Hansjörg Blöchliger
OECD Economic Surveys: Iceland 2025
Abstract
Abundant cheap and green domestic electricity has long been a mainstay of economic development in Iceland. Yet growing demand driven by decarbonisation efforts and the digital transition, among others, are straining Iceland's power system. Supply constraints are biting more frequently, and prices are rising. The ageing transmission grid is reaching its capacity limits. Land-use disputes and a tedious licensing process are holding back new generation and transmission projects. Wind energy remains underdeveloped with insufficient compensatory hydro generation when the weather is calm. The energy market is dominated by a few players connected through confidential agreements and the absence of differentiated (or marginal) pricing complicates demand management. The government should develop a 'fast-track' administrative framework for prioritized power projects, streamline the licensing process with binding timelines, and establish a one-stop shop for permit requests. It should also gradually deepen the wholesale market.
For decades, abundant and clean domestic electricity, mostly from hydrological reservoirs and geothermal sources, has powered Iceland’s economy. However, growing demand is putting Iceland's power system under strain. This rising demand is closely linked to climate policy, as the move away from fossil fuels is a key strategy for reducing carbon (or greenhouse gas) emissions. Iceland’s per capita carbon emissions are considerably above the OECD average (Figure 3.1, Panel A). The highest share of emissions comes from industry, mainly due to the operations of three large aluminium smelters and the fossil fuel-based fishing fleet (Panel B). Emissions from electricity generation, mainly carbon leakage from geothermal harnessing, are almost negligible. Transport including aviation still emits a lot of carbon, but its share has fallen below the OECD average.
Note: Panel A, OECD average refers to unweighted average of 38 member countries.
Source: OECD, Environment Statistics database; OECD, Effective Carbon Rates; and Environment Agency of Iceland.
The government plans to cut greenhouse gas emissions from non-ETS sectors by 41% by 2030 compared to 2005, under the joint effort sharing mechanism with the European Union, and to become fossil-free by 2040 (Figure 3.1, Panel D). The climate action plan, first published in 2018 and updated in 2024, outlines around 150 measures, particularly in transport and land use, to meet this goal (Government of Iceland, 2024). The plan emphasizes the electrification of transport, considered the "third energy transition" following the completion of transitions in energy generation and heating, as a key strategy. Land transport emissions are targeted to decrease from over 900 million tonnes of carbon annually, or a third of all emissions, to around 600 million tonnes by 2030, primarily through road transport electrification and increased use of e-fuels. Significant investments in carbon capture and sequestration, especially in the industrial sector and through land use change, are also planned to reduce the carbon imprint. Broadening and further raising carbon taxes, which currently amount to EUR 55 per tonne and exempt several sectors could further accelerate progress towards climate targets and raise demand for electricity (Figure 3.1, Panel C). The distance-based car tax for fossil-fuel cars, to be implemented in summer 2025, will help reduce emissions by encouraging shorter trips. Such a tax also better reflects the cost of infrastructure use (chapter 1).
The electrification of land transport will considerably increase electricity demand. Projections assume that by 2030 all newly registered cars, and by 2040 all newly registered vans, trucks, and buses, will be electric. The greening of the fishing fleet will also push up power demand, as ships will be propelled by batteries or domestically produced e-fuels (hydrogen and related) (Government of Iceland, 2024). Demand from aviation will grow more slowly, with renewable fuel expected to account for 5% of international flights by 2030 and 50% by 2050, while 50% of domestic flight energy is expected to be renewable by 2035. Additional electricity demand will come from innovative energy-intensive industries such as data centres, aquaculture, and the pharmaceutical sector. Little additional demand is expected from large industrial users like aluminium smelters, especially as the largest power company Landsvirkjun does not intend to provide electricity to new smelters. Also, the power companies did not renew delivery contracts with cryptocurrency miners in 2024, and are focusing on new sectors such as AI and aquaculture instead.
