The competition regulator has given tentative approval to Virgin Australia extending its alliance with Air New Zealand on trans-Tasman routes but spurned their request for capacity conditions to be dropped.
The Australian Competition and Consumer Commission has signalled in a draft ruling that it will approve the tie-up for another three years - two years less than the airlines were seeking.
The regulator said it planned to approve the alliance for three years because it was likely to result in "material public benefits by allowing the airlines to link" with each other's domestic networks.
But it was concerned about the potential for competition to be lessened on some routes, including between Melbourne and Christchurch, and Sydney and Dunedin.
As a result, it plans to impose conditions requiring the airlines to maintain capacity on eight routes.
The airlines will also have to provide performance data to help the ACCC decide whether their alliance has had an "adverse effect on competition more generally".
While it falls short of what the airlines were seeking, Macquarie Equities analysts emphasised that Air New Zealand and Virgin will now have greater flexibility to respond to demand because the regulator has indicated it will not impose an "over-arching capacity commitment".
New Zealand airports and councils had claimed that removing the conditions on the amount of capacity would lead to the airlines reducing flights in a bid to raise fares.
Virgin and its largest shareholder, Air New Zealand, signalled on Wednesday that they will lobby the regulator to drop the orders that require them to retain a certain number of flights on some routes.
They also indicated that they will push for the ACCC to give approval for five years rather than three. In contrast, Qantas and Emirates' extensive alliance, which includes co-operation on routes between Australia and New Zealand, was approved for a five-year period.
Virgin and Air New Zealand have a combined market share of almost 57 per cent on the trans-Tasman route compared with about 40 per cent for Qantas, Jetstar and Emirates.
They will also need approval from New Zealand's Ministry of Transport to extend their tie-up.