Despite struggling with lower milk prices and higher operating costs over the past year, U.S. dairy producers have done a bang-up job of producing milk. December’s milk production is up 2.4 percent from last year and we continue to add cows to herd as much of the solid weekly slaughter numbers are offset by record heifer replacements.

All this fat-laden milk has helped keep a lid on the price of butterfat for quite sometime.  But the days of cushy butter prices may be numbered. And as we hope for another banner year of milk production, I would be remiss if I did not play devil’s advocate for a minute.  

In early February, Cooperatives Working Together — a voluntary, producer-funded program developed by the National Milk Producers Federation — announced it’s accepting bids for the fourth dairy herd retirement program since 2003. Simply stated on the CWT Web site, “Bids are accepted from any producer who has contributed, either directly or through his/her co-op, to the CWT assessment. Selected bidders are then required to commit their entire herds to slaughter.”

In other words, the CWT program officials are — in an effort to support the price of milk and ultimately the price of butter — calculating how many cows they can take out of the milking herd. Most analysts are looking for the program to remove 50,000 to 80,000 head. I’m expecting 120,000 or more during this year’s retirement round.

In addition to the CWT program, a cheap U.S. dollar has attracted some newfangled foreign cattle buyers to our shores. Saudi Arabian dairymen, for example, recently purchased approximately 10,000 U.S.-born bred heifers for shipment by boat to their sandy homeland. And since most dairy cows will have a total of two lactations during their career, the absolute removal of animals in this case will likely amount to more than we first think. I don’t have enough real estate in this magazine to talk about the potential buyers currently shining their auction paddles in China.

Foreign buyers and slaughter programs aside, the recent rally in corn prices is also doing its part to jeopardize the milk production picture for 2007. As a rule, dairymen can’t feed expensive grain for too long to cows producing low-priced milk. Eventually, producers cut the corn ration of their daily feed and as corn gets cut, the percentage of butterfat in milk may dwindle before we see a substantial drop in overall milk production. Add to this possibility the fact that the “spring flush” months are typically low-yielding butterfat months and a once rosy butterfat picture gets blurred even further.

To set the record straight, butter fundamentals are anything but bullish here in early February. The most recent USDA Cold Storage Report showed that butter inventories in December 2006 were 58 percent higher than a year ago. Butter production in this country, as reported in the December Dairy Products Report, is humming right along — up 9.4 percent from previous year levels.

But this warning is not about what the butter supply situation looks like, but rather what the future has in store for butterfat supplies as we begin to see important changes on the horizon for the U.S. dairy cow herd.

Dave Kurzawski is an account executive with Chicago-based commodities brokerage Downes-O’Neill LLC.