Brian Fallow: Conflict of interest in Air NZ bid

Like Caesar's wife, the Government needs to be above suspicion in its handling of Air New Zealand's bid to be allowed to collude with Qantas on prices and capacity on the Tasman routes.

As the 80 per cent owner of Air NZ, it has a conflict of interest and should be at pains to ensure there is a transparent, rigorous, plainly arm's-length process for evaluating the proposal.

It is doing nothing of the sort.

Why should we care? Because, to put it bluntly, what the airlines propose could be a licence to rip the ditch-crossing public off.

"Could be" because claims about the impact of the proposal on prices need careful and expert evaluation, of the kind the airlines' earlier attempt to merge received three years ago.

But we have no assurance that they will get that sort of scrutiny, at least on this side of the Tasman.

The airlines are seeking official sanction to collusively rationalise (reduce) capacity, fix fares and carve up revenue on the Tasman routes. Only their costs will be independent.

They may call that "code-sharing" to make it sound routine and innocuous.

But it is three-fourths of a merger, of the kind the Commerce Commission, the Australian Competition and Consumer Commission and the New Zealand High Court rejected as not in the public interest two or three years ago.

Professor Tim Hazledine, a University of Auckland economist with a longstanding interest in aviation markets, has been crunching the numbers and his conclusions are troubling.

He and a research assistant laboriously collected thousands of observations of fares on Tasman flights last year. Also in the public domain is which airlines served those routes, what their capacity in seats was and what proportion of those seats got filled.

Armed with such data, he is able to run regressions - a mathematical technique economists use to figure out how much difference this factor or that makes to whatever they are interested in - in this case Tasman air fares.

Capacity makes a difference. Air NZ and Qantas estimate there are 6300 empty seats on Tasman routes each day - in all the airlines, not just them. That is the equivalent to 11 empty Airbus A320s making two return trips a day.

Hazledine reckons that withdrawing capacity as the airlines propose could raise prices by 5 to 10 per cent.

He says that may or may not be reasonable if the market has been over-competitive.

But a bigger factor is market concentration - how many players there are in a market and how big their market shares are.

Overall, the two airlines convey at least three in every four passengers crossing the Tasman.

Combining their operation as proposed, Hazledine reckons, could raise prices another 10 to 15 per cent on top of the 5 to 10 per cent achieved by reducing capacity.

The picture that emerges from his analysis does not bear out Air NZ's and Qantas' story that they are price-takers, forced to match the low-cost carrier Pacific Blue, or the "fifth freedom" carrier Emirates, which is able to price at marginal cost in order to use planes that were in the neighbourhood anyway.

Their load factors and gross yields are well below those of the big two.

Hazledine said if Pacific Blue and Emirates were really driving the market they would be selling more seats.

They are not aggressive price leaders but inferior-product followers - inferior in the sense of non-price factors like the timing of their flights and connectivity with other flights at either end.

The big two acknowledge the importance of those factors when they argue that neither of them can afford to just unilaterally reduce capacity.

"The consequences of a network carrier unilaterally removing capacity from a market such as the Tasman would be to cede competitive advantage to the competing airline's network while effectively marginalising its own network," they say in their application to the ACCC.

The reference to "the" competing airline [singular] is telling. They mean each other.

Yet the crux of their argument is that the proposed agreement is only about reducing overcapacity and cost and that there will be no impact on fares. The competitive constraint of Emirates and Pacific Blue, or potential new entrants, will keep them honest and prevent them from raising their fares.

They quote Emirates as saying last year that it has to fill only 40 per cent of its seats to be profitable across the Tasman.

But Hazledine's data, presented in a lecture hosted by the public policy think tank Motu last week, show Emirates above that threshold only occasionally through 2004 and 2005.

The airlines' application to the ACCC draws heavily on the 2004 decision of the Australian Competition Tribunal, which overturned the ACCC's rejection of the earlier "alliance" plan. It was the only body to approve it.

But Wellington International Airport, which opposes the new proposal, argues that the ACT has been proven over-optimistic about the competitive constraints on any Air NZ/Qantas collusion.

Virgin Blue, in the form of Pacific Blue, in particular has proven a sore disappointment.

It runs 28 services a week across the Tasman on six of the 25 possible routes, only enough to keep two aircraft gainfully employed.

It has pulled out of the Wellington-Sydney route. It runs two routes from Auckland but with limited frequency.

Virgin Blue's presence is likely to remain limited unless and until it develops the confidences to expand its operations at the New Zealand end.

But that won't happen if the two incumbents are officially allowed to gang up on it.

Clearly a proposal like this, so heavy with implications for competition, ought to be examined by the Commerce Commission.

But instead the airlines have opted to do an end run around it, invoking antique provisions of the Civil Aviation Act that allows the Minister of Transport to authorise "contracts, arrangements and understandings relating to international carriage by air" and putting such matters out of reach of the restrictive trade practices provisions of the Commerce Act.

The benchmark for the rigorous consideration of such a proposal, however, should be the Commerce Commission process: public submissions and cross-submissions, a draft determination, followed by another round of submissions and cross-submissions, followed by a public hearing and only then a decision. Plenty of opportunity to test assertions and tap expertise.

Instead, we have an opaque, behind-closed-doors and for all we know perfunctory process being run by the Ministry of Transport.

The only hope we have is that Australia's competition watchdog will not be cowed by the earlier ruling of its appellate body and will examine the proposal properly.

An opinion Wellington airport has obtained from administrative law expert Professor Michael Taggart concludes that at least some provisions of the agreement, like revenue sharing, fall outside the scope of what the minister is empowered to authorise.

And any subsequent behaviour by the airlines will still be subject to Commerce Act disciplines on the abuse of market power, he says.