Iemma and his Treasurer Michael Costa have been forced into the compromise after the state opposition scuttled the government's original $25 billion electricity privatisation plan.
Under the new proposal, the state-owned electricity retailers would be sold, while potential power station development sites would also be offered to the private sector.
However, in a departure from the original plan, the existing state-owned power generators would remain in NSW hands.
The amended proposal does not require legislation, and therefore the support of state parliament, to proceed.
It was given unanimous support in cabinet, while Iemma said caucus had given the plan a "resounding endorsement" but did not vote on the issue.
Costa said the state would be at least $8 billion - and possibly up to $20 billion - worse off as a result of retaining ownership of the generators.
NSW was now likely to have to rely on a series of peaking plants to meet the growing electricity demand, he said.
"The cost to the taxpayer is an increase in electricity prices because we'll be introducing peakers, by and large, into the system instead of baseload," Costa said.
But the revised proposal was "a package we have to go forward with to restore our economic credibility," he added.
The government will also review its capital works program in a mini-budget, with projects like the M4 East extension and western metro rail line now under threat.
Iemma and Costa revealed the new power option after the state opposition declared it would vote down the original proposal.
The government needed the coalition's support after a number of ALP MPs threatened to cross the floor to vote against the plan.
Parliament was recalled a month early at a cost of $500,000 to vote on the enabling legislation, but the government killed off the debate when it was clear it would be defeated.
Iemma said Opposition Leader Barry O'Farrell's stance equated to economic vandalism.
"He took five minutes of political opportunism and acted against the long-term interest of the people of NSW," he told reporters.
"The government is going to act and act immediately to protect the people of NSW."
But his new plan has not won over any of Iemma's opponents in the Labor Party, who say any form of privatisation of the electricity sector should be abandoned.
Unions NSW secretary John Robertson said that in bypassing parliament, Iemma and Costa were "effectively signing their political death warrants".
"I would say it's the ultimate in arrogance," Robertson said.
Blacktown MP Paul Gibson, who voiced his opposition to the sale at Labor's state conference back in May, said the new plan was still against the ALP platform and policy.
"It should have gone before parliament, it's the supreme decision-making situation," Gibson told reporters.
O'Farrell said Iemma was bypassing parliament because he lacked the courage to confront his own party.
He said the public could not trust Iemma, who had promised not to sell off the electricity sector before the last state election, and only on Wednesday said there was no "plan B" should the privatisation proposal fail.
"Today, we understand not only is there a plan B, but there is legal advice to support the fact that it can proceed without reference to the parliament," O'Farrell said.
