Scenario Analysis

Energy prices have been highly volatile since the outbreak of the conflict in the Middle East, reflecting shifting expectations about its duration and the extent of the related energy supply disruptions. A larger and more persistent disruption than assumed in the baseline projections of this forecast would not only affect oil and gas markets, but also weaken global growth and trade, depress confidence, and raise risk premia. This Special Topic assesses the potential macroeconomic impact of one such downside scenario. 

As the conflict in the Middle East drags on, oil and gas prices could stay high for longer than assumed in the baseline projections. When the assumptions for this forecast were finalised, futures curves remained downward sloping over the forecast horizon, though by end-2027 both oil and gas prices were still around 20% above their pre-conflict levels. This market pricing appeared broadly consistent with expectations of a relatively swift reopening of the Strait of Hormuz—possibly by early summer 2026—followed by a rapid, though partial, normalisation of flows. ⁽[5]⁾ However, as the conflict persists, the window for such an outcome continues to narrow, increasing the risk that current market pricing may prove too benign. ⁽[6]⁾ 

In a downside scenario, supply disruption would be both larger and more persistent than currently embedded in market prices. At this stage, many scenarios remain possible. This analysis illustrates one plausible downside path whereby physical and logistical constraints continue to limit oil and gas exports from the Gulf countries well into early 2027. ⁽[7]⁾ This scenario results from continued restrictions to maritime transit through the Strait of Hormuz, even after its assumed reopening in late summer 2026, and gradual restoration of production and export infrastructure—together resulting in persistent logistical bottlenecks limiting the effective delivery of oil and gas to international markets. Only around half of pre-war oil export volumes and roughly one fifth of gas export volumes from the Gulf would reach international markets by end-2026 under this scenario. As a result, prices decline only gradually as energy flows from infrastructure repairs progress sufficiently, shipping conditions normalise, and additional LNG export capacity from other suppliers comes online, allowing supply conditions to normalise only gradually after the reopening of the Strait of Hormuz. 

The scenario differentiates between oil and gas markets, reflecting important structural differences in global market functioning. Oil markets are deeper, more liquid and globally integrated, with larger inventories and greater substitution possibilities across suppliers. This allows part of the disruption to continue being absorbed through inventory releases, trade re-routing and higher output elsewhere, including from North America and Norway. At the same time, the sheer scale of the supply shortfall still leads to a sharp price increase, with oil prices peaking at around 180 USD/bbl in late 2026, before easing gradually as supply conditions improve.

Gas markets are assumed to remain tight for longer. The impact on Europe arises mainly through higher global LNG prices, given the intensified competition with Asian buyers for flexible cargoes. Seasonal factors amplify these pressures, as storage refilling during summer 2026 is followed by stronger winter demand for heating and electricity generation amid lower renewable energy production. In this scenario, continued restrictions to shipping through the Strait of Hormuz delay the normalisation of global LNG supply flows. This contributes to European gas prices rising to around 80 EUR/MWh in late 2026, before easing progressively throughout 2027 as global LNG supply, particularly from new capacities in North America, expands further. 

Graph I.7.1:  Quarterly oil and gas price paths under the baseline forecast and the downside scenario

For reference, the external assumptions from the previous forecast round (AF25) are also plotted, illustrating the shift in the baseline since autumn 2025. It should be noted that the baseline already incorporates elevated energy prices relative to pre-conflict levels. The downside scenario captures only the additional impact of a more prolonged and severe disruption relative to the baseline.

These alternative energy market assumptions are incorporated into the European Commission’s Global Multicountry (GM) model to assess their macroeconomic implications ⁽[8]⁾. The GM model captures the joint adjustment of inflation, monetary policy, domestic demand, trade flows and public finances following a large external price shock. Monetary policy responds endogenously through an estimated Taylor-type rule, while automatic stabilisers drive adjustments in government revenue and expenditure in the absence of discretionary fiscal measures. Growth in the rest of the world and trade also respond endogenously to a global shock in prices, generating negative spillovers to EU export performance. The model is estimated based on historical data, including that of the 2022 energy crisis, and therefore embeds empirically observed lag structures, substitution effects and historical macroeconomic relationships. 

