If oil keeps going up, fares will continue to rise, As fares rise, less people fly. The player with the lower costs has more room to maneuver, still keep butts in seats and still eek out a profit. The player with the higher costs either matches fares it can't make money at, or increases fares and loose market share.
This scenario basically plays out anytime people stop their flying habits for whatever reason. Price increases or a demand drop.
With that said.
Piggy.
In 2002 a gapping hole was left in the Market by Canada 3000.
In 2002 AC did not have the aircraft versatility it has today. Matching demand with the correct gage aircraft will be huge in this high fuel price environment. The Burrito is producing a CASM impressively close to a 319. AC can actually go smaller gaged without increasing CASM by very much.
For example at the end of April I was traveling YYC-YYZ. AC had down gaged everything all day to the Burrito. It was a slow time of year and it was packed. Gave up and went to WJ. The flight I got on had a Burrito load on it. (are you impressed with my massive cross section of analysis?

My point is simply that right sizing a route will become more important as fuel becomes a larger and larger portion of CASM. It is probably one of the only advantages AC has over WJ.
I expect AC to do much better against WJ this time around. I also expect that WJ, will show restraint in capacity increases if need be. They have done it before.
I don't think the domestic market is AC's biggest issue at the moment.