Are Qantas, Virgin Australia airfares set to rise?

With Qantas and Virgin Australia calling a halt to a capacity war which flooded the domestic market with extra flights and spare seats, will tickets become more expensive as the supply-demand equation shifts back into balance?

There was certainly an over-supply as both airlines goosed the market, putting more seats in the air than travellers required – and in the process seeing 'yield' or passenger-based revenue slide away as the cost of tickets fell.

It was a case of what Cold War commentators called 'mutually-assured destruction', until earlier this year when Qantas and Virgin called a detente in the face of mounting losses.

Last week Qantas revealed that its domestic arm only just remained in the black, with underlying earnings of $30 million in the 2013-2014 financial year, down from $365 million over the previous period.

Qantas CEO Alan Joyce cited "market capacity increases ahead of demand" as a key factor for the decimation of Qantas Domestic revenue, which "declined relative to the prior year, due to a second consecutive year of market capacity growth well ahead of demand."

Virgin Australia's domestic operations contributed an $86.9 million loss to the airline's total $356 million loss for the last financial year.

Over-supply and demand

Virgin Australia CEO John Borghetti admitted that "it was the war that had to happen when you have a dominant player that wants to ensure that he maintains his position."

But airfares aren't likely to be jacked up anytime soon, as it will take some time for the natural growth of the market to catch up to the capacity level already set by the airlines.

In June this year, Alan Joyce said that while "the market has an underlying growth of 4 per cent or 5 per cent... in the last year you’ve had 8 per cent capacity growth."

Scott Carroll, analyst at Morningstar Equity Research, estimates that the market "is 2% to 3% over-supplied" and predicts that "a key driver of demand and improved profitability for all domestic carriers will most likely rely on an unwinding of excess capacity."

While airlines could trim capacity to match current demand, Carroll believes it's more likely they will "maintain capacity at current levels so underlying demand growth allows the market to move into supply-demand balance within 12-24 months."

John Borghetti agrees there will still be a healthy baseline of bargain airfares, telling journalists during last Friday's financial results "I don't think you should definitely assume the lowest fares for consumers are definitely going to move".

The number of those low-cost tickets allocated to each flight will likely shrink over time, however, nudging travellers up into the higher fare brackets.

In some cases capacity is also being actively throttled back.

With the first of its two oldest Airbus A330s now retired from the fleet, and the second soon to follow, Virgin Australia has shifted several Brisbane-Perth flights onto the smaller Boeing 737-800, which has some 100 less seats than the A330.

Both Qantas and Virgin could also shift to a combination of smaller aircraft and fewer flights outside of peak travel periods, depending on the route.

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David Flynn

David Flynn is the Editor-in-Chief of Executive Traveller and a bit of a travel tragic with a weakness for good coffee, shopping and lychee martinis.