Australians travelling domestically could be hit by a spike in airfare costs in coming months and years, the consumer watchdog has warned, as it puts capital city airports on notice amid fears they could be “systematically taking advantage” of the Covid-reopening and hiking fees they charge airlines.

In its Airline Competition in Australia report released on Wednesday, the Australian Competition and Consumer Commission has also found people flying in and out of regional Australia continue to face higher ticket costs.

This is due to a lack of core demand on some routes, as well as diminishing competition since Virgin Australia’s restructuring last year that has seen Qantas extend its dominance on regional travel.

Lockdowns and Covid restrictions were continuing to shrink aviation operations in Australia, with July marking the first time ever that routes in and out of Sydney airport did not feature in the top 10 busiest Australian routes.

With New South Wales and Victorian residents barred from most states and under lockdown, intrastate routes in Queensland and Western Australia were among the busiest routes in July. Brisbane to Cairns was the busiest route, with routes from Townsville and Mackayand Perth to Karratha also busy.

As lockdowns set in across NSW and Victoria in July, airlines were forced to cancel one in three domestic flights across all states. The ACCC chair, Rod Sims, said Sydney dropping out of the top 10 busiest routes “is a sign of the state of the industry”.

The bleak portrait of the domestic aviation industry painted by the ACCC’s report follows a wave of excitement among Australian travellers triggered by state government reopening plans, with Qantas’s international and domestic flight schedules also leading to a surge in travel searches.

A survey of traveller sentiment released on Tuesday showed 59% of Australians planned to catch a flight, either international or domestic, by March.

Domestic travel had recovered strongly in the first half of the year, before the Delta variant broke out across several states, with levels in April at 68% of pre-pandemic passenger traffic.

However, Delta lockdowns and border closures ground travel from traditionally busy routes to a halt, with domestic passenger levels in July dropping to 23% of pre-pandemic levels.

While the ACCC’s report collected data until the end of July, the watchdog said air travel was “expected to have fallen further during August and September 2021” as lockdowns continued in a number of states and territories.

“The Delta outbreak has hit the domestic airline industry hard, and it has unfortunately halted the airlines’ recovery just as they were starting to approach pre-pandemic levels of flying,” Sims said.

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Earlier this month, the Morrison government announced it would extend a $750 a week aviation support for cabin crew and pilots to international airlines until March, at a cost of $183m, a sign the sector will not significantly expand operations until next year.

The ACCC’s monitoring found the aviation industry “remains optimistic that demand for domestic travel, especially to leisure destinations, will bounce back strongly when vaccination targets are reached and border restrictions are eased”.

However, airlines have voiced concerns to the watchdog that as they are renegotiating contracts with major airports, they are concerned that airports are seeking to “significantly increase aeronautical charges to recover their Covid-19 lost profits”.

Sims said the ACCC would monitor airports’ pricing to determine if they were “systematically taking advantage of their market power”.

The ACCC warned there were industry pricing principles that stipulate prices should be set only to recover the actual costs they incur, and that recovery of lost profits is not a valid reason, but that ultimately, “large airports face minimal constraints on their pricing because they are effectively unregulated regional monopolies”.

Airlines are concerned that airports could seek to increase these charges in renegotiations happening not just currently, but also over coming years – a sign of how significantly the pandemic has hit industry profits.

Sims said “we would be very concerned if the major Australian airports sought to use their monopoly position to charge airlines excessive prices in order to recover any lost profits from the pandemic”.

“This could limit an already vulnerable sector’s ability to recover, and impact on both consumers and the economy.”

Following the ACCC’s warning, a Sydney Airport spokesman told Guardian Australia “we’ve shared the pain fairly and equitably right through the crisis, demonstrated by the fact that we’ve provided our airline partners more than $60m in relief for things like property rent and aircraft parking, and that’s a principle we intend to stick to”.

“The last 18 months have been terrible for everyone in aviation, but we look forward to rebuilding the industry together,” the spokesman said.

Regarding regional travel, the ACCC found that since Virgin Australia regeared its focus after emerging from voluntary administration last year, Qantas group – which also owns budget carrier Jetstar – “has further extended its dominance in regional areas”.

Qantas carried 87% of passengers flying between two regional locations in June, and 70% of passengers on routes between regional airports and larger cities.

This lack of competition, combined with a low economies of scale on many regional routes, meant regional passengers were more likely to face higher airfares, the ACCC said.

Last year, counter-terrorism experts criticised as “ludicrous” a government decision to allow some regional Australian airports to remove all passenger and baggage screening to cut costs, warning there were now no measures in place to prevent extremists hijacking planes flying into cities.