Hydrogen's Hidden Cost: Why Government Backing Creates Losers, Not Markets

The Grattan Institute wants Australia to back hydrogen. Not all of it, not recklessly, but specifically: green hydrogen for ammonia, alumina, and iron production, underwritten by somewhere between $600 million and $2 billion a year in government support. The analysis is careful, the intentions are genuine, and the case is made with the rigour you would expect from serious policy researchers. It is also, at its core, a proposal for the government to pick a winner. And that is where the trouble starts.

The subsidy logic looks clean on paper — and breaks down in practice

The Grattan report is admirably honest about where hydrogen does not work. It rules out hydrogen for home heating, personal vehicles, and most road freight. That discipline is real. But the framework still requires someone to determine where hydrogen does work well enough to justify public underwriting. That someone, under this proposal, is the government. And the history of that arrangement is not encouraging.

The logic runs like this: hydrogen faces a "green premium," the gap between what it costs to produce green steel or green ammonia versus the conventional alternative. Markets won't close that gap on their own because carbon is not fully priced. So the government should subsidise demand, lift the carbon price through the Safeguard Mechanism, and invest in the electricity infrastructure that makes cheap electrolysis possible. Close the cost gap, create the industry, then step back.

It is a plausible sequence on paper. The problem is that paper and reality diverge in a very specific way when government money enters the picture. The moment a technology attracts public underwriting, the incentive structure for everyone involved shifts. Producers lobby to maintain the subsidy rather than innovate past it. Competing technologies that might have found a cheaper path to the same outcome get crowded out by the funded incumbent. The "temporary" support calcifies. And because the downside of getting it wrong is absorbed by taxpayers rather than by investors, the normal feedback loop that would correct a bad bet is severed.

Australia has seen this in other contexts. Renewable energy subsidies have driven genuine capacity growth, but the cost of firming, storage, and grid stability has been socialised across consumers rather than borne by generators. The technology that captured the support captured the upside too; the system costs landed everywhere else. There is no particular reason to expect the hydrogen story to unfold differently.

That is not industrial strategy. That is substituting a hidden cost for a visible one.

Picking hydrogen over the carbon price is a political choice disguised as an economic one

What the Grattan framework cannot answer is the harder question: if hydrogen genuinely is the best way to decarbonise alumina and iron production at scale, why does it need a demand guarantee to get there? If the economics work, private capital will find them. If they do not work without ongoing subsidy, then what the government is actually funding is not a transition to a viable industry but the permanent operation of an uneconomic one in the hope that costs eventually fall. That hope may be reasonable. But it is a gamble, and the stake is public money.

The cleaner alternative is to let the carbon price do the work. If the Safeguard Mechanism is set at a level that actually reflects the cost of emissions, every producer has an incentive to find the cheapest decarbonisation path available, whether that is hydrogen, electrification, carbon capture, or something that does not yet have a name. The market searches the solution space. Government does not need to pre-select the answer. The reason this does not happen is that a carbon price high enough to make green hydrogen competitive would be politically brutal for energy-intensive industries. So instead of accepting that difficulty, the proposal routes around it: subsidise the specific technology so that the broader carbon price can remain more modest.

That is not industrial strategy. That is substituting a hidden cost for a visible one.

None of this means hydrogen will fail. It may well prove out as a cornerstone of green industrial production. The point is that the process of proving it out should run on market discipline, not government confidence. The technologies that have actually transformed energy systems have done so by becoming cheap, not by becoming subsidised. Hydrogen's advocates need to make the case that it can get there. What they cannot credibly claim is that the path there runs through Canberra.

Sources

Grattan Institute — Hydrogen: hype, hope, or hard work?

Frequently Asked Questions

Why does the government want to subsidise green hydrogen?
Green hydrogen costs more to produce than conventional alternatives — a gap known as the 'green premium' — and carbon is not priced high enough to close it through market signals alone. The Grattan Institute argues that targeted subsidies of up to $2 billion a year, combined with a stronger Safeguard Mechanism, could bridge that gap and anchor new export industries in ammonia, alumina, and steel.

What's the problem with governments picking winning technologies?
Once a technology receives public underwriting, producers have an incentive to lobby for continued support rather than innovate past the need for it. Competing technologies that might reach the same outcome more cheaply get crowded out, and because taxpayers absorb the downside if the bet fails, the normal market feedback that corrects bad investments is severed.

Why not just raise the carbon price instead of subsidising hydrogen?
A carbon price high enough to make green hydrogen genuinely competitive would impose severe costs on energy-intensive export industries, making it politically untenable. Subsidising hydrogen directly lets the broader carbon price remain modest — but that substitutes a less visible cost for a more visible one rather than resolving the underlying problem.

Has Australia subsidised clean energy before and what happened?
Renewable energy subsidies drove genuine growth in solar and wind capacity, but the associated costs of grid firming, storage, and network stability were spread across all consumers rather than borne by generators. The industry that captured the support also captured the upside; the system costs were socialised.

Where does green hydrogen actually make sense as an industrial fuel?
Grattan limits its endorsement to hard-to-abate industrial processes — specifically ammonia production, alumina refining, and iron ore processing — where electrification is not straightforwardly available. It explicitly rules out hydrogen for home heating, personal vehicles, and most road freight.