28-Jan-2013 7:45 PM

Qantas and Emirates trans-Tasman alliance in the hands of New Zealand's Transport Minister

Analysis

Qantas and Emirates' global alliance has already been granted interim approval by Australia's competition regulator, but the New Zealand Government is yet to pass judgment on the partnership to be extended across the Tasman.

In Sep-2012 Qantas and Emirates announced a long-anticipated partnership proposal, the first of a world-shaking series of announcements over following weeks, in which the three Gulf airlines, Emirates, Etihad and Qatar Airways, drove a massive wedge in the resistance of their major legacy airline opponents.

Once finally approved, all Qantas group airlines, including Jetstar, will be permitted to share passenger and freight revenues, codeshare and otherwise act almost as one airline.

Summary

Qantas and Emirates have proposed a global alliance, which has been approved by Australia's competition regulator but is still awaiting approval from the New Zealand Government.
The alliance will allow Qantas and Emirates to share passenger and freight

The alliance has, however, met with stiffer resistance in New Zealand than was the case in Australia, particularly from airports concerned that the union will turn the competitive trans-Tasman route into an effective duopoly. The combination of Air New Zealand/Virgin Australia and Qantas/Jetstar/Emirates would provide about 95% share of all capacity on the route and all of the seats on routes other than to and from Auckland.

Trans-Tasman alliance approval is in the hands of the New Zealand Minister of Transport

Although there are still some near-formalities to be completed, the Australian Consumer and Competition Commission (ACCC) has all but approved the extensive agreement which will link the futures of Qantas and Emirates. Nothing is ever certain in the grey world of competition law, but all looks set to be operational. But there is also a New Zealand aspect to the agreement.

Unlike the decision in Australia, which is made by the competition regulator, the trans-Tasman component of the alliance is subject to approval from New Zealand Minister of Transport Gerry Brownlee, rather than New Zealand's equivalent, the NZ Commerce Commission. Mr Brownlee will make his decision on advice from the Ministry of Transport under section 88 of the Civil Aviation Act 1990.

The minister has the authority under the Civil Aviation Act 1990 to rule on arrangements between two airlines where the arrangement involves the fixing of tariffs or capacity of international air services, as is the case in the Qantas/Emirates alliance.

In approving an arrangement the minister must consider the effects of the arrangement on international comity between New Zealand and other states in relation to international aviation agreements.

He must also ensure that an arrangement does not disadvantage consumers or prevents competitors from entering the market.

Submissions on the Qantas and Emirates alliance application to the Ministry of Transport closed on 19-Oct-2012, and the ministry will provide its advice to Mr Brownlee by Mar-2013.

The ACCC has all but approved Qantas and Emirates alliance, excluding the Tasman

The ACCC has meanwhile all but given its blessing for the alliance, granting Qantas and Emirates' request for interim approval on 17-Jan-2013, allowing the carriers to start implementing their agreement and ensuring the alliance can take effect from 01-Apr-2013 and in time for the northern hemisphere summer schedules, subject to final approval being given.

However, the interim approval excludes the trans-Tasman route, where the ACCC holds concerns that the alliance will increase the ability and incentive for Qantas and Emirates unilaterally to reduce or limit growth and capacity on the four key city pairs absent the capacity condition in order to raise air fares.

Approval must be granted on both sides of the Tasman to allow the alliance to be extended to New Zealand.

The ACCC gave its draft approval for the wide-ranging partnership on 20-Dec-2012. The regulator considered that "the alliance is likely to result in material (although not substantial) public benefits." Final approval is expected in Mar-2013.

The only modest restriction placed on the carriers was a requirement that they maintain FY2012 capacity levels on four key trans-Tasman routes where their existing networks overlap. Those routes are Sydney-Auckland, Melbourne-Auckland, Brisbane-Auckland and Sydney-Christchurch which together accounted for about 65% of total seat capacity on the trans-Tasman in the year to 30-June-2012.

Approval was also granted for just five years, instead of the 10 year authority requested by the airlines.

