The equal-height-difference passive heat removal system (EHDPHRS) utilizes the ocean as the heat sink for infinite heat dissipation and has broad application prospects in ocean nuclear power plants. However, the equal height difference between the heat source and heat sink is susceptible to severe flow instability. In this study, a fully visualized experimental facility was constructed to analyze the transient flow characteristics in the EHDPHRS. The experimental results revealed three typical two-phase natural circulation flow modes in the EHDPHRS. The formation mechanism of each flow mode was analyzed using thermal–hydraulic parameters. The results revealed that the flow mode is determined by the steam–water direct contact condensation and reverse flow of subcooled water, and both factors promote each other. Moreover, condensation-induced water hammer (CIWH) was found to be the most severe flow instability in the EHDPHRS. CIWH events can lead to violent pressure peaks and reduce the natural circulation capacity. In addition, when the occurrence position of CIWH events is concentrated at the pipe outlet, the influence of CIWH events on the two-phase natural circulation flow capacity gradually decreases. These research results aid in the optimal design of the EHDPHRS and prevention and control of CIWH events.