A looming power shortage in Iceland could have dire economic consequences 

By Elías Thorsson - May 20, 2024
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The Kárahnjúkar Hydropower Plant in the east of Iceland is the biggest power plant in the country and its construction was met with fierce protest from environmental groups. (Visit Austurland)

Internationally Iceland is known for its abundant green energy and for being a leader in hydro- and geothermal power technology, but concerns over environmental impacts has led to almost two decades of stagnation and a failure to increase energy production and expand capacity.

“I think more and more people in Iceland are realizing that those who don’t want to utilize natural resources, leave nature completely untouched and not affect ecological systems at all, are in fact preaching a decrease in living standards. We need to grow the economy, because the population is growing, but in the past five years nothing has been done in regards to increasing energy production,” says energy consultant and economist Þórður Gunnarsson. 

Gunnarsson currently works as an advisor for Iceland’s Ministry of finance and economic affairs and sits on the board of Reykjavík Energy. 

Economist Þórður Gunnarsson works for the Icelandic Ministry of finance and economic affairs and sits on the board of Reykjavík Energy.

The twentieth century was a period of vast economic growth in Iceland, which was driven by three main catalysts; the U.S. military’s need for infrastructure and labor, the mechanization of the fishing fleet and a rapid development of energy production. 

Electricity production in Iceland began in earnest in 1965, when the National Power Company Landsvirkjun was founded and with the construction of the Búrfell Power Station in 1969. The installed capacity of power plants in Iceland was around 270 MW in 1970, but it was set to multiply almost tenfold by the year 2007. The strategic decision to harness the country’s energy resources, with the aim of producing and selling electricity to industrial enterprises, represented one of the most significant turning points in Icelandic economic history. Johannes Nordal, the former CEO of Landsvirkjun, claimed that the commissioning of the Búrfell Power Station essentially marked a new phase of settlement in the country. 

The construction of Búrfellsvirkjun was among the most significant moments in Iceland’s economic history. (Hrafn Malmquist)

Since 2007, following the completion of the Fljótdalsstöð Power Station, the pace of increasing electricity production capacity in Iceland has significantly slowed down. Installed capacity increased by less than 15% between 2007 and 2023. The global financial crisis that began in 2008, hit Iceland especially hard. This had serious implications for the electricity market as Icelandic energy companies were heavily indebted, limiting their ability to invest.

“It is understandable that Landsvirkjun and Reykjavík Energy, which were struggling financially following the crash, stopped establishing new power plants in the immediate aftermath of the financial crash of 2008. But as the two companies recovered, there was increased pressure by the owners—the Icelandic government and the Capital Area municipalities—on the companies to pay out dividends,” explains Gunnarsson. “This was a marked difference from the last decades of the twentieth century when the policy was to invest revenue in new power plants to maintain a buffer for the future, to meet increased demand.”

The debate about balancing energy needs with protecting Iceland’s untouched nature is a longstanding one and during the mid twentieth century plans were even put in motion to dam the country’s most famous waterfall Gullfoss. It took popular protest, which included a local woman threatening to throw herself into the 32 meter high waterfall, to put an end to those plans. 

Gullfoss waterfall. (Diego Delso)

The movement to protect Gullfoss undoubtedly inspired a similar mass movement half a century later with the construction of the Kárahnjúkar Hydropower Plant. The 690 MW plant would become the biggest of its kind in Iceland when it started operation in 2007 and would mainly supply power to the Alcoa Fjardaál aluminum smelter located in nearby Reyðarfjörður. The massive reservoir caused significant changes to local ecosystems and inundated large areas of highland wilderness. The debate over the ecological impact of Kárahnjúkar left a lasting impression on the popular psyche, which has gained added layers of complexity as Iceland seeks to fulfill its climate commitments. 

“On the one hand, there is something we call environmental protection, and then there is nature, or ecological protection and these two concepts have a tendency to clash. When we are producing electricity with renewable methods such as hydro, then we need to sacrifice natural environment, by building dams, etc.,” says Gunnarsson. “The environmental groups who want us to become fossil fuel free, need to understand that if we want to achieve that goal, then we need to produce more electricity, which will always cause some sacrifice of nature.” 

The plan is for Iceland to become carbon neutral in 2040, but according to Gunnarsson, based on the current progression of energy production, that goal is a “complete pipe dream.” Achieving full energy independence will require doubling electricity production in Iceland and it is doubtful that this will be achieved by that time, unless significant investments are made in energy production.

Large factories such as the aluminium smelter in Straumsvík are the biggest buyers of energy in Iceland. (Steinninn)

The small North Atlantic nation is almost completely dependent on imports for most of its products. To maintain its trade balance with the rest of the world it has three sources of foreign currency: seafood exports, tourism and large energy consumers, which traditionally are large factories, but increasingly are data centers. 

Some environmentalists argue that the way to meet the looming energy shortage is not to increase the supply but to cut the demand, by halting sales to the largest consumers. 

“Let’s say we just stop selling electricity to the large factories, which are the biggest users, are we willing to sacrifice the foreign currency these companies bring into the economy? Well, then that means that we need to be willing to sacrifice the living standards we’ve become accustomed to,” says Gunnarsson.

Gunnarsson also argues that Icelanders also need to look beyond their shores when weighing their energy production, as it plays a role in the global fight against climate change. 

“We should also think about this from a global perspective. If we decided to stop selling our green energy to the aluminum smelters, the world isn’t just gonna stop consuming aluminum. The factory will just pack up and move to China where it will be powered by coal.” 

“We won’t escape from this hole we have dug ourself into just like that. It’ll take years to fix and equally problematic is our lagging investment in our energy infrastructure. We are very limited in how much energy we can transport from one end of the country to the next, because our system is outdated,” says Gunnarsson.

According to Statistics Iceland, individuals with permanent residence in Iceland could become a million by the year 2100, Gunnarsson claims per capita GDP could double during the same period. Which implies an annual economic growth rate of around one percent on average, compared to the significantly higher average of 3.3% over the past 40 years.

“Energy is the foundation that the economy is built on, take the U.S. for instance. It has a healthy stable growth, because they are large producers of energy, while Germany is currently struggling because they bet on access to cheap Russian gas which they have no wlost.. We in Iceland have always had more energy than we’ve needed, but underinvestment and increased regulatory obstacles has changed that reality and put Iceland in a tough spot for the time being when it comes to energy supply,,” says Gunnarsson.