"The role of the USA - the country with the most leverage over Israel - is key," said the analysis written by the Department for International Development (DFID) in consultation with the Foreign Office.
"Frustration with aspects of the Palestinian leadership, preoccupations in Iraq, presidential elections and security concerns for US citizens may risk USA disengagement at the highest levels from the peace process when it is most likely to start collapsing," said the report published in the Guardian newspaper on Wednesday.
"There is now a medium to high probability that there will be a lack of effective international engagement on the Middle East peace process due to other international priorities in 2004."
"The EU, by contrast remains focused, but has limited influence," it said.
"The Palestinian state which would be left if Israel controlled all access and/or permanently withdrew behind the current and planned route of the separation barrier would not be viable or stable"
DFID, Foreign Office report
Without action soon, Israeli settlement expansion and the continuing construction of the separation wall in the West Bank would make a viable two-state solution "almost impossible," said the report.
"Continuing failure to make progress towards a political solution" leading to the "continued construction of the separation barrier on Palestinian land, and gradual disappearance of the prospects for creating a viable Palestinian state" is the most likely scenario, it said.
"The Palestinian state which would be left if Israel controlled all access and/or permanently withdrew behind the current and planned route of the separation barrier would not be viable or stable," the report said.
It might instead prompt a majority of Palestinians to drop support for a two-state solution and "instead back a single bi-national state from the Jordan to the Mediterranean."
"Palestinians would outnumber Jewish Israelis in such a state within the next decade," it added.
The DFID report said this would be "the logical consequence of indefinite occupation by Israel".