The government cut its U.S. corn harvest projection 1.6 percent and said stocks of the grain will fall to a seven-year low, signaling higher feed costs as livestock and dairy producers compete with exporters and ethanol distillers for shrinking supplies.

American farmers are expected to harvest 13.16 billion bushels of corn this year, the U.S. Department of Agriculture said in a report Friday. While that would be a record crop, the estimate is down from the USDA’s projection of 13.37 billion bushels a month ago.

Heavy August rains in parts of the Midwest caused crops to deteriorate, prompting the USDA to trim its average U.S. corn yield projection to 162.5 bushels an acre from 165 bushels.

In Iowa, the top corn producer, excessive rainfall early in the month “left many low-lying fields completely saturated, stunting growth and yellowing portions of the crop,” the USDA said.

Tightening corn supplies and higher prices present a growing concern for beef, pork and dairy producers, analysts say. Further gains in corn prices may jeopardize producers’ recent return to profit after at least two years of losses stemming from high feed costs.

“It’s kind of a fragile time for the feed sector,” Brian Basting, an analyst with Advance Trading, Inc., said at a press briefing held on the CME Group trading floor following the release of the report.

An increase of another 25 cents or so in corn “puts them in a lot more difficult position,” Basking said, referring to livestock producers. “Profitability is coming back, but I don’t think they could handle another surge” in corn.

Livestock producers “would be vulnerable if we continue to rally,” Basting said.

Farm prices for corn are expected to average $4 to $4.80 a bushel in 2010-11, up from a previous forecast of $3.50 to $4.10, the USDA said.

Also Friday, the USDA raised its estimate of the U.S. soybean crop to 3.48 billion bushels, a record, from 3.36 billion in an August report.

U.S. grain in demand amid Russia drought
Overseas demand for U.S. grains is increasing as China’s economy expands and drought cuts Russia’s wheat crop. In the U.S., the biofuels industry is using a larger share of the country’s corn production as fuel makers blend more ethanol to comply with federal mandates.

In a separate report, the USDA raised projected U.S. corn exports to 2.1 billion bushels from 2.05 billion bushels in a previous estimate. Projected U.S. corn stocks at the end of the 2010-11 marketing year were trimmed 196 million bushels to 1.12 billion bushels, the lowest since 2003-04.

Corn stocks as a percentage of use in 2010-11 are expected to be the lowest since 1994-95, the USDA said.

Friday’s USDA reports “opens plenty of opportunities to tighten that further,” said analyst Terry Roggensack, who also spoke at the CME press briefing.

Beef and pork producers can still make money as corn rallies if animal prices remain high, said Roggensack, who’s a founder of The Hightower Report, a Chicago-based advisor. He doesn’t expect a reduction in livestock numbers in coming months.

“Livestock feeders could handle it if cattle and hog prices continue to rise,” Roggensack said. “It would take a serious double-dip recession to knock down livestock numbers further.”

“The cost of producing livestock is going up and the livestock producer needs to be rewarded with higher prices,” Roggensack added. “It’s going to cost more to do business.”

Milk price forecasts
Milk prices are expected to be higher than previously forecast, partly reflecting stronger exports, the USDA said.

Class III milk, used to make cheese, is expected to average $14.50 to $14.70 per hundredweight in 2010, the USDA said. That’s up from a previous estimate of $14.15 to $14.35. In 2011, the USDA projects average prices of $14.40 to $15.40.

“Strong demand for cheese and tight supplies of butter support higher forecast prices for 2010 and 2011,” the USDA said. “Stronger demand is forecast to absorb most of the increased production, although prices are expected to be tempered during the latter part of 2011.”