U.S. dairy farmers cut milk production last year for the first time since 2001, as a milk-price crash prompted herd liquidation.

Milk production totaled 189.3 billion pounds in 2009, down 0.4 percent from 190 billion pounds in 2008, according to a monthly report from the U.S. Department of Agriculture. Western states led the decline, with milk production falling 4.6 percent in California and approximately 11 percent in both Arizona and Colorado.

The report is a bullish signal for milk prices, because world demand has picked up and U.S. dairy farmers are still culling cows to stem losses, said Alan Levitt, a Crystal Lake, Ill.-based market analyst who writes CME Group Inc.’s Daily Dairy Report.

“We started the year with 250,000 fewer cows, and it will take years before we can add 250,000 back,” Levitt said. “We may over-correct and milk supplies could be really tight in 2010.”

The milk production drop in 2009 was just the third annual contraction in the past 18 years, Levitt said. He projects an average Class III milk price of $17 per hundred pounds in 2010, an increase of almost 50 percent over $11.36 in 2009.

Milk prices tumbled from record highs in 2008 amid expanding supplies and a global recession that curtailed export demand for U.S. dairy products. Dairy farmers’ losses exceeded $100 per head per month in some cases, Levitt said.

“Farmer profitability in ’09 was the lowest I have records for,” Levitt said. “So the only thing farmers could do was kill cows. Virtually every farmer lost money in ’09.”

There were 9.082 million milk cows nationwide at the end of 2009, down 2.7 percent from 9.334 million at the close of 2008, according to today’s USDA report.

In California, the No. 1 milk state, the milk-cow herd shrank 4.1 percent to 1.764 million head, while New York’s declined 2.4 percent.

Meanwhile, in Wisconsin, the No. 2 milk-producing state, the herd increased 0.3 percent to 1.259 million cows, and 2009 production rose to 2.14 billion pounds, up 4.3 percent from 2008.

Milk production in 23 top dairy states totaled 14.6 billion pounds in December, down 0.8 percent from the same month in 2008 and the fifth consecutive monthly year-over-year decline, according to USDA figures.

Chicago-based CME Group’s dairy futures also signal higher prices as 2010 moves along.

January Class III milk futures on the CME rose 1 cent today to $14.44 per hundredweight, the highest closing price in more than three weeks. September and October contracts both ended at $16.11.