Qantas and Emirates assert air fare and capacity fixing deal will improve competition

In their application to the New Zealand Ministry of Transport the partners repeat the assertion made to the ACCC that the alliance "will arrest the terminal decline of the international operations of Qantas".

The alliance will involve fixing fares and capacity, but Qantas and Emirates argue this will have no negative effect on competition, but rather, will be "pro-competitive" and result in significant public benefits to New Zealand including:

Committing to maintain existing levels of capacity which should lead to lower fares and better product and service offering from competitors.
A significantly expanded global network allowing seamless travel from New Zealand to Australia, Europe, including Britain, the Middle East and North Africa.
Enhanced benefits from frequent flyer programmes.
Establishing a long-term business model to optimise the operating performance of both Qantas and Emirates, including reducing costs.
Increasing tourism and employment, promoting international trade.
Materially enhancing and accelerating Emirates' long-term growth strategy in New Zealand and Australia.

The New Zealand Airports Association (NZAA) cautions in its submission that "it is important to remember that there is no guarantee that these claimed benefits will materialise and that, if they do, there is no guarantee of the extent to which they would be passed on to the end consumers.

"It is notable that many of the stated benefits would be expected primarily to enhance the market positioning and market share of the Applicants as opposed to delivering market growth above that which would be expected in the absence of the proposed activity."

The NZAA submitted that the trans-Tasman market is a "highly concentrated market" as measured by the Herfindahl-Hirschman Index (HHI) allowing for the existing airline groupings of Qantas/Jetstar and ANZ/Virgin Australia. The NZAA also submitted that adding Emirates to the Qantas group will increase the HHI by another 923 points to 4,661. An increase of 200 points is considered as the point at which market power is likely to be enhanced, reducing competition and leading to higher fares.

But Qantas and Emirates suggest the real competitive rivalry exists between the Qantas/Jetstar and ANZ/Virgin Australia groupings. This indeed is a point which is currently highly relevant in the Australian domestic market too, as the whole competitive dynamics of airline markets are changing. There, Virgin Australia argues its proposed acquisition of control of LCC, Tiger Australia, while taking a competitor out of the market, would actually enhance Virgin's competitiveness against a dominant Qantas.

Yet, as NZAA notes, in respect to the Air NZ/Virgin Australia alliance, Qantas told the ACCC in Oct-2010 that "Emirates operates as a constraint at a fare level and adds a significant amount of capacity to some trans-Tasman routes".

Alliance is a lifeline for Qantas loss-making long-haul network

For Qantas the alliance is a lifeline to stem the losses on its long-haul network where it is unable to compete as an end of line carrier against dominant sixth freedom network carriers like Emirates, Singapore Airline and Cathay Pacific.

Qantas reported an AUD450 million (USD469 million) loss on its long-haul international operations in the financial year to 30-Jun-2102 and its international market share has declined as liberalisation spread.

In return Emirates gains greater access to the Australian and New Zealand markets

Emirates will benefit from gaining access to the Australian and New Zealand domestic networks allowing it to market services to Wellington, Dunedin and Queenstown served by Qantas and Jetstar, but where Emirates cannot operate its own long-haul aircraft due to runway restrictions.

Emirates launched trans-Tasman services in Aug-2003 as an extension to its Dubai-Australia long-haul network and currently operates daily services to Auckland from Sydney, Melbourne and Brisbane as well as a daily service between Sydney and Christchurch.

Emirates argues that by placing its code on Qantas' trans-Tasman services it will effectively increase its frequencies on the route. In particular it will allow the carrier to sell and market services to Wellington on Qantas aircraft. Emirates' large long-haul aircraft are not able to land at Wellington International Airport.

Emirates believes capacity restrictions under the current air services agreement between New Zealand and the United Arab Emirates are likely to be eased as a result of the New Zealand Government's new international air transport policy announced on 20-Aug-2012, promoting greater liberalisation under reciprocal open skies agreements.

