An Analysis Paper by the Carboun Institute’s Decarbonization Pathways Program

Conflict and Contagion: Industrial Diversification at Risk in GCC countries

Author: Kapil Narula

The US–Israel war against Iran has ignited geopolitical instability in the Middle East, triggering a global energy supply shock, severe disruption to trade, and physical damage to critical infrastructure. For the Gulf Cooperation Council (GCC) countries, this has created a spectrum of risks from capital flight to forecasts of recession in the first half of 2026.

Collectively, the GCC countries accounted for a GDP of approximately US$2.3 trillion in 2024, ranking ninth globally. Their economic influence is underpinned by the production and export of nearly a quarter of global crude oil and natural gas, their role as a regional trading and logistics hub, ample financial reserves held in sovereign wealth funds (SWFs), and their growing appeal as real estate investment and tourism destinations. GCC countries are also engaged in an ambitious drive to diversify their economies away from fossil fuels and expand their industrial base. This strategic necessity to diversify beyond hydrocarbon exports has been reinforced by the ongoing war.

Since hostilities began in late February 2026, the industrial sector has faced export losses, sharp increases in input costs, and supply chain breakdowns, leading to a slowdown in economic activity that will impact GDP growth across the GCC. In the medium to long term, these disruptions present a structural stress test that may prompt a recalibration of the economic diversification agenda.

Prolonged instability in the region could trigger an industrial policy drift and reshape future economic trajectories. Governments may prioritize fossil-fuel-powered manufacturing over renewables-based production, delaying the energy transition within the industrial sector. In the worst case, a structural retreat could ensue as governments reevaluate the high risks and uncertain returns of diversification investments and prioritize the stability of hydrocarbon-dependent growth models over economic diversification goals.

This analysis aims to address the following questions in the context of GCC countries:

• What are the current economic growth and economic diversification trends?

• What are the likely impacts of the war in the short, medium, and long term?

• What policy approaches could accelerate industrial diversification and green industrialization amid conflict?

The analysis is focused on all six GCC countries: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE. It begins with an assessment of economic growth trends and progress in diversification, followed by a description of the scenario methodology used to evaluate the war’s impacts. The core analytical section examines the likely effects of the Iran war on industrial diversification. The paper then considers policy approaches and proposes recommendations to accelerate industrial diversification before concluding.

Throughout this analysis, economic diversification refers to the structural shift from hydrocarbon dependency toward diversified industrial, services, and knowledge-based economic activity. Industrial diversification denotes the expansion of an economy's productive base across multiple industrial sub-sectors, reducing dependence on any single output and strengthening resilience to sector-specific shocks. The analysis focuses on the manufacturing and energy supply components of the industrial sector, which are central to economic diversification across the GCC countries. Green industrialization refers to the transformation of industrial activity toward low-carbon energy sources and carriers, creating new productive capacities that decouple economic growth from fossil-fuel dependence while enhancing long-term industrial competitiveness. Green industrialization is treated here as a strategic pathway of industrial diversification, whose momentum may be strengthened or stalled by the unfolding regional war.