Overall, the latest 2024 energy forecast from the regulator anticipates domestic electricity demand to rise from around 20 Terawatt hours (TWh) to approximately 27 TWh by 2050 (Figure 3.2). The projections have become steeper over time, with the 2023 forecast for 2050 being about 13% higher than those made just two years earlier, reflecting the impact of recent policy initiatives such as the decarbonisation of transport (lower projections in 2021 compared to 2018 reflect slowing industry demand). The network operator Landsnet predicts an even steeper increase in power demand (Figure 3.5, Panel A). Although Iceland's projected demand profile is less steep than in most OECD countries as the energy transition is more advanced and projected demand from industry lower, energy security - defined by the International Energy Agency as the uninterrupted availability of energy at an affordable price - has become a public concern. A key challenge for Iceland is to meet this rising demand for electricity in a way that is consistent with the country’s climate targets.
Gross electricity consumption in terawatt-hours, actual and projected
Source: The Electricity Regulatory Authority.
The economic impact of weather and climate-related events has been small so far (Figure 3.3) but might rise going forward due to increased risk of flooding, more frequent droughts, and ocean acidification, while the melting of the country’s glaciers would provide storage for more hydropower, at least for some time (Ministry of Environment and Natural Resources, 2021). As such the government is currently developing its first climate adaptation plan, to be published in 2025. The plan should assess climate-related risks to identify adaptation needs, design policies to address relevant risks, and assess related financial needs. Chile’s recent earthquake insurance arrangement offers insights into how insurance can support the financing of climate adaptation costs (World Bank, 2025). Past recommendations and actions taken to address climate change and foster green growth are shown in Table 3.1.
Economic losses caused by weather- and climate-related extreme events (1980-2023)
Source: European Environment Agency; Eurostat.
Abundant and cheap electricity has long been a beacon of Iceland’s economic development strategy. Since the 1960s, hydropower, and since the 1980s, geothermal energy, have rapidly replaced fossil fuels, now contributing virtually 100% of electricity production (Figure 3.4). The strategic decision to harness these energy resources for large industrial exporters is considered a pivotal moment in Icelandic economic history. Today, power supply and economic growth remain closely linked, particularly with the rapid expansion of energy-intensive industries like data centres and aquaculture. The widespread availability of low-cost energy, both electricity and geothermal heating, also supports high living standards for households. Regulatory reforms, including alignment with the EU energy regulatory framework and the partial unbundling of generation, transmission, and distribution in 2005, have helped maintain the power sector's efficiency and competitiveness (Box 3.2).
Electricity generation and calculated electricity consumption
Source: International Energy Agency, World Energy Balances; and International Energy Agency, Monthly Electricity statistics. The difference between generation and calculated consumption are transmission losses.
However, energy supply has expanded less in recent years, leading to a decline in energy security (IEA, 2021). While electricity generation quadrupled from 1995 to 2015, annual growth has since slowed to just over 1% per year (Figure 3.4). Iceland’s largest electricity producer reports that the power system is now running at full capacity, with households and small firms adding 5 to 10 MWh or 0.5% of power demand per year, excluding additional demands from the transport sector (Landsvirkjun, 2023). Only a fraction of the power projects approved by Parliament in the past decade have been completed or are well advanced (Government of Iceland, 2021). As a result, some power companies have curtailed deliveries to large industrial consumers when supply falls short (Orkustofnun - National Energy Authority, 2023). Moreover, some power providers have rejected demands from green industrial projects for lack of sufficient capacity. Against this backdrop, forward prices are rising, although they remain relatively low, as Iceland’s grid is isolated from global factors (Figure 3.5, Panel B). The Federation of Icelandic Industries and the transmission system operator (TSO) Landsnet estimate total losses from electricity curtailments, above all lower export revenues, at around 0.5% of GDP per year.
The gap between demand and available supply is expected to widen in the coming years (Figure 3.5, Panel A). Planned increases in generation fall significantly short of projected consumption, both in the short and long term. The system already appears to be operating at full capacity, before new power stations are expected to come online around 2028. The situation could become challenging again by 2040 or earlier, depending on the scenarios. Increased burning of fossil fuels to compensate for insufficient renewables, as is currently happening, or unstable transmission and distribution could further undermine climate targets. Supply disruptions caused by natural disasters, such as the 2023 volcanic eruption that temporarily cut a transmission line serving Grindavik on the Reykjanes peninsula, could exacerbate potential energy shortages.
