The author is director of Dairy Policy Analysis, University of Wisconsin-Madison.

Do you remember what it was like in 2008 . . . when corn and other feed costs were really high, but the milk price also was quite high? Well, I think that 2011 is going to feel a lot like that except without such strong milk prices. Whether you view 2011 as a financially challenging year or a really bad year will depend on whether you are growing your forages and some of your concentrates or whether you are purchasing most of your feeds.

The supply side
2010 was a recovery year. Milk prices have rebounded from the extreme lows of 2009 to a level that many producers would consider "tolerable" but not adequate to restore the equity lost in the prior year. In fact, the 2010 margin between milk and feed prices was enough to stimulate large gains in milk production per cow and even to boost cow numbers somewhat. As a result, 2010 milk production has been up about 2 percent above 2009 levels.

The recent election results were, in part, a demonstration that our domestic economy has not rebounded. Too many people still are unemployed, and even those who have a job are concerned enough to spend their money carefully and to save a bit more for the future. This impacts the dairy industry as consumers have not been eating out of the home as much. Dairy products are prominently featured on restaurant menus. On the plus side, in 2009 when consumers were rediscovering their dining room table, they also were purchasing more beverage milk.

There is a bright spot on the horizon for consumption. In the past few months, the restaurant performance index has been rising and, in fact, has gotten to the point which indicates an expansion of that industry. I have found the restaurant performance index to be a leading indicator of the general economy, and I think that it is pointing to stronger domestic demand for dairy products in the second half of 2011.

The tea leaves on manufactured dairy products are mixed. A combination of feeds and a very hot summer east of the Mississippi caused a milkfat depression in our milk supply. There also was strong export demand for butter as Russia and western Europe experienced extreme heat during the summer and loss of milk production. Butter prices were very strong through most of 2010 as butter stocks were drawn down to unusually low levels. Low butter stocks and high butter prices are consistent, but we also saw high cheese stocks and high cheese prices . . . something that is harder to explain.

Exports helped
Much of our higher milk production in 2010 made it into cheese vats. Domestic demand for cheese was not equal to those production levels, but we had opportunities to export more cheese. The total value of dairy exports nearly reached the very high levels that we saw in 2008. This was, in part, because recovering economies in the rest of the world wanted to increase their consumption but also because the value of the U.S. dollar has been weak against most currencies.

A weak dollar makes product from the U.S. look like a good buy for importing countries and a bad sell for countries wanting to export to the U.S. The modest recovery in 2010's milk price primarily was due to good export opportunities, but imports of dairy products into the U.S. were also down.

At an estimated 12.7 billion bushels, the 2010 corn crop was the third largest in history. However, because of strong demand, the corn stocks-to-use ratio is estimated to be the smallest in 14 years. The futures markets have reacted to this information with corn prices over $6 a bushel in 2011. Soybean futures also are high, and we can expect forage values to follow these prices up. The chart shows you actual values for the NASS dairy ration and my values estimated from the futures market prices. This clearly will be another feed price shock of a magnitude like we saw in 2008. Because of the timing, I expect this shock to last longer than 2008s.

The feed shock will keep a damper on growth in milk per cow in the year ahead, and I also expect cow numbers to contract. This calculus implies a very minor rise in the U.S. milk supply.

Looking ahead
The big unknown in my milk price forecast is demand . . . both domestic and export opportunities. I believe that we will begin to see a stronger recovery in our domestic economy during the second half of 2011. I also think that will translate into stronger demand for dairy products. A big question is what our opportunities for export will be.

Foreign demand for dairy products will continue to be strong, but our opportunities will be limited by export competitors. The European Union has quite a bit of skim milk powder stocks from intervention efforts last year. They will want to be selling those stocks into world markets in the year ahead.

The other major world suppliers, New Zealand and Australia, have had a strong start to their production season and expect to boost their sales into world markets. The gap in world demand is left for us to fill, so Oceania's production is the real unknown.

Extreme weather patterns can be spawned by unusually warm or cold waters in the Pacific. A warm ocean is known as El Niño and often is associated with drought in Australia and dry conditions in New Zealand. La Niña is the cool water phase and is often associated with wet weather in Oceania and dry, warm weather in the southwestern United States.

We are in the beginning of a La Niña right now and, if the rains are excessive for Oceania, pastures may suffer. However, more moderate rains could be good news for the regions of Australia that have been in persistent drought for the last decade.

Look to second half
I think that milk prices will be lower in the first half of 2011 and much stronger in the second half. I currently am projecting a slightly lower annual average (about 10 cents) than 2010, but I would leave room for considerable upside potential. I think that those of you who purchase most of your feeds will find 2011 to be another devastating year. Southwestern producers may find not only their margins squeezed but also may battle extreme heat and dry weather from La Niña. If you are looking for optimism, look to the second half of 2011.