Milk prices set to recover.

Dairy farmers are dealing with the lowest milk prices in 25 years. The USDA reported the all-milk price is currently hovering around $11 per cwt. In 2002, milk production increased 2.6 percent, while demand, measured by commercial disappearance, was only up 0.5 percent. The excess milk caused dairy product production to rise, which weighed on prices due to increased supplies. The very strong milk prices of 2001 have helped farmers cope with low prices, but most dairy farms are still in financial distress.

Expansion plans, especially in the West, have continued to play out despite the poor milk prices. Small and medium-sized operations have been encouraged to push production due to the government's Milk Income Loss Contract (MILC) program. The MILC program makes deficiency payments on the first 2.4 million pounds of milk produced per year, which on average would cover a 125-cow dairy. The average payment for 2002 was $1.14 per cwt, but that has jumped to $1.69 per cwt for the first half of 2003. But even with the government assistance, most producers are losing money, and the number of exiting dairy operations is expected to pick up through the second half of 2003.

Luckily, the growth in milk production has slowed. For the first quarter of 2003, milk production was up 1.3 percent compared to a year ago, and in May, production fell 0.4 percent compared to 2002--the first year-over-year decline in 18 months. Cow numbers had been on a steady rise since the beginning of 2002, but the 20-state cow numbers in May were down 21,000 head from the beginning of the year. Decreased cow numbers in the Midwest have been partially offset by the continued expansion in the western United States--cow numbers continue to grow in California, New Mexico, Arizona and Idaho.

Stagnant growth in demand and the increased product production have pushed stocks higher. In the first quarter of 2003, milk equivalent stocks stood at 12.6 billion pounds. While that is down 3.6 percent from the end of 2002, it is still relatively large. Stocks at the end of 2003 were 46 percent above the previous five-year average. While per capita consumption of fluid milk continues to trend lower, cheese demand has typically grown. It takes 10 pounds of milk to produce a pound of cheese, so its consumption is very important to milk prices. The weak economy limited demand in 2002, but there are signs that cheese demand is improving.

The National Milk Producers Federation has approved a plan called CWT, Cooperatives Working Together, in an effort to decrease milk production and dairy product inventories. Approved in early July, producers accounting for 70 percent of the nation's milk supply agreed to a scaled-down version of the original plan. CWT will take 5 cents per cwt of milk for a 12-month period, which will go to establish a fund to provide a bonus for exporters to move dairy products. The plan also includes herd retirement and reduced milk marketing programs. While many are skeptical of its success, the goal is to reduce the milk supply by 1.2 billion pounds and raise prices by 36 cents per cwt.

The all-milk price is expected to improve in the second half of 2003 and into 2004. However, the large buildup of stocks will limit price improvement. Signs of improved cheese prices along with the slowing pace of increased milk production should help the supply / demand balance. We look for the all-milk prices to recover into the $12 per cwt area by the end of the year. That, however, may not be enough to keep many dairy farmers in business. But improved retail demand and supply management programs could help prices improve further as we move into 2004.

Greg Scheer is an economist for Doane Agricultural Services, St. Louis, Mo.