CHICAGO — U.S. milk production is headed for the biggest contraction in 12 years as a drought-fueled surge in feed costs drives more cows to slaughter.

Output will drop 0.5 percent to 198.9 billion pounds (90.2 million metric tons) in 2013 as the herd shrinks to an eight- year low, the U.S. Department of Agriculture estimates. Milk futures rose 45 percent since mid-April and may advance at least another 18 percent to a record $25 per 100 pounds by June, said Shawn Hackett. The president of Boynton Beach, Fla.-based Hackett Financial Advisers Inc. correctly predicted the rally in March.

Dairies in California, the top milk-producing state, are filing for bankruptcy, and cows are being slaughtered at the fastest rate in more than a quarter century. Corn surged to a record in August as the USDA forecast the smallest crop in six years because of drought across the U.S. Global dairy prices tracked by the United Nations rose 6.9 percent last month, the most among the five food groups monitored, and that will probably mean record costs next year, Rabobank estimates.

"Farmers can't afford to buy as much grain and protein, and that affects milk production," said Bob Cropp, an economist at the University of Wisconsin in Madison who has been following the industry since 1966. "In California, there've been some foreclosures and some sell-off of cows quite heavily. You're going to see that in other parts of the country."

Class III milk, used to make cheese, jumped 22 percent to $21.10 on the Chicago Mercantile Exchange this year. That's more than 21 of the 24 commodities in the Standard & Poor's GSCI Spot Index, which rose 2.2 percent. The MSCI All-Country World Index of equities climbed 12 percent, and Treasuries returned 1.8 percent, a Bank of America Corp. index shows.

The global dairy market is facing a scarcity of supply in the next 12 months as output slows in the United States and Europe and demand keeps expanding, Rabobank said in a Sept. 27 report. Surplus milk available for shipment from the seven biggest exporting regions will decline for the first time in four years, and there is little excess inventory, the bank's team of 11 dairy analysts estimate.

U.S. cows produced 1,776 pounds of milk each on average in August, 0.5 percent less than a year earlier, government data show. That's the first decline in 13 months and the biggest year-on-year drop since February 2004, according to Bill Brooks, an economist at INTL FCStone Inc. in Kansas City. Productivity probably slipped because of the heat waves and changes in feed rations, said Brooks, who grew up on a Missouri dairy farm and has covered the industry for two decades.

Almost 2.04 million dairy cows were slaughtered in the first eight months of the year, 6.7 percent more than in 2011 and the most for that period since 1986, government data show. The U.S. dairy herd will shrink 1.1 percent to 9.11 million head in 2013, the smallest since 2005, according to the USDA.

While slaughter rates are rising, farmers tend to cull their least-efficient animals and replace them with younger, more-productive cows, said Robert Chesler, a Chicago-based vice president in the foods division of INTL FCStone Inc., which handled $75 billion of physical commodities in 2011.

Production per cow will rise 0.6 percent to 21,830 pounds next year, from an estimated 21,690 pounds this year, the USDA forecasts. A more-productive herd may mean an increase in total supplies rather than the decline the government is predicting, Chesler said.

Higher prices may crimp demand, with cheddar traded on the CME rallying 26 percent to $2.075 a pound in the third quarter. The increase in wholesale prices may be passed along to retailers, Chesler said.

"We're hitting levels where buyers are getting concerned," he said. Commercial milk consumption next year may slide 0.5 percent to 192.2 billion pounds, compared with a 2.1 percent increase this year, the USDA forecasts.

Food prices measured by the U.N. index may climb to a record 243 by June 2013, from a six-month high of 215.76 in September, Nick Higgins, an analyst at Rabobank in London, said in a report Sept. 19. The U.N.'s gauge of 55 food items, which gained 7.7 percent since June, peaked at 237.92 in February 2011.

Chinese demand for dairy products and lower production in the U.S. and New Zealand probably will keep prices rising into next year, said Hackett. China is the world's biggest buyer of whole-milk powder and will import four times more this year than a decade ago, USDA data show.

U.S. exports of cheese, whey, lactose and other dairy products reached records last year, valued at $4.82 billion, or 30 percent more than in 2010, according to the Arlington, Va.-based U.S. Dairy Export Council. The total amount of U.S. dairy products shipped will increase 2 percent to 5 percent this year from 2011, the council forecasts.

Riley Walter, an agricultural bankruptcy lawyer in Fresno, Calif., said he's had 58 cases of dairies in some kind of financial difficulty over the past year and half, including bankruptcy filings, out-of-court liquidations and moving operations into receivership.

"Dairies go through cycles, and I've hit every one of them since 1979, but nothing like this," Walter said. "The recent spike in feed prices due to the drought and ethanol policies really put a nail in the coffin of a lot of people."

So far this year, 49 bankruptcy cases have been filed by family farms in California, up from 43 cases filed last year in the same period, according to federal court records. The cases include dairy and other family-run farms that are eligible to use Chapter 12 of the U.S. Bankruptcy Code to try to reorganize their debt.

"We're all hemorrhaging hard financially," said Jim Wilson, 44, whose dairy in Riverdale, Calif., milks about 3,000 cows and is losing about $200,000 a month. "We're all on the brink of going under and just culling herds harder because we can't afford to feed them."

— With assistance from Jeff Wilson in Chicago, Alan Bjerga in Washington and Steven Church in Wilmington, Del.