Note: “EU policy” and “Government policy” refer to the relevant emission reduction targets (Figure 3.1, Panel D).
Source: Landsnet (Transmission Operator).
Transmission capacity faces similar challenges. Parts of the electricity grid, some featuring wooden high-voltage pylons from the 1970s and 80s, have not been upgraded for decades and are now running at full capacity. Generation at a large hydropower plant in eastern Iceland is underutilized because the transmission grid is unable to transport the power to the populous southwest. Similarly, a bottleneck in the northern grid prevents geothermal power from reaching the south (Figure 3.6). An ageing electricity grid could also be the cause of relatively high transmission losses of between 2.5 and 5% of production (Figure 3.4). The costs of transmission bottlenecks and the potential benefits of investment in the grid are not directly visible because the network operates as a single zone, unlike the Nord Pool region, which is divided into separate pricing areas (or bidding zones) (OECD, 2024). Expanding transmission capacity is often hindered by land use conflicts and lengthy administrative procedures (see below), with landowners and environmental organisations resisting grid expansions and additional overland lines. While underground transmission cables could reduce opposition, this option is costly and in some cases impractical for high-voltage lines.
Wind energy expansion could alleviate demand pressure and improve energy security in Iceland, but concerns about intermittency limit the use of more wind. Onshore wind is among the cheapest energy sources when the winds blow. Planning for several large wind farms is advanced, driven by rising demand for hydrogen and other e-fuels whose production does not require full and uninterrupted baseload energy supply. Adding wind to the energy mix could indeed enhance resilience to idiosyncratic shocks (Jasiūnas, Lund and Mikkola, 2021). However, wind production varies with the weather, causing intermittency, stronger price fluctuations and higher risks of shortages during calm periods. Strong winds may overload the grid, requiring specific regulation and pricing. As such, additional wind power needs to be supported by new hydro energy, increased transmission capacity and storage, and greater flexibility in electricity use. Consequently, planned wind projects are on hold as power companies cannot offer sufficient backup hydrocapacity. Offshore wind does not yet seem to be commercially viable in Icelandic waters, although several projects are undergoing feasibility studies.
Transmission grid, carrying capacity in kV
Note: The dotted line reflects the most significant bottleneck in Iceland’s power grid.
Source: Landsnet (Transmission Operator).
Given the long delays in implementing electricity infrastructure, the government should establish a roadmap to guide the scoping and sequencing of new generation and transmission projects, based on its long-term energy strategy “Energy Policy 2050” (Government of Iceland, 2020), as planned. This should include expanding the generation and transmission of a balanced mix of hydro, geothermal, and wind energy, along with careful coordination of network expansion and individual power generation projects and based on comprehensive cost-benefit analysis. In April 2025, the government started a public consultation for legislation on a long-term energy roadmap.
Obtaining the licenses and permits needed to build or expand power plants and transmission lines has become a major obstacle to expanding electricity supply. While power companies and the TSO are ready to advance investments rapidly, administrative processes seem to have slowed to a crawl. The licensing and permit process is often described as unpredictable, expensive, and lengthy. Processing times have increased in recent years without apparent changes in laws or regulations. Veto powers are strong, with municipalities and landowners having relatively low thresholds to appeal permit decisions. Facing tedious licensing processes, power companies are hesitant to start new projects to avoid costs and stranded investments.
Competing interests over land use often cause long waits for permits. Landowners frequently resist new power projects and appeal expropriation, particularly in the case of new transmission lines, arguing that they diminish property values. Environmental and nature conservancy organisations also intervene during or after the administrative process, claiming that power projects harm the natural environment. Appeals and judicial reviews extend the duration of the licensing and permit process. Almost any private landowner or environmental organisation can request a review by the Board of Appeal, whose decisions are considered final but can still be contested in court. As noted, technical solutions like putting grid lines underground can sometimes ease land-use conflicts, but they are costly and not always feasible. Thus, land-use conflicts clearly reveal the tension between achieving one environmental objective (reducing carbon emissions) and another (conserving nature).
