Lights off in Iran: What caused the power crisis and what comes next?

Energy subsidy reforms and policy change critical to resolve the crisis, analysts say

Traffic flows on a main road past electricity transmission towers in Tehran. Iran has been struggling to cope with increased energy demand during the winter months. AFP

As Iran struggles with a major energy crisis, with businesses and government offices partially shut and remote learning under way in certain areas, strong and immediate government action is needed to stem the “significant” economic impact it is having, according to analysts.

The country has been struggling to cope with increased demand during the winter months and has already called on households to lower heating levels to avoid blackouts.

Last week, Iranian President Masoud Pezeshkian also apologised to the public in a local interview. “Unfortunately, this year, we are compelled to ask the public to show some restraint,” he said, adding, “we will work hard to ensure that such events do not occur next year”.

The current crisis stems from the government’s “inability to manage energy and petrol consumption costs effectively”, said Mahdi Ghodsi, an economist at The Vienna Institute for International Economic Studies.

In Iran, one litre of fully subsidised petrol costs about 15,000 rials or less than 2 US cents, according to the unofficial rate on Wednesday on currency exchange site Bonbast.

Last year, the fossil fuel subsidy per capita for Iran is estimated to be about $917.5, according to International Energy Agency estimates. Subsidies covering oil, electricity and gas increased to more than $154 billion in 2022, before falling to $81.8 billion last year, the IEA said.

Daily petrol consumption reached 111.3 million litres in the last Iranian fiscal year, which starts mid-March, up from 102 million litres the previous year, according to official data.

“This heavy consumption is coupled with significant government subsidies, which have become unsustainable,” Mr Ghodsi said. Long-standing issues such as underinvestment in power infrastructure have also led to the current situation.

Iran possesses vast hydrocarbon reserves – it was the fourth-largest crude oil producer in Opec last year and ranked as the world’s third-largest oil and second-largest natural gas reserve holder last year, according to the US Energy Information Administration.

However, despite being a major oil producer, the main reason for the imbalance in energy production and consumption in Iran is energy subsidies, said Mohammad Farzanegan, professor of Middle East economics at the Centre for Near and Middle Eastern Studies, Philipps-University Marburg in Germany.

“As a result of cheap energy, the energy intensity of production remains high, and there is less interest or incentive to improve energy efficiency,” Prof Farzanegan said. “It is also problematic to attract private investors and foreign direct investment in sectors where the government actively intervenes in regulating prices.”

Economic sanctions have also increased the political risk in Iran and raised the transaction costs for international projects, he added.

But while the Iranian regime has blamed sanctions for the crisis and that is a factor, the bigger issue is one of mismanagement, bad governance and “a regime that doesn't know what to prioritise”, said Alex Vatanka, senior fellow and director of the Iran programme at the Middle East Institute.

Dimming economic growth

Iran’s economy has already been struggling under crippling Western sanctions and while the economic impact of the power crisis is “significant”, it grows more severe as power cuts become longer and more frequent, said Mr Ghodsi.

“Power cut disrupts economies of scale, reducing efficiency not only during the outage itself but also in the recovery period once power is restored. This inefficiency compounds over time, particularly if the power cuts are unpredictable,” he explained.

While the economic cost of the power crisis has not yet been fully estimated, Prof Farzanegan cited a recent estimate by the former director of the Iran Chamber of Commerce in local media, which projected a loss of $110 million a day due to power cuts last year.

While there is talk about increasing fuel prices and cutting out subsidies, “energy is sensitive and … a lot of people rely on cheap energy”, Mr Vatanka said.

“Instead of suddenly increasing the price of energy, the government could have spent the last year or two educating the public about good practices when it comes to energy use. [People] have become used to almost free energy, but the government doesn't engage in education on those things. Instead, it educates about ideological issues. So again, it points to wrong priorities,” he said.

Subsidies can be reduced and removed, but the government will need to compensate for that, he explained. Energy efficiency can and should be improved, considering the amount of energy that is wasted in the country, but political and foreign policy change is critical for any change, Mr Vatanka said.

According to Prof Farzanegan, to rectify the situation, there is a need for energy subsidy reform and the removal of US sanctions.

“Both require a strong government, political will, and significant support from civil society. A large campaign within Iran is necessary to raise public awareness of the significant and costly effects that the continuation of energy consumption subsidies has caused.”

At the same time, the government needs to find a way to negotiate with the new administration in the US to lift the sanctions. The latter may “require difficult agreements”, he said.

To navigate the current crisis and restore stability, the government must take bold and decisive action, added Mr Ghodsi. It must “prioritise cutting unnecessary expenditures that do not serve the public interest”.