Energy conversion from hydrogen represents a viable contribution to sustainable development. For this reason several authors have investigated clean hydrogen production and its end uses. One end use is a hydrogen storage system with a fuel cell to mitigate grid instabilities inherent to renewable power generation or intermittent reactive loads. Another end use is burning hydrogen in internal combustion engines for motive transport or remote power generation. Blending hydrogen with traditional hydrocarbon fuels is also possible. The aim of this paper is to assess the opportunity for realizing a small-scale renewable hydro methane production system in Italy. The system is completely integrated in an electrical and thermal smart grid. For this reason, a techno-economic feasibility analysis on hybrid systems was carried out to quantify the carbon avoidance cost associated with blended hydrogen fuels. Twelve different scenarios were simulated with the HOMER software and the optimal system configuration was identified by applying the levelized cost of hydrogen (LCOH) as evaluation criterion. Furthermore, a sensitivity analysis was applied to explore potential fiscal policy scenarios. The simulation results show that the lowest LCOH (8.041 (sic)/kg) was achieved with a 5 Nm(3) electrolyser capability (operating for about 4000 h/yr) and a grid connected 160 kW(P) PV array when hydrogen was produced only during the winter season. Instead considering the same operating hours and modifying the hydrogen production daily and monthly profile (i.e. hydrogen production from May to September) the best results were obtained (LCOH = 0 (sic)/kg). An analysis of carbon avoidance costs showed the optimal hydrogen mixture of approximately 23% by volume to provide the best economic and environmental trade-off. Finally, if the hydrogen cost is equal to 1.5587 (sic)/kg a null over price for decarbonisation is achievable. To obtain this result a dedicated incentive scheme to encourage the hydrogen production should be developed by Italian Government. Copyright (C) 2014, Hydrogen Energy Publications, LLC. Published by Elsevier Ltd. All rights reserved.