A lengthy administrative process compounds the problem. Implementing power projects follows four stages (Table 3.2). The first stage is for a power project to be included in the Icelandic Master Plan for Nature Protection and Energy Utilisation, adopted by Parliament (Government of Iceland, 2021). This rolling plan aims to reconcile the competing interests of nature conservation and energy utilisation on a country-wide scale. Parliament selects projects based on the recommendations of a technical committee and assigns them one of three priority levels: utilize, hold on, or protect. The second to fourth stage involve the actual licensing and permit process, which is fraught with procedural obstacles. The process involves roughly a dozen agencies potentially issuing around 20 permits, plus mandatory reviews from public and private stakeholders. Agencies tend to work sequentially, meaning each agency starts processing requests only after another agency has completed its procedures. The process lacks a central agency to act as a one-stop shop for power companies and coordinate procedures within the administration, unlike in Norway, where the Water Resources and Energy Directorate is the top agency for licensing power projects above 10MWh. Moreover, deadlines set for agencies are rarely binding, and a “silence is consent” principle or similar is lacking. The Minister for Foreign Affairs has appointed a working group to address the "gold plating" of EEA rules, where authorities impose provisions exceeding the minimum requirements of EEA legislation, with repercussions on power projects (Chapter 4). Overall, faster administrative procedures could considerably help to speed up the implementation of new electricity projects.
Agencies involved in issuing permits and licences for a new power project
Source: Landsvirkjun (national power company).
Municipalities have insufficient incentives to approve or accelerate new power projects and often use their zoning and administrative powers to delay development. They receive property tax from power stations but no local water royalties or fees, while the financial benefits of the mostly public power companies go to the central government. In contrast, Norwegian municipalities receive up to 50% of royalties from local power plants. Additionally, low administrative capacity in the municipalities often delays the licensing process. A recent amendment to the planning act provides for the possibility of a single plan and licence for power lines crossing multiple municipalities, issued by a Committee appointed by the Minister of Social Affairs and Housing. However, no project has been found to meet the criteria so far. Finally, a few municipalities seem to delay approval for higher transmission capacity on the grounds that maintaining energy consumption close to generation plants could help develop the local economy. In 2024, a working group recommended extending the municipal property tax to all power infrastructure except transmission lines.
Thorough processes and stakeholder involvement are hallmarks in political decision-making for sensitive areas like property rights, energy production and nature conservation, ensuring broad and long-term societal support. However, electricity producers believe that the length and potential disruptions of the approval process have gone too far in Iceland (Landsvirkjun, 2023). Opinion polls show that over 60% of Icelanders support new power projects and favour faster implementation. To address this, early consultation with key stakeholders and strengthening fast-track solutions once projects are politically endorsed could help accelerate the process and reduce uncertainty, as seen in the 2024 Swiss power law reform (Box 3.1). The redesign of licensing, including establishing a one-stop shop for applicants, could streamline procedures and make outcomes more predictable. In early 2025, a bill was sent to Parliament providing for measures to simplify the permitting procedures, which is welcome.
In a referendum held in June 2024 Switzerland adopted a new electricity law intended to increase domestic and renewable power generation and improve energy security. The law requires the country to increase renewable power (hydro, wind and solar) from 37 TWh in 2022 to 73 TWh by 2035 and 84 TWh by 2050. A key objective of the law was to speed up new construction or extension of power projects through regulatory reform. The law designates large wind and solar installations as in the national interest, subjecting them to accelerated and more consistent planning procedures. It also lists 15 projects for hydropower (akin to the “high priority” ones in Iceland’s Master Plan) which will undergo a faster, streamlined licensing process. Additionally, the law introduces dynamic pricing, particularly for solar energy, to balance supply and demand and prevent network overload during peak times.
