Just as milk prices are improving and dairy farmers are seeing better returns, the rising cost of feed is now obliterating their gains and further wrecking balance sheets.

Producers have been trying to dig out from under the catastrophic milk price collapse of 2009 that shuttered dairies and created huge losses for the surviving ones.

With milk prices rebounding through much of this year, dairy farmers were starting to see a positive cash flow again and paying off some of their debts. It appeared the corner had turned and better times lay ahead—until feed prices shot up in recent weeks, diminishing hopes of a speedy financial recovery.

“It’s kind of the hangover from last year. It just can’t quite get well,” Jack Hamm, a producer in San Joaquin County, said of dairy farmers’ ailing financial health. “You think you’re making a little bit of headway, and then you go back into the grind.”

Joel Karlin, a market analyst for Western Milling in Goshen, said feed prices have been on a very strong rally since the first half of the year and are projected to be at their second-highest levels from 2008, when corn prices reached an all-time high.

He said part of what’s been driving corn prices higher were expectations of a much larger corn crop that didn’t materialize. After predicting a record U.S. corn harvest earlier this year, the U.S. Department of Agriculture has been adjusting downward the nation’s corn yield, and its latest forecast puts U.S. corn production at 12.54 billion bushels, down 124 million from October projections.

Even though that is still the third-largest corn crop on record, Karlin noted that current corn stocks are actually tighter than two years ago. USDA forecasts ending stocks for 2010-11 to be the lowest in 15 years.

“It’s a decent crop, but U.S. corn yield is going to fall way short of usage this year,” Karlin said. “Prior to next year’s harvest, our stockpiles of key commodities such as corn and soybeans are going to be critically low.”

Leslie “Bees” Butler, a dairy economist at the University of California, Davis, said with so much uncertainty in the corn supply, futures markets are now looking quite grim for dairy farmers looking to lock in their feed prices.

“The corn thing really threw us for a loop,” said Hamm. “Everybody was predicting low corn prices, so very few people locked up any corn.”

Karlin said most producers are now buying corn on a hand-to-mouth basis, and he doesn’t expect feed prices will retrench in any significant way before the end of March, when USDA comes out with its planting projections for the next growing season.

Given the outlook for high feed prices, Karlin said there will be an intense battle among various crops to secure more acreage, “and one of these crops is going to get the short end of the stick.”

“Who’s going to plant alfalfa when you have much more attractive prices for cotton?” he said. “For a lot of growers of corn silage and alfalfa, their main customers are dairies, and if dairies are in a very cash-poor situation and they’re not going to get paid, it’s going to make it more likely that an alternative crop is going to get seeded.”

Mike Blagg, a Nevada County producer who raises spring heifers, said hay growers are already raising their prices for premium quality alfalfa. He said although he has purchased enough hay for the year, he held off on buying grain, hoping that prices would soften.

One thing that has helped him is the weather, he said, because he runs his heifers on grass and recent rains have replenished his supply.

Hamm said he has been feeding his cows more forage because he has the land to grow his own. Aided by high beef prices, he said he’s been able to maintain his herd size and milk production by replacing his less productive cows with newer stock.

What’s equally concerning for dairy farmers is that at the same time their production costs are going up due to feed, milk prices have also dropped in recent weeks, said Michael Marsh, chief executive officer of Western United Dairymen.

“There are still some dairies that are having trouble getting financing,” he said. “From the banker’s perspective, they want to see cash flow. We finally got that positive news coming and just as soon as it came, it went away.”

Mary Cameron, a producer in Kings County, said she fell so far behind on her bills that she had to sell her pool quota and borrow against her life insurance to pay off some of her debt. She also culled heavily to take advantage of high beef prices, but now her milk checks have shrunk considerably because she’s milking fewer cows and producing less milk.

“So you see, I cut my own throat,” she said.

Although California cow numbers declined from 1.77 million head in September 2009 to 1.75 million head in September 2010, California milk production actually increased 7.3 percent during that time, according to USDA.

The mild summer helped California dairy cows produce more milk, and with dairy farmers culling their least productive cows, Hamm said he is not surprised the state’s milk production has risen.

“With feed prices going up as high as they are currently, it may temper milk production a little bit,” Butler said, though he added that dairy farmers are trying to build back the equity they lost in the last two years, and the way to do that is to produce more milk and get more money to pay off their loans.

“If producers continue to produce more milk through next spring at the rate they have been in the last couple of months, then we’re going to have surpluses again, despite the fact that the export market might continue to be good,” Butler said.

Marsh said California’s dairy export markets have been doing very well, with nearly 15 percent of the state’s milk going overseas.

But expanding or maintaining the state’s export market will depend in large part on currency exchange rates and the low value of the dollar to keep California exports more competitive in world markets, Butler said. And while a weak dollar is good for dairy exports, it also encourages grain exports, leaving less supply for domestic use, he added.

Looking forward, Karlin said if the U.S. economy continues to improve, with more job growth and greater consumer spending, then domestic demand for dairy products, which has remained sluggish, could strengthen and help buoy farmers’ bottom line.

The rise in feed prices will also likely cause producers to cut back or tweak their rations, maybe use less corn and more forage, he added.

“What that usually results in is less milk per cow,” he said. “Even though it wouldn’t be good for the individual dairy producer, collectively, the fact that milk production may start to decline would be beneficial for prices. But that’s a little longer term.”

Source: Ching Lee, Assistant Editor, California Farm Bureau Federation