.. allowing Emirates to grow its presence in New Zealand

This, Emirates suggests, will help grow its presence in New Zealand in the longer term.

In reality, however, opponents argue that Emirates' growth is likely to be limited to codeshare passengers on Qantas services because Emirates' growth using its own aircraft is constrained by the scheduling window dictated by its long-haul flights between Australia and Dubai.

Average load factors of about 67% would also suggest it is unlikely to deploy more capacity in the foreseeable future.

But Qantas and Emirates say cooperation on the Tasman will allow them to better match aircraft size to service joint passenger demand, exploiting economies of scale of larger aircraft and reduce unit costs.

There are certainly opportunities for the two carriers to consolidate flights by removing wing-tip services on four frequencies. Emirates' Brisbane-Auckland services operates at an identical time to Qantas' service while the Sydney-Auckland services operates 25 minutes apart.

Qantas' Auckland-Melbourne service also leaves only five minutes ahead of the Emirates service and 10 minutes ahead of Emirates' Sydney-Auckland frequency.

Emirates frequencies vs nearest Qantas frequencies

ACCC fails to take up Auckland-Adelaide route offer

Better feeder traffic could also improve demand on typically marginal secondary trans-Tasman routes and 'potentially' allow the alliance to launch new services from Auckland to Adelaide, currently served only by Air NZ with a daily A320 operation.

Qantas operated the Auckland-Adelaide route between Dec-2004 and Jul-2007 three times a week, but withdrew after declaring the route unviable.

Emirates launched a four times weekly Dubai-Adelaide service in Nov-2012 and will move to a daily service from 02-Feb-2013.

Perhaps surprisingly, in light of this concession, the ACCC has elected not to extract a commitment from Qantas to open any new routes.

While the Qantas/Emirates alliance has the Qantas long-haul survival at its core, Air NZ questioned the rationale for including the Tasman to the arrangement. The New Zealand flag carrier, which partners with Qantas competitor Virgin Australia, estimates that just 25% of traffic on Qantas and Emirates trans-Tasman services is to or from markets beyond Australia.

Air NZ is also concerned about the open ended nature of the application which includes vague statements such as "the exact scope of the proposed conduct may change" and "the applicants may commence code sharing on Jetstar".

Alliance promises New Zealand tourism growth through expanded global network

Qantas and Emirates expect their alliance will stimulate growth in inbound tourism to New Zealand through their expanded network, allowing for two-stop travel from Europe and the Middle East and North African region via Dubai and Australia.

Certainly, Emirates' multiple European points could benefit New Zealand tourism by encouraging more dual destinations travel.

The alliance should also boost inbound tourism for example from Malaysia by linking Emirates' Kuala Lumpur-Melbourne service to combined trans-Tasman services.

Such dual destination tourism is increasingly important to New Zealand given the number of travellers that combine Australia and New Zealand in a single holiday, especially by Asian tourists.

While the alliance in its initial form is restricted to routes between New Zealand, Australia, Dubai and on to Europe, Qantas and Emirates intend to cooperate on a global, network basis.

Emirates president wants A380 link across the Pacific

Emirates president Tim Clark said in Jan-2013 that he wants to extend Emirates' relationship with Qantas across the Pacific to create a round the world A380 service via Los Angeles. Mr Clark told Bloomberg that while the focus of the alliance was on long-haul routes to Europe and within Australia, "I'm sure we could do trans-Pacific business on Qantas metal as part of this overall deal."

Such an arrangement would be likely to be in the form of Emirates code-sharing on Qantas trans-Pacific services rather than an extension of the proposed alliance which would require further regulatory approval.

Qantas may also not be as keen on the idea of sharing the still-relatively profitable Los Angeles route with Emirates under the alliance. Qantas' existing codeshare partner on the route and throughout the US, American Airlines, may also be equivocal on the proposal.

However, American is itself going through alliance hoops, including forming a relationship with Emirates competitor from the Gulf, Qatar Airways, which is about to join oneworld.

