output per cow in the second half of the year. The prospects for the rest of 2009 and 2010 are for cow numbers to continue to decline and for production per animal to continue increasing. In 2010, the U.S. dairy herd is expected to average below 9 million for the year.

The production increase per cow per day is expected to be about 1 percent in 2009, well below the 5-year-average rise. In 2010, production per cow is expected to rise by

1.8 percent during the year, above the 5-year average.

The recovery in production per cow next year is predicated on forecast lower corn and soybean meal prices in 2010. Alfalfa hay prices have retreated in 2009 from their 2008 highs and with normal weather next year, supplies should be adequate to keep prices moderate. Despite productivity increases, production in 2010 is forecast to decline to 187.2 billion pounds, down slightly from this year’s projected 188.9-billion-pound production. The expected smaller cow herd trumps the production per cow increase, resulting in the second year-over-year production decline.

Export prospects are improving. Economic recovery has exceeded expectations in several countries in recent months with the result that demand for dairy products has improved. Reportedly, an increase in exports to China and greater sales into North Africa and Middle Eastern markets has boosted world prices, especially for whole milk powder. U.S. producers are in position to benefit as the dollar weakens relative to a number of foreign currencies.

While still below 2008’s stellar levels, milk equivalent exports are expected to reach almost 4 billion pounds this year and improve to 4.3 billion in 2010 on a fat basis. Milk equivalent exports on a skims/solids basis are forecast at 21.5 billion pounds and 23.6 billion pounds for this year and next. The current forecasts represent an upward revision of earlier USDA export forecasts.

Commercial domestic use on a fats basis is projected to rise 1.6 percent from 2008 use. In 2010, commercial domestic use on a fats basis will be essentially unchanged from this year’s use. On a skims-solids basis, commercial use will increase about 2 percent in 2009 and an additional 1 percent in 2010.

Stocks of cheese and butter remain high compared with recent years; yet prices have continued to trend upward through 2009. Lower cheese production in the near term, along with improving export prospects into next year, should firm cheese prices for the remainder of 2009.

Forecast lower milk production in 2010, along with strengthening exports, will likely lead to higher prices for both butter and cheese in 2010. Nonfat dry milk (NDM) and whey prices are forecast to increase as well, though not as much. Cheese prices are forecast at $1.265 to $1.275 per pound this year and will rise to $1.515 to $1.605 in 2010. High butter stocks should moderate butter price increases for the rest of 2009, despite sharply lower butter production as more milk moves to cheese production relative to butter/powder.

7

Butter prices will likely increase in 2010 from this year’s expected $1.165 to $1.195 per pound average to $1.400 to $1.520 per pound as lower milk production next year affects all dairy products. NDM and whey prices should also firm up in 2010.

NDM prices, forecast to average 87.5 to 89.5 cents per pound this year, are expected to average 95.5 cents per pound to $1.025 per pound in 2010. Whey prices will likely average 24.5 to 25.5 cents per pound this year and climb slightly to 30.0 to 33.0 cents per pound next year.

Strengthening dairy product prices will lead to recovery in milk prices in 2010. The

Class III milk price is forecast at $11.00 to $11.10 per cwt this year and $13.85 to $14.75 next year. The Class IV price is forecast at $10.35 to $10.55 per cwt this year and to firm to $12.00 to 13.00 per cwt in 2010. In the face of tighter milk supplies and improved demand, the all milk price is expected to rise to $14.70 to $15.60 per cwt next year after averaging $12.35 to $12.45 this year.

The milk-feed-price (MFP) ratio, a widely used indicator of profitability in the dairy sector, reached its lowest level in nearly 35 years in May 2009, dropping below its long-term average of 2.74 for 21 consecutive months from January 2008 through September 2009, with reports of financial stress in the sector reaching what many consider to be crisis proportions.1

The MFP ratio reached 1.5 this May and June, comparable to its level in August 1974.2. The 21-month duration of the present crisis is so far considerably less than the 56-month crisis that extended from December 1972 through July 1977. However, the present crisis may rank as at least a close second, as the worst dairy crisis in more than 35 years, before the MFP returns to a more normal level.

