Air alliance could survive regulatory knock

By Nick Stride

Friday 11th April 2003

Air New Zealand and Qantas were yesterday preparing to play the second hand in their game of regulatory poker after competition watchdogs knocked back their proposed alliance.

The carriers will be trying to guess just how much more they will need to put on the table to satisfy the Commerce Commission and the Australian Competition and Consumer (ACCC) Commission.

In an environment of plunging traveller numbers neither will want to give an inch more than they have to.

For the same reason neither will want to go to round three, further putting off the financial benefits they hope to reap.

Since the alliance proposal was announced both airlines have come under pressure from effects of the Iraq war and the outbreak of the Sars virus.

Qantas this week said it would lay off 1000 staff by July and shed a further 400 through attrition. It has cut international flights by 20%.

The worsening outlook has prompted speculation Qantas is getting cold feet about spending $550 million on a 22.5% Air NZ stake. Deutsche Asset Management portfolio manager Shawn Burns said Qantas "would probably be having second thoughts about how much they want to pay for it."

Air NZ responded by saying the price for Qantas' stake is not negotiable while Qantas chief executive Geoff Dixon said the pressures had made the alliance all the more imperative.

JB Were aviation analyst Peter Sigley said it was unlikely Qantas would be reconsidering.

"Given it's a long-term deal for them I wouldn't have thought they'd let it slip because of short-term considerations."

The rejection will have come as no surprise to Finance Minister Michael Cullen, who predicted on March 11 that both agencies would decline to authorise the deal.

The government, however, is keen to see it go ahead. Dr Cullen has said the alliance is crucial to both airlines, arguing the damage to competition should be outweighed by the national interest.

But the Commerce Commission's draft determination found the competition detriments would outweigh the public benefits.

The Australian Federal government also supports the deal.

The commission will hold a conference in Wellington from May 20 to May 23 and intends to release its final ruling by the end of June.

The airlines asked the commission for authorisation under the Commerce Act restrictive trade practices section, a necessary concession as the two will effectively collude on prices and services.

An authorisation for Qantas to buy in under the act's business acquisitions section is also needed. Authorisations can be granted even when a deal will result in a "substantial lessening" of competition, provided there are "countervailing public benefits."

One of the main weapons the airlines have wielded in their attempts to persuade regulators to approve the deals has been a study by Australia's Network Economics Consulting Group.

The study at first concluded the benefits from cost savings, more rational passenger and freight scheduling, and higher tourism numbers among others would outweigh the competitive detriments by some $1.4 billion over five years in New Zealand alone.

NECG has since scaled that figure back to $1.08 billion.

The main reason for the cut was the withdrawal from the Auckland-Los Angeles route of United Airlines, which is in US Chapter 11 bankruptcy.

In response, Air NZ is putting more flights on that route and has suspended its Sydney-Los Angeles service.

United's departure leaves Air NZ and Qantas as the only airlines flying from New Zealand to the US West Coast.

NECG's study has been criticised vigorously by Sir Richard Branson's Virgin Blue, which has vowed to fly across the Tasman and on New Zealand domestic routes whether the alliance goes ahead or not.

In submissions to the ACCC, Virgin, citing a report by its own consultants, Frontier Economics, said the claimed cost benefits were unsubstantiated and that there was no basis for predicting the surge in tourism numbers.

Predicted price increases and seating decreases had also been substantially understated.

The commission largely agreed, saying the detriments would be $202 million to $432 million a year and the benefits only $30.2 million to $46.3 million.

Virgin wants the Commerce Commission to demand as a condition of an authorisation that Air New Zealand should be made to sell its discount transtasman offshoot Freedom Air to "a new entrant," that is, Virgin.

Its stance provoked a strong reaction from Air NZ. It said Freedom Air was vital to its profitability and claimed Virgin was asking to be handed a monopoly in one air travel segment.

The airlines have backed their "countervailing public benefits" arguments with enforceable undertakings they claim will mitigate the impact of less competition on prices and services.

The undertakings ensure access to airport facilities for any new passenger services player and guarantee not to increase combined capacity beyond natural growth on existing transtasman routes for one year after a new entrant announces it will start operating on that route.

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