The S&P/ASX200 finished Thursday down 21.2 points, or 0.2 per cent, to 8665.8 while the broader All Ordinaries eased 28.1 points, or 0.32 per cent, to 8887.6.
Brent crude prices soared above $US125 a barrel - the highest levels reached since the Middle East war began - following reports of a possible military escalation by US President Donald Trump amid gridlocked talks with Iran.
Moomoo Australia and New Zealand market strategist Michael McCarthy said markets were caught in a bind.
"There was a lot of optimism, particularly coming out of the US, but shared by some investors around the globe, that the conflict in the Middle East would be quickly resolved," Mr McCarthy told AAP.
"That confidence is being eroded."
Australian oil and energy stocks closed higher but weakening sentiment weighed on consumer staples and mining stocks.
Australian supermarket chain Woolworths warned higher fuel costs due to the Middle East war were putting customers under pressure and adding to operating costs, clouding its earnings outlook with uncertainty.
Shares in the grocery giant fell 7.8 per cent, with competitor Coles down 3.6 per cent.
The two big supermarkets have also been accused of deceiving customers with misleading discount pricing claims by the consumer watchdog, which is pursuing them in the Federal Court.
Miners were broadly lower on weaker gold prices and a deteriorating global growth outlook.
Diversified miner South32 dived 5.4 per cent after reporting cost overruns and delays on one of its projects, while lithium and iron ore player Mineral Resources defied the trend with a 2.9 per cent gain after upgrading full-year guidance across parts of the business.
BHP fell 2.2 per cent to $53.72, Rio Tinto slipped 2.0 per cent to $167.40 and Fortescue dipped 2.8 per cent to $19.65.
Australian tech was mixed after reporting from four of the Magnificent Seven stocks showcased a rosy outlook for the artificial intelligence boom.
Mr McCarthy said Australian tech stocks with AI exposure were performing best, including data centre operator NextDC, up 1.7 per cent, and logistics tech company WiseTech, which gained 3.4 per cent.
"It's not buy all tech, it's buy particular tech," he said.
Financial stocks finished higher, with ANZ outperforming the other Big Four banks, up 1.3 per cent to $36.65.
CommBank gained 0.9 per cent to $173.66, Westpac lifted 0.7 per cent to $38.50 and NAB climbed 0.5 per cent to $39.88.
Exchange operator ASX Ltd stocks climbed 5.1 per cent after group executive for markets and listings Darren Yip was appointed interim chief executive.
The Australian dollar is buying 71.16 US cents, down from 71.58 US cents at close on Wednesday.
ON THE ASX:
*The S&P/ASX200 finished down 21.2 points, or 0.2 per cent, to 8665.8
*The broader All Ordinaries eased 28.1 points, or 0.32 per cent, to 8887.6
One Australian dollar trades for:
* 71.16 US cents, from 71.58 US cents at 5pm AEST on Wednesday
* 114.28 Japanese yen, from 114.29 Japanese yen
* 60.98 euro cents, from 61.20 euro cents
* 52.79 British pence, from 53.03 British pence
*122.09 NZ cents, from 112.08 NZ cents
