Hydropower development offers significant potential for energy supply and water resource management; however, it faces critical institutional, policy, and economic challenges that constrain sustainable water–energy governance. This study aims to identify and prioritize the strengths, weaknesses, opportunities, and threats (SWOT) shaping hydropower development within the framework of water–energy governance in Iran. Utilizing policy document analysis, literature review, and semi-structured expert interviews, key internal and external factors were extracted and subsequently prioritized through an integrated SWOT and Analytic Hierarchy Process (AHP) framework. The findings reveal that the expansion of pumped-storage hydropower, adoption of advanced energy storage technologies, utilization of innovative financial mechanisms (e.g., trading environmental certificates), mobilization of local capacities, and development of small-scale regional hydropower plants to facilitate an equitable distribution of national energy benefits represent the most critical strengths and opportunities. In contrast, institutional shortcomings in ownership structures, regulatory and oversight mechanisms, and the persistence of subsidization policies for low-cost conventional fossil energy constitute the primary barriers to sustainable sectoral development. In addition, policy trends over the past four decades demonstrate that despite a gradual shift from a top-down, command-and-control paradigm toward market-based approaches, the sector continues to suffer from a lack of complementary social policies and the fragmentation of financial incentives. Therefore, achieving sustainable hydropower development necessitates comprehensive policy reforms, strengthening private-sector financing models, and establishing integrated water–energy governance. These findings provide actionable insights for revising national hydropower strategies aligned with energy security and environmental sustainability goals in Iran.