Prolonged Consequences of the Iran War

A Global Energy Shock with Domestic Consequences

New Zealand is facing an ongoing macroeconomic challenge because of the Israel-US military invasion of Iran in February 2026. The sudden shock to the energy sector caused by the war led to a significant oil price shock, with uncertain duration for the world economy.

The International Energy Agency (IEA) described the situation as the “largest supply disruption in the history of the global oil market.”

Despite yesterday’s announcement of a two-week ceasefire, the outlook remains highly uncertain. The current Trump Administration has demonstrated unpredictability in its approach, often operating from a zero-sum perspective in international relations.

A Fragile Domestic Starting Point

Our current circumstances are not optimistic either. Our domestic economy has stagnated for the past couple of years, with our GDP per capita dropping by 3.9 per cent since 2023.

Inflation has dropped from 7.2% to 3.1% as of December 2025, and it is anticipated to worsen significantly beyond the Reserve Bank of NZ’s 1–3% target range.

From a fiscal policy standpoint, the New Zealand government is currently stuck, as its attempt to consolidate fiscal policy by 2028 is already at risk due to higher fiscal deficits under the previous Labour government, caused by declining tax revenue and weak demand.

This is not only a shock; it is a macroeconomic shock that is impacting an already fragile, potentially stagflation-prone economy.

Transmission Through Prices and Costs

For New Zealand, this presents immediate cost pressures and potential longer-term risks to inflation, consumption, and investment decisions. There is a very high likelihood of renewed inflationary pressure if elevated oil prices persist. Households would already have felt pressure on their disposable incomes.

The rising fuel costs are especially pertinent, given a 140% increase in diesel since the start of the US-Iran War, which is more expensive than both 91 and 95 fuels. Many businesses that rely on industrial logistics and the transport of goods and services will witness rising input costs across various sectors, including the primary and manufacturing sectors.

Policy Constraints and Trade-offs

The New Zealand government opted to use public finance to support both households and businesses from further consequences. The government has already committed to using the operational allowance to support low-income families with $50 per week, at a cost of $373 million over a 12-month period.

Monetary policymakers at the Reserve Bank of NZ will have an even greater challenge. Our central bank has tried to balance financial stability and inflation, with the Official Cash Rate remaining at 2.25% while simultaneously issuing a hawkish warning that “inflation is likely to become more persistent.” Achieving the delicate balance between preventing even higher inflation and maintaining macroeconomic stability will be extremely difficult.

Structural Vulnerability to Energy Imports

Unfortunately, what is clear is that the cost-of-living crisis facing New Zealand will not wane. We face higher relative risks than other nations because of our heavy reliance on external markets for refined fuel. The New Zealand economy is extremely vulnerable due to its dependence on external parties for energy security.

New Zealand’s exposure to this shock differs from that of other countries. Unlike larger, more energy-independent economies such as Norway, our country operates across long supply chains and relies on transport-intensive industries.

Our current energy sector relies heavily on two East Asian trading partners, South Korea and Singapore, which supply 80% of our refined oil imports. Although we have a sustainable electricity sector powered by abundant renewable energy, our oil and gas sector depends on imports.

External Imbalances and Exchange Rate Pressure

The consequences extend beyond higher petrol prices. Rising fuel costs flow directly into domestic prices, squeeze household incomes, and increase businesses’ operating costs. In an economy already experiencing weak growth, these pressures are more likely to compound than dissipate.

There are also important implications for New Zealand’s current account position. Higher fuel import costs will widen the current account deficit, increasing reliance on foreign capital at a time when global conditions are uncertain. Confidence across the New Zealand economy is softening again, comparable to those seen during the Global Financial Crisis. Even if our low-valued dollar has contributed to higher exports and a positive trade balance, this reinforces inflationary pressures.

Sectoral Exposure: Agriculture Under Pressure

The agricultural sector is particularly exposed. Farming in New Zealand is highly dependent on fuel for machinery, irrigation, and transport, as well as energy-intensive inputs such as fertiliser and feed. With higher costs, farm margins will come under significant pressure, resulting in reduced investment and even slower growth.

From Temporary Shock to Persistent Weakness

In a prolonged shock scenario, these dynamics risk reinforcing each other. External pressures feed into domestic weakness, and domestic weakness limits the economy’s ability to adjust. This is how a temporary shock can evolve into a more persistent, low-growth and high-cost environment.

Scenario Outlook Under Uncertainty

We can anticipate a few scenarios that could emerge based on our understanding of contemporary macroeconomic conditions.

If the ceasefire in Iran continues beyond the two-week period agreed yesterday, the conflict would be short-lived. While oil prices initially rise due to uncertainty and risk premiums, markets would gradually stabilise as supply chains adjust and geopolitical tensions do not escalate further. Financial markets would price in a short-lived shock with limited medium-term implications.

Secondly, a prolonged scenario is plausible where the conflict persists without a clear resolution. Markets would remain volatile with periodic price spikes reflecting ongoing geopolitical risk. This could resemble, but exceed, the shock following the Russian invasion of Ukraine. The shock becomes embedded in the domestic economy rather than remaining temporary.

