For tourists relaxing in the hot springs of Iceland's famous Blue Lagoon, just outside the capital Reykjavik, the issues of climate change and energy security are not likely to be occupying most bathers' minds. But what many visitors may be surprised to know is that the hot water they are sitting in is part of a remarkable journey by one country from oil dependence to a world leader in harnessing renewable energy.

Iceland's stunning scenery, with its bare, lava-strewn flats, snow-capped mountain ranges, glaciers, volcanoes and hot springs, is due to its location on one of the earth's major fault lines, the mid-Atlantic ridge. While this landscape is attracting an increasing number of tourists each year, the country's geographical peculiarities also mean that Iceland is the only country in the world that can claim to obtain 100% of its electricity and heat from renewable sources.

The glaciers and rivers of the interior of the country are harnessed to generate 80% of the country's electricity needs through hydropower, while the geothermal fields provide up to 20% of the country's electricity needs. These underground fields, which give tourists and locals their bathing pools, also provide Icelanders with an almost limitless and inexpensive supply of natural hot water.

There is no national grid in Iceland – harnessing the energy comes via the remarkably simple method of sticking a drill in the ground near one of the country's 600 hot spring areas, and using the steam that is released to turn the turbines and pump up water that is then piped to nearby settlements.

Geothermal water is used to heat around 90% of Iceland's homes, and keeps pavements and car parks snow-free in the winter. Hot water from the springs is cooled and pumped from boreholes that vary between 200 and 2,000m straight into the taps of nearby homes, negating the need for hot water heating. It's also purified and cooled to provide cold drinking water.

While the government believes that exploiting geothermal energy for space heating alone saves Iceland $100m (£50m) in imported fossil fuels each year, it also means less CO2 emissions. If the geothermal energy used for heating homes in a single year is equivalent to the heat obtained from the burning of 646,000 tonnes of oil, the government estimates that the total release of CO2 in the country is cut by nearly 40%.

But the task remains to move the country's remaining fossil fuel-dependent sectors to clean technology: Iceland's fishing fleet, cars and buses, which run on oil and petrol, ironically make the country one of the highest per head greenhouse gas emitters in Europe. Research is underway on how to use geothermal electricity to split hydrogen from water, and then to use hydrogen fuel cells to power the country's vehicles and fishing trawlers.

In 20-30 years, if this is achieved, it would make Iceland self-sufficient in energy terms, and 100% powered by renewable energy.

Energy by accident

Geothermal energy in Iceland happened by accident. In 1907, a farmer in west Iceland took steam from a hot spring that ran below his farm through a concrete pipe and into his house several metres above. A few years later, another farmer became the first Icelander to use hot spring water for heating, and extensive distribution of hot water to heat homes began in the capital in 1930.

Icelanders began to harness their natural powers into the 1940s, but was still getting 75% of it energy from coal until the oil crisis of the 1970s forced it to change its energy policy. With rising costs, the government moved its focus from oil to hydropower and geothermal heat. It put funding and resources into searching for new geothermal resource areas, and built new heating services and transmission pipelines from thermal fields into towns, villages and farms.

"When the oil crisis receded in the 1980s all the interest other countries had shown in renewables disappeared and they fell back on their oil-reliant ways," says Einar Karl Haraldsson, the chief political adviser to the Icelandic foreign ministry. "But we continued to make progress in renewable energy development and now Icelanders are going to reap the benefits."

The economic savings gained by switching from oil to geothermal energy – an estimated $8.2bn over 30 years - have contributed significantly to Iceland's prosperity – transforming it from one of the poorest countries in the EEA to one of the most productive in the world in terms of GDP per capita and quality of life rankings.

Digging deeper

Geologists say that Iceland has barely scratched the surface of its geothermal energy potential. The country's National Energy Authority estimates that only 20-25% of the technically and environmentally feasible hydropower, and only 20% of the conventional geothermal potential available for electricity production in Iceland, have been harnessed.