The current crisis shares one characteristic with the crisis of 1972-1977 and has one important difference. The similarity is that both crises were at least partially precipitated by sharp increases in dairy feed costs. Feed costs had been relatively stable from January 1970 through the fall of 1972. However, as news of sudden and significant feed and food grain purchases by the (now) former Soviet Union as a result of several years of poor harvests emerged in late 1972, feed prices began to sharply increase.

With continued shortfalls in its grain production, the Soviet Union remained a major purchaser of U.S. feed and food grains, contributing to dairy feed ration costs that more than doubled by August 1974. The dairy feed ration cost remained quite variable during the early crisis and thereafter, but at around a level roughly double its pre-crisis level.

Between the fall of 1972 and August 1973, the MFP ratio dropped to 1.6 from near its long-term average of 2.74. The decline occurred entirely because of the sudden increase in dairy feed costs, as the all milk price generally continued to increase.

The MFP ratio then began to increase in August 1973 as a result of higher dairy support prices (tied to parity) mandated in the 1973 Farm Bill. In spite of the 1973 Farm Bill and other policies aimed at ameliorating this earlier dairy crisis, the crisis persisted for an additional 3 years, which were characterized by general inflation and a 16-month recession extending from November 1973 to March 1975.

However, an important underlying cause of the 1972-1977 dairy crisis was that the dairy sector had not adjusted to a doubling of its feed costs. The current dairy crisis was also precipitated by higher feed costs, but initially these were largely offset by a nearly concurrent dairy-price-enhancing-surge of dairy product exports.

The cost of dairy feed doubled from a relatively stable average of about $4.00 per cwt from early 1998 to summer 2006, to over $8.00 per cwt by spring 2008. The sharply higher feed costs were not trade-induced as in the 1970s, but occurred at least partially because of policies that mandated higher ethanol use, along with higher oil prices that also encouraged more use of ethanol and strong grain exports encouraged by a weak U.S. dollar.

1 The milk-feed-price ratio is published by NASS, and is defined as the number of pounds of a 16-percent protein mixed dairy feed equal in value to the value of 1 pound of whole milk. The price of commercial prepared dairy feed is based on current U.S. prices received for corn, soybeans, and alfalfa hay. The modeled feed uses 51 percent corn, 8 percent soybeans, and 41 percent alfalfa hay. For simplicity, it is calculated as the value of 100 pounds of milk (all milk price) divided by the value of 100 pounds of the mixed ration.

Livestock, Dairy, & Poultry Outlook/LDP-M-184/October 16, 2009

Economic Research Service, USDA

Increases in feed prices that began in the fall of 2006 were followed by proportionately greater increases in the all milk price, as U.S dairy products surged onto world markets in 2007 that were growing as a result of strong world economic growth, a favorable U.S. exchange rate, and reduced supplies among major U.S. dairy competitors in Oceania (Livestock, Dairy, and Poultry Outlook. June 17,

The major difference between the current dairy crisis and the 1972-1977 crisis is that this year’s collapse in the all milk price was brought about partially by the collapse in world demand and partly by decreased domestic demand as a result of the U.S. recession.

Thus, in response to the current crisis, dairy producers must not only adapt to higher feed prices but also to international demand, which is unlikely to return to the 2007 level in the near future because of slower global economic growth and a resumption of more-normal dairy production in Oceania.

While milk prices are forecast to increase and feed prices are expected to remain low relative to early-2009 levels for the remainder of this year and through at least 2010, the MFP ratio is unlikely to exceed 2.74 before the end of 2010, based on October WASDE forecasts.

The MFP ratio would therefore remain below its long term average for at least an additional 15 months. Added to the 21 months from January 2008 through September 2009 in which it has already been below its long term average that would place it at least 36 months below its long-term average, making this crisis a close second as the worst dairy crisis in more than 40 years.

In recognition of the continued severity of the present crisis, ameliorative actions have been taken by USDA and the U.S. Congress, and separately by the dairy industry. On July 31, the Secretary of Agriculture announced a 3-month increase in the purchase price of nonfat dry milk from $0.80 per pound to 0.92 per pound; block cheese from $1.13 per pound to $1.31 per pound; and barrel cheese from $1.10 per pound to $1.28 per pound.

During FY 2009, USDA has purchased 277 million pounds of nonfat dry milk and 4.6 million pounds of butter under the Dairy Product Price Support Program. USDA has also made over $700 million in direct payments to dairy producers in FY 2009 under the Milk Income Loss Contract Program.