Qantas currently operates double daily service between Sydney and Los Angeles, using an A380 on one of those frequencies and a Boeing 747-400 on the other. At the other end, Emirates, however, operates only a daily Boeing 777-300ER between Los Angeles and Dubai.

In addition, under the current schedule - which depends on Australian-US customer preferences and the respective airport slots - a lengthy lay-over would be required in Los Angeles, with Emirates' existing service arriving from Dubai at 12:50, but Qantas' A380 service not departing for Sydney until 23:20.

Similarly Qantas' A380 service arrives in Los Angeles from Sydney at 09:40, while Emirates' existing service does not depart Los Angeles for Dubai until 16:00.

The trans-Tasman market is dominated by Air New Zealand/Virgin Australia and Qantas/Jetstar

A total of seven airlines operate on the Tasman including ANZ/Virgin Australia, Qantas/Jetstar, Emirates, LAN Airlines and China Airlines (the latter three operating with fifth freedom rights on this liberal route).

Air NZ dominates capacity with 30,160 seats in the week 21-Jan-2013 to 27-Jan-2013, followed by Qantas with 17,069 seats.

Top seven airlines on the trans-Tasman route ranked by seats: 21-Jan-2013 to 27-Jan-2013

Auckland-Sydney is the biggest route, offering 21,575 seats in the week 21-Jan-2013 to 27-Jan-2013.

Top trans-Tasman routes ranked by seats: 21-Jan-2013 to 27-Jan-2013

Emirates brought significant competition to the trans-Tasman market

Emirates' entry to the trans-Tasman in 2003 added about 15% capacity to the route using a mix of long-haul widebody aircraft. It currently deploys A380s to Auckland from Sydney and Melbourne and operates Boeing 777-300s between Brisbane and Auckland, and Sydney to Christchurch, according to Innovata.

But the partners claim that Emirates imposes limited price constraint on Qantas and Jetstar on the Tasman due to its relatively small share of traffic of about 8.8% in FY2012.

Under the alliance Qantas/Jetstar and Emirates would have a combined share of traffic of 39.6%, compared to 56.7% held by the Air NZ/Virgin Australia alliance, according to application documents.

However, on a seat capacity basis Emirates offered 14% of all seats on the Tasman in FY2012, only slightly below Virgin Australia's 15.2%.

A combined Qantas/Jetstar/Emirates grouping would command a 45.8% share based on FY2012 figures against 50.1% from the Air NZ/Virgin Australia grouping.

Furthermore, while Emirates operates on just four of the 22 trans-Tasman routes, those four routes account for 65.1% of total Tasman capacity, arguably making Emirates' competitive influence on the overall market disproportionately greater.

Emirates' capacity influence from just four daily frequencies is further demonstrated by its 24.7% share between Melbourne and Auckland in the week 21-Jan-2013 to 27-Jan-2013, and 38.6% between Sydney and Christchurch, according to Innovata data. Emirates offers 16% of seats on the Sydney to Auckland route.

New Zealand transport minister must assess the competitive balance

Emirates is the only other competitor of scale on the Tasman. Its daily services on the four biggest trans-Tasman routes are limited to afternoon arrivals and departures in New Zealand, which, while not attractive to time-sensitive business travellers, target the leisure market.

Emirates initially at least, deployed its large long-haul aircraft on the Tasman on a marginal cost basis in preference to leaving the aircraft parked at Australian airports awaiting their return leg to Dubai in the evening.

However, Qantas and Air NZ argued, unsuccessfully, in 2006 that regulators should approve a trans-Tasman alliance between the two flag carriers in the face of the growing competition from the Gulf carrier's "capacity dumping".

New Zealand's minister of transport will have to weigh up whether removing Emirates now as the effective third competitor on the trans-Tasman route, in effect creating a duopoly with broader global reach, is in the interests of consumers and competition. His mandate is somewhat different from the more narrow, formalistic considerations that competition law impose. That does not necessarily make it any easier to come up with the 'right' decision.