A recent surge in butter prices hasn’t done much to improve a sour mood in the Chicago’s dairy futures market.

U.S. dairy producers haven’t cut herds as much as they were expected to after last year’s milk price crash, and cheese stockpiles, up about 10 percent over last year’s levels, remain burdensome, traders and analysts said.

Those factors have helped send milk futures down almost 10 percent this year, based on the closest-to-expiration contract at CME Group, the Chicago-based exchange operator. April Class III milk futures ended trading today at $12.85 per hundred pounds. Nearby futures ended 2009 around $14.22.

Last week, the U.S. Department of Agriculture last week lowered its 2010 milk price forecast. The USDA’s monthly Cold Storage report, scheduled to be released April 22, may bring more bearish news on cheese supplies, traders said.

“The question is going to be, do we get over 1 billion (pounds) on cheese” supplies, one CME dairy trader said today.

At the end of February, U.S. cheese stocks in cold storage totaled 983.6 million pounds, up from 892.5 million pounds a year earlier, according to the USDA.

Another question, the CME trader said, is whether U.S. dairy exports increase, “or are we going to be overwhelmed” with domestic supplies.

Cheddar cheese prices have also slumped this year, reaching a 27-week low of $1.2866 a pound as of April 3, according to USDA data. The April 3 price is up about 1.2 cents from a year ago.

Meanwhile, wholesale butter prices are up about 24 percent over a year ago, with CME spot butter yesterday reaching the highest level since November 2008, at $1.56 a pound.

Recent butter price strength partly reflects tighter cream supplies, as ice cream processors ramp up production for summer, independent consultant Alan Levitt said.

Additionally, U.S. butter production from August through February ran 10 percent below year-earlier levels, he said.

Higher ice cream demand “leaves less cream available for the churn,” said Levitt, who writes CME’s Daily Dairy Report.

Generally, firmer butter prices “seem to be driven by fears of shortages in the second half of the year, particularly on the international market,” he said.

Butter probably has little additional upside, with the rally “about done” if prices reach $1.60, the CME trader said.

The USDA took a similar view in its monthly Supply and Demand report, released April 9.

For 2010, the USDA estimated butter prices will average $1.42 to $1.50 a pound, up slightly from a previous estimate of $1.415 to $1.505.

“Stronger prices in the first half of the year may largely be offset by lower second-half prices as butter production increases,” the USDA said.

The USDA also raised its U.S. milk production forecast for 2010, to 189.9 billion pounds from 189.5 billion, citing a reduced pace of herd reduction.

Dairy products prices were lowered “as milk production is forecast higher and demand is weaker than expected,” the USDA said.

Class III milk will average $14.10 to $14.60 per hundredweight in 2010, down from a previous forecast of $14.20 to $14.80, the USDA estimated.

Source: Bruce Blythe, Vance Publishing