During the past four years, robust consumer demand has led to good dairy prices, except when temporary gains in milk production overcame demand.

However, according to the December issue of USDA's Agricultural Outlook, several clouds loom on the horizon, including a softening in demand for dairy products and increased milk production. Here's a look at the supply-and-demand forecast and what it means for farm prices.

Demand side
Cheese, butter and fluid cream - products used heavily by restaurants - experienced increased demand as consumer spending at restaurants rose briskly over the past few years. Meanwhile, sales of fluid milk, ice cream and other perishable products - things eaten at home - showed little growth.

Despite current economic conditions, some of those food-spending patterns should persist, at least into 2002. Restaurant spending will probably be heavier than in past recessionary periods, including this last fall, but less than the exuberance we saw the past few years and immediately before the Sept. 11 terrorist attack. Consumers will certainly be more sensitive to menu prices, and restaurants will likely respond with tighter controls on the amounts of ingredients used.

Since cheese is used heavily in all types of restaurants - fine dining to fast food - shifts in where people eat out should not have much effect on demand. However, there could be gradual erosion in total restaurant use of cheese and other dairy products over the course of the year.

In the retail sector, weakness in consumer demand will develop slowly. Consumer belt-tightening probably will consist of eliminating at home treats, and replacing away-from-home treats with less costly at-home treats. That means the demand for ice cream could increase, as it is seen as an inexpensive luxury item. In addition, more at-home meals could lead to an increase of fluid milk use.

"However, these gains are unlikely to offset weakening demand for other products. Overall, dairy demand is expected to grow next year, but the increase probably will be smaller than in recent years," says the report.

Supplies of good quality forage were tight, stressful winter weather and more-than-normal heat stress during the summer all contributed to a drop in milk production of about 1 percent for 2001. Barring those same problems, the report predicts 2002 milk per cow will rise by 3 percent. Helping spur that increase is a favorable milk-feed ratio that will allow producers to feed more concentrates if the forage supply remains tight next year.

Tight forage supplies were a minor consideration compared to the high cost of heifers. Soaring heifer prices, and the ability to find quality replacement animals, stalled many expansions. Producers can only afford to operate below capacity for so long. Look for those facilities to fill in 2002. Cow numbers should strengthen and finish the year just a bit below where they will begin in 2002.

With an increase in milk per cow and stronger cow numbers, the report looks for total milk production to rise by almost 3 percent. That level of growth will be more than projected demand. A price drop seems certain. The extent of the decline however will depend on how much demand softens. As of this report, USDA predicts a price decline of $2 per hundredweight in farm prices for 2002.