A broad consultation process helped identify the hydro projects for accelerated licensing. Following several roundtable discussions prior to the parliamentary debate, power companies, environmental organisations, cantonal governments, and federal agencies agreed to include 14 projects in the draft law. Parliament added one hydro project and cancelled none, indicating broad political support for the projects agreed upon beforehand. The projects enshrined in the law are fully exempt from municipal land use planning and licensing requirements. Appeals and judicial reviews for these projects are also more limited than for non-listed projects, further accelerating their implementation. With these fast-track privileges, the permit and licensing process is expected to become considerably faster and more predictable for power companies and TSOs.
Source: (Swiss federal government, 2024) (Swiss federal government, 2022).
Reforming the regulatory framework in the power sector could enhance energy security and promote more efficient electricity usage. Such measures include expanding the wholesale market, introducing and expanding dynamic (or peak-load) pricing of electricity, while ensuring minimum safeguards for households. Overall, the Icelandic power market stands to benefit from regulatory reforms (Box 3.2).
Iceland’s electricity sector is mostly owned and operated by public companies. Landsvirkjun is the largest production company, generating around 71% of the country’s power, followed by Reykjavik Energy (19%) and a few smaller power companies. Landsnet, the network operator, is in the main part owned by the government (93%) after Landsvirkjun sold its 65% share at the end of 2022. Five distribution companies and municipally-owned retailers are responsible for getting electricity to households and firms. Several environment and energy authorities are responsible for monitoring and regulating power companies and, among others, for issuing licences for new power plants. Iceland has been following EU regulation on electricity markets since 2005, but regulation is more stringent than in most EU countries because of a large share of publicly-owned companies, restrictions on foreign ownership and a small wholesale market (Figure 3.7). In 2021 Iceland aligned legislation with the EU’s third energy package, notably introducing better consumer protection and a clearer definition of energy security.
Product market regulation in the electricity sector, 2023
Note: The indicator assesses regulation, conduct and public ownership in the electricity sector. 0 is the least restrictive, 6 is most restrictive.
Source: OECD 2023/2024 OECD PMR database.
The market is oligopolistic, dominated by a few large producers and consumers, primarily firms producing energy-intensive commodities such as aluminium and other metals. Long-term bilateral agreements, most of which are confidential, govern the relationships between market participants, with prices potentially deviating from long-term marginal costs. Most large industrial consumers establish direct contractual relationships with producers or the network operator, bypassing distributors. Although barriers to entry in the power generation market are relatively high, several private companies have recently shown interest in installing wind power. Two trading platforms (ELMA and Vonarskarð) are in operation as wholesale power exchanges with transparent trading rules and an effective price-setting mechanism for both short and long-term transactions since 2024/25.
Source: (OECD, 2023) and updates provided by the administration.
Market concentration and the prevalence of a relatively small wholesale market could undermine the efficiency of the power sector. Approximately 80% of electricity consumption is governed by long-term contracts between suppliers and large industrial consumers, creating barriers for new entrants on both the supply and demand sides and hindering innovation. The two wholesale power exchanges, established in 2024 and in 2025, cover only around 20% of the total market, primarily serving households and SMEs. Furthermore, the available associated financial derivatives instruments are still very limited, making risk management and price hedging, as practiced in the Nord Pool area, challenging (Nordic Energy Research, 2024). In this context, deepening the wholesale market to become more competitive and transparent, with prices reflecting both short- and long-term electricity scarcity, should be a core element of power market reform. The gradual expansion of the wholesale market should be accompanied by contingency plans and backstop supply guarantees for households and small enterprises in case of shortages. Enhanced use of price signals would also foster the development of smart technology (such as more flexible turbines and digitalisation) to increase productivity.
Finally, better aligning electricity prices with demand peaks could promote more efficient electricity use at the household level. Currently, most households pay a single power tariff, regardless of the time of day or season, which encourages wasteful or excessive electricity use. Only recently have the first smart meters been introduced, allowing metered households to pay power fees that vary over time. Differentiated pricing helps to better manage demand, balance electricity consumption, and prevent grid overloads. The government plans to gradually extend smart metering to all households. Such initiatives are welcome as they provide the instruments for greater flexibility in electricity use and foster sustainable consumption.
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