Thirdly, rapid geopolitical escalation cannot be ruled out. A severe escalation could result in a global depression, with widespread stagflationary conditions, sharp increases in input costs, and heightened currency instability.

Shifting Global Order and Strategic Implications

Finally, the diversification away from the US dollar is likely over the longer term. As the world’s reserve currency, the dollar depends on investor confidence. However, rising US debt levels and the geopolitical use of financial systems may weaken that confidence.

As noted by economist Kenneth Rogoff, the global economy may pivot further towards Asia, with increased reliance on alternative monetary systems such as the Yuan.

For decision-makers across the private sector and government institutions, forward planning and scenario analysis will be critical. Investment allocations may need to shift towards more stable markets across the Asia-Pacific.

Governments should also consider strategic hedging by maintaining constructive relationships with both the United States and China.

Conclusion: A Test of Economic Resilience

The US-Iran War represents more than a temporary geopolitical disruption. It is a stress test of New Zealand’s macroeconomic resilience in an increasingly fragmented global order.

For policymakers and market participants alike, the challenge is not merely to respond to immediate pressures but to adapt to a world characterised by recurring supply shocks and deep uncertainty.

Economic resilience will depend on prudent macroeconomic management and a more strategic positioning within the Asia-Pacific region to safeguard long-term stability and prosperity.

Bringing Transparency and Liquidity to Aotearoa’s Electricity Hedge Market

Principal Economics is delighted to release our new report for the Electricity Authority, evaluating market-making parameters for a standardised super‑peak hedge contract. This analysis supports regulatory design that promotes price transparency, market liquidity, and robust consumer outcomes.

Key Findings

• Tiered Spread Cap Recommendation:
  We suggest a responsive cap structure with a 3.5% spread during normal conditions, and up to 8% during high-volatility or stress periods, ensuring a balance between affordability for hedge-takers and sustainable participation by market makers.
• Optimal Quote Depth Identified:
  Market-maker net benefits peak between 10–15 MW of quote depth. Beyond this range, marginal benefits decline, reflecting diminishing returns.
• Evidence-Based Elasticity Insights:
  Regression results show that in high-volatility environments, a 1% increase in volatility increases spreads by ~0.37%, while doubling depth lowers spreads by ~8%, highlighting the trade-off between risk and liquidity.
• Real-World Spread Benchmarking:
  Analysis of super‑peak auction data reveals median effective spreads around 3%, with the 95th percentile reaching 9–10%, supporting the recommended cap framework.
• Policy Framework Based on an Optimal Frontier:
  We apply an optimal frontier approach, plotting trade-offs between spread and depth to identify efficient market-making combinations. These choices deliver targeted liquidity at minimal cost—supporting the Electricity Authority’s public-interest objectives.

Why This Matters

The findings inform regulatory calibration of market-making in New Zealand’s super-peak hedge markets—helping ensure resilience amid volatility and price shocks, while avoiding onerous caps that stifle market participation. Our evidence-based design framework is meant to support durable, fair, and cost-conscious policy choices.

Read the full report for a comprehensive breakdown of our methodology, data, simulations, and policy implications:
Download the report PDF here.

The Emissions Reduction Plan 2 (ERP2) delineates Aotearoa New Zealand’s strategy to attain its emissions reduction objectives for the 2026-2030 period, alongside setting a path towards achieving long-term emissions reduction objectives. ERP2 aims to reduce annual average emissions from 72.5 MtCO2e to 61 MtCO2e. The Ministry for the Environment (MfE) engaged Principal Economics Limited, the Centre of Policy Studies, and Infometrics Limited to evaluate the comprehensive impact of the proposed policies. This includes:

• Assessing the comprehensive economic repercussions of emissions mitigation policy packages within ERP2.

• Estimating and understanding of secondary or indirect consequences.

• Carrying out distributional analysis of these ramifications.

The critical policies investigated in our report include:

• Increasing renewable energy through Electrify NZ

• Targeting 10,000 public EV chargers

• Lowering agricultural emissions

• Investing in resource recovery

• Improving public transport

• Investigating carbon capture, utilisation and storage.

Cite this article

Torshizian E, Adams P, Stroombergen A. 2024. Economic Impact of New Zealand’s Second Emissions Reduction Plan. Report to Ministry for the Environment by Principal Economics Limited in collaboration with the Centre for Policy Studies and Infometrics Limited.

Aotearoa New Zealand suffers from an infrastructure deficit. Without the key infrastructure needed now for our economy to thrive, we deprive future generations from significant economic prosperity. While transformational infrastructure projects necessitate time to be developed into sound technical solutions to our needs, many New Zealand projects are further delayed by policy decision and financing constraints.
In this novel application of the infrastructure Wider Economic Benefits approach, we quantify the cost to society of these further delays for the first time, by using the example of the Waikato Expressway. We used our subregional CGE model to estimate the downstream benefits of the Expressway. At a high-level, results of our analysis quantify the annual benefits of having the Waikato Expressway in the economy. Without the expressway in function as early as possible, $334 million of economic benefits were forgone each year.

Cite this article

Principal Economics. (2022). Great decisions are timely: Benefits from more efficient
infrastructure investment decision-making. Report to Infrastructure New Zealand.