Albert Albertsson, the deputy chief executive officer at Iceland's Resource Park, which includes the Blue Lagoon hot springs and one of the country's largest geothermal power stations, says that while no one knows how much energy could be eventually harnessed, it could be possible that all the energy needs of the northern hemisphere could be met by Iceland.

"What you've got to remember is that we've been working on this for less than 30 years," he said. "We really have only harnessed a tiny fraction of the potential energy."

The government has embarked on a research project at the Resource Park to drill boreholes down to greater depths of around 5km, which would yield far greater power than the conventional bores which only reach depths of 2-3km.

"The water pumped into those bores will reach an unbelievable pressure and deliver four to five times the power yield of conventional bores," added Haraldsson.

The energy sector in Iceland is expanding continuously, and the country is now exporting expertise in this field. New hydroelectric power stations are under construction and there are plans for five or six more. Electricity produced from geothermal sources is expected to double by 2010, but the government is being careful to balance economic needs against any environmental impact.

However, in terms of business, new industrial users that harness geothermal energy on a large scale have not yet emerged in spite of the high potential.

The country's substantial aluminium manufacturing sector has moved to using geothermal energy to power its smelting process, and natural resources are also used in the processing and production of salt, seaweed, pet food and fish farms and to heat the greenhouses that grow the island's fruit, vegetables and flowers. The tourism economy has also benefited, with more people coming to visit and bathe in the hot springs.

But Iceland's remote location means that even if it does tap into more of its natural energy resources, it has no way of exporting it. And so it has embarked on a drive to attract more industries to its shores that can exploit its supply of green and cheap energy.

Green data centres

It has set its sights on the IT sector, with its huge energy demands and growing emissions, which are estimated to account for 4% of UK emissions (aviation is only 2%).

Haroldsson says the country has the potential to become a "hotspot" for data storage centres because of Iceland's cheap and reliable energy supply, naturally cool environment, no need to pay future carbon taxes, an abundance of land and a population which is politically secure and boasts a high level of computer literacy.

"In the big cities where many firms locate their data centres, energy is either expensive or polluting, if it is available at all," he said. "We have energy and we also have a cold environment and an abundance of clean water for cooling [data centres]."

The first to bite is Hitachi Data Systems, which recently announced a partnership with Data Islandia to offer its multinational customers data storage in a new facility powered by 100% green energy.

Hitachi plans to build its first centre by this summer, and there are plans for a further five or six large-scale centres in the geologically stable south-west of Iceland over the next five years.

Hitachi's centre is still in the planning stages but early drafts show how it will be built partly underground in a way that doesn't disrupt the natural landscape and uses green construction methods and materials. It takes into account the passive cooling that will be provided by Iceland's climate, in which temperatures rarely rise above 21C in the summer. The roof will be covered in moss and the resulting condensation will cool the centre even further, while the curved dome-shaped roof will help to draw cool air across its surface.

Hitachi's ecosolutions spokesman, Alec Bruce, says that such a design can save 60% of the energy required to cool a conventional data centre, and by customising its clients' varying storage needs (for example, powering down data that does not need to be accessed as regularly as others), it can save a further 30%.

Bruce says Hitachi's customers have "responded aggressively" to the opportunity which gives businesses with burgeoning carbon footprints and data storage costs the chance to boost their green credentials while saving money.

In a bid to convince more firms to locate their data centres on the island, Iceland's government has cut corporation tax to 15% and committed to laying new high-speed data cables to improve the connections with Europe and north America.

Credit crisis

The drive to attract new industry to Iceland has become even more critical of late, with the warnings last week that Iceland may be one of the first economies to feeling the effects of the global credit crunch.

Risk-averse investors have begun pulling out of the country and the Icelandic krona has fallen by 25%. Inflation is running at 6.8% and interest rates reached 15.5%.

But while the prospect of an economic downturn is of course unwelcome, ultimately Iceland's potential to exploit its natural resources means – just like those bathers in the hot springs – that energy security is at least not an immediate concern.