Palestinians said the measure would deepen a humanitarian crisis brewing in the occupied West Bank and Gaza Strip.
The head of the Palestinian petrol commission, Mujahid Salama, said on Wednesday he expected petrol supplies to run out on Thursday.
"If this happens, there will be a humanitarian crisis," he said.
The stoppage has already virtually stalled the public transportation system and brought about shortages in cooking gas and other fuel derivatives. In the Gaza Strip, a higher number of mule carts than usual were seen on the streets.
Salama said Palestinian officials were in touch with American and European diplomats hoping to pressure Israel to reverse the measure by Dor Energy.
The Hamas government spokesman, Ghazi Hamad, said Israel's move was political.
"We have an agreement with that company, the problem is not the money, the problem is political. Israel is trying to scuttle this government in a sea of crises, they are saying that openly."
Asaf Sharif, an aide to Ehud Olmert, the Israeli prime minister, confirmed that Dor had decided to halt the shipments.
In the past, Israel paid the debt from tax revenues it collects for the Palestinian Authority. However, Sharif said Israel would not do so again.
Israel has frozen the $55 million in monthly tax transfers to the Palestinian Authority as part of its boycott of the new Hamas-led government which took power in March.
"If this happens, there will be a humanitarian crisis"
head of the Palestinian petrol commission
The money has been placed in escrow. Israel used some of the money last month to pay the fuel debt, preventing a fuel emergency.
Israel said, however, it would not oppose measures by the Middle East Quartet for peace - the United Nations, European Union, United States and Russia - to resume channelling aid to the Palestinians through a new mechanism that will bypass Hamas.
Khalid Amayreh in the West Bank contributed to this story.