Higher energy prices are also assumed to raise global uncertainty lift risk premia, weighing on consumer confidence, and constrain global growth. These amplifying channels are imposed as additional exogenous assumptions in the model. EU risk premia increase by 25 basis points relative to the baseline assumptions, raising the cost of funding. Consumer confidence declines further, ⁽[9]⁾ raising the saving rate. Output growth in the rest-of-the-world is assumed to decline by an additional 0.25 pps. in 2026, over and above what is already implied by the endogenous transmission of the energy price shock. ⁽[10]⁾ 

The terms-of-trade shock pushes up inflation and, together with the additional amplifying channels, exerts a sizeable drag on activity. As a net energy importer, the EU experiences a decline in real income as higher oil and gas prices raise production costs and reduce households’ purchasing power. Weaker confidence and tighter financial conditions amplify the drag on domestic demand. Namely, concerns about the future raise precautionary savings and depress household consumption; while higher risk premia and rising borrowing costs weigh on investment. Meanwhile, firms pass part of the higher input costs on to consumers, generating inflationary pressures that spill over onto core inflation. The tightening of monetary policy is concentrated in 2027, with policy rates on average around 30 basis points higher than in the baseline. External demand also deteriorates, with rest-of-the-world growth slowing by around 0.5 pps. relative to the baseline, reducing export growth further. Automatic stabilisers only partly cushion the shock, still leading to a deterioration in the general government balance of around 0.5% of GDP in 2027. Overall, weaker domestic and external demand, together with monetary policy tightening, exert a disinflationary force that partly offsets the direct inflationary impact of higher energy prices, though not enough to prevent a significant rise in headline inflation.

All in all, in this downside scenario, EU GDP growth is almost halved relative to the baseline, while inflation ends up significantly higher, especially in 2027. EU GDP growth is falling by a further 0.4 pps. in 2026 (to 0.7% vs. 1.1%) and 0.7 pps. (also to 0.7% vs. 1.4%) in 2027 (see Graph I.7.2). ⁽[11]⁾ As commodity prices peak only towards end-2026, the bulk of the pass-through materialises in 2027. In 2026, inflation is only 0.3 pps. higher than in the baseline (3.3% vs. 3.0%), but in 2027 the gap widens to around 1.1 pps. (3.5% vs. 2.4%). The tightening of monetary policy implied by the estimated policy rule helps contain the surge in inflation but exerts an additional drag on GDP. The effects are persistent due to endogenous lags in the pass-through to consumer prices and wages, as well as the gradual adjustment of interest rates implied by the model's estimated policy rule.

Graph I.7.2:  Downside scenario: Results

The energy price shock dominates the inflation profile, while most of the drag on activity stems from trade, confidence and risk premia effects. The aggregate effect can be decomposed into the initial terms-of-trade shock and the amplifying shocks. The latter slightly dampen inflation, as the demand-reducing effects of lower confidence and tighter financial conditions partially offset upward price pressures (Graph I.7.3).

Graph I.7.3:  Decomposition

Important limitations apply to this analysis. Beyond scenario uncertainty, the results are also subject to model uncertainty. The simulations may understate the economic costs of a prolonged energy shock if behavioural responses become increasingly non-linear at sustained high price levels. Since the estimated elasticities are primarily identified from historical observations characterised by more moderate energy-price fluctuations, their validity may diminish when applied to exceptionally large and persistent shocks. Similarly, non-linearities in energy price formation, particularly through the gas-to-electricity price link, as well as a possible de-anchoring of inflation expectations, could amplify inflationary pressures beyond what is captured by the model (on renewables as a mitigating factor, see Box I.6.1). Finally, the scenario is conducted at EU level; impacts across Member States would differ depending on their energy import dependence, energy mix and the speed of pass-through to consumer prices.