The Potential Impact of a Prolonged Middle East Conflict on Australia’s Economy
A prolonged war in the Middle East could have significant economic consequences for Australia, with our latest research indicating that it might add an extra 5% to existing inflation levels. This projection is based on two distinct scenarios: one where the conflict ends by mid-April and another where it continues until September. Both scenarios highlight the potential for increased fuel costs to ripple through various sectors of the economy, including freight, food production, and manufacturing, leading to higher prices for goods ranging from steak to steel.
Two Different Futures
To assess the possible outcomes, we utilized the Global Trade Analysis Project model, a sophisticated tool widely used in international trade and energy policy research. This model enables us to trace how an oil price shock affects trade, production costs, industry output, and household spending across the global economy.
In our moderate scenario, the conflict lasts six weeks, ending by mid-April, with the Brent crude oil price settling at around US$90–$100 (A$130–$145). This aligns with baseline modeling by insurance firm Allianz, which assumes a ceasefire is negotiated. In contrast, our severe scenario assumes the conflict persists for six months, ending around September, with the price of Brent crude reaching US$100–$150 (A$145–$218).
A Short Blip or a Major Shock?
Under the moderate scenario, the impact on Australia’s economy would be relatively minor. Gross domestic product (GDP) would decrease by about 0.02%, while consumer prices would rise by 0.6% on top of existing inflation. The energy sector would be most affected, with most industries experiencing small cost increases. However, Australia’s oil and gas extraction would likely expand as higher global prices make domestic production more profitable.
Australia’s terms of trade – the ratio of how much it gets paid for its exports to how much it pays for its imports – would improve by about 1%. This reflects its role as an energy exporter. However, the benefits would largely go to the resource sector rather than households facing higher costs.
A Drawn-Out War
If the conflict continues for a longer period, the effects become more alarming. GDP would contract by 0.16%, roughly eight times the impact of the moderate scenario. Consumer prices would surge by 5.1% by around September this year.
The impacts would follow a clear transmission chain from oil shocks to other disruptions. Energy-intensive industries such as refineries, steel and metal production, and chemicals would be hit first. Refineries would see output shrink by 25%, while steel and metal production would fall by 15%, and chemicals production by nearly 14%.
Rising fuel costs would then affect the transport sector, with costs jumping 7.7%. This would impact everything that travels by truck, rail, or ship. Agriculture and food production, central to the Australian economy, would also face challenges, with meat and livestock production potentially falling nearly 7.6%, and processed food by 4.4%. Higher production costs would likely be passed on to consumers.
The only sector likely to expand is natural gas extraction itself, but its gains are concentrated within a narrow part of the economy and workforce.
Australia’s Neighbours Fare Worse
Australia’s GDP impact, while significant, is considerably smaller than that of some of its import-dependent Asian neighbours. Under the severe scenario, Singapore’s GDP would take a 4.7% hit, South Korea’s would be 4.4% lower, Thailand’s 3.3%, and Japan’s 2%. These figures are all higher than Australia’s 0.16% reduction.
The pattern is clear: economies more dependent on imported oil, particularly from the Middle East, and those producing less domestically, face larger hits. Australia, with its energy exports, particularly liquefied natural gas, is somewhat shielded from the shock. However, it remains exposed due to limited refining capacity.
Australia currently has only two oil refineries left, both operating under government subsidies, which have been extended to 2030.
The ‘Stagflation’ Trap
History shows that countries must be cautious when responding to an oil shock. Japan’s response to the 1970s crisis serves as a cautionary tale. Japan’s interest rates were already too low before the crisis, with inflation exceeding 10% by mid-1973. When oil prices spiked later that year, Japan had already raised rates, but only slowly. By spring 1974, inflation reached near 25%, triggering a prolonged period of stagflation.
Something similar could happen today if governments respond by subsidising fuel or lowering interest rates. Australia faces this dilemma now, with inflation already at almost 4% and interest rates at 4.1%. The Reserve Bank of Australia is already battling inflation, and there is no easy solution. Lowering interest rates could embed expectations that prices will continue to rise, while keeping rates high worsens the cost-of-living squeeze and slows the economy.
Where to From Here?
Two priorities should guide Australia’s response. First, consumer relief must be targeted, not universal. Cutting the fuel excise, as done after Russia’s invasion of Ukraine, is politically appealing but risks worsening inflation. Means-tested support for vulnerable households, possibly funded by a windfall tax on gas profits, would be more equitable and cause less market distortion.
Second, this crisis reinforces the case for accelerating the electrification of the economy and investing in renewables. Renewables and storage already contribute more than 50% of supply on Australia’s main electricity grid. Every dollar invested in domestic renewable capacity permanently reduces Australia’s exposure to future oil shocks.
Thanks to Anda Nugroho for his contribution to this article. George Verikios does not work for, consult, own shares in, or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
