Air New Zealand and Virgin Blue must go back to the drawing board following a regulatory knockback for their proposed transtasman alliance.

The Australian Competition and Consumer Commission said there were a number of routes between New Zealand and Australia where the alliance raised competition worries.

"These routes account for around one-quarter of passenger traffic in the transtasman market. This means that more than one million passengers per year may be adversely affected by the removal of competition between Virgin Blue and Air New Zealand," ACCC chairman Graeme Samuel said.

The proposed alliance between Air New Zealand and Virgin Blue, parent company of Pacific Blue, involves collaboration on future route and product planning, code sharing and frequent flyer programme benefits.

The airlines said it would deliver cheaper airfares, increase frequency, better connections, and expand lounge access.

The alliance would benefit the airlines by tens of millions of dollars a year and fortify them against rivals Qantas group and Emirates on the highly competitive Tasman route.

Though the ACCC accepts that an alliance would have public benefits, such as reduced prices, it has doubts about the magnitude of the benefits.

The regulator was also concerned that the alliance would increase the likelihood of co-ordinated conduct on routes between New Zealand and Australia.

Air New Zealand said yesterday it would respond to the ACCC's concerns once they were identified.

First NZ Capital analyst Jason Familton said the airlines would have to make concessions to get the ACCC decision overturned.

"It depends on how much the submitting parties are willing to give."

Raising concerns about the public benefit was putting the burden of proof back on Air New Zealand and Virgin Blue. The draft ruling was not a good sign for the deal's success.

"In all likelihood I think it's unlikely they'll change their mind but there is obviously a little bit of water to go under the bridge."

Air New Zealand chief executive Rob Fyfe has said the main benefit would come from increased passenger numbers, an optimised network and, consequently, more stable revenue, rather than cost savings.

The alliance had approximately $20 million to $30 million of benefit to Air New Zealand a year, with most being revenue increases from carrying more passengers, Fyfe said in May.

New Zealand's Ministry of Transport is also considering the application but Familton said that, given the ACCC's draft ruling, its decision was nullified.

"It becomes a moot point - if the ministry approves it, it still can't go ahead because the ACCC hasn't approved it - it's a chicken and egg situation."

Centre for Asia Pacific Aviation executive chairman Peter Harbison said he was surprised with the decision, considering the partnership was not as far reaching as the Air New Zealand-Qantas proposed merger, and did not believe it would stand.

He believed the eventual outcome would be approval, with conditions particularly for routes such as Dunedin where they accounted for all transtasman seats available.

Air New Zealand shares closed up 1c at $1.27.