Sapphire Energy says it’s pioneering an entirely new industry in New Mexico.

The San Diego-based startup plans to invest $100 million in a 300-acre biofuel operation that will convert algae into gasoline starting in 2011, the first such algae-based, commercial-scale biofuel production facility in the U.S.

Once the site’s commercial viability is demonstrated, plans call for it to expand to 1,200 acres and produce more than 1 million gallons per day of green crude, said Sapphire CEO Jason Pyle. That would generate a total investment of $1 billion over the next eight years.

“Green crude will replace black crude right here in New Mexico,” Pyle said in a keynote address at the first annual conference of the Southwestern Biofuels Association in Albuquerque May 27-28. “We’re looking at the next industrial revolution.”

Sapphire is not the only company planning a local biofuel operation, but other companies want to make biodiesel, not gasoline, and those methods use a variety of crops and feedstocks.

Sapphire is unique because it has developed a proprietary process for turning oil from algae into renewable gasoline that is genetically identical to sweet crude pumped from the ground. That means it can simply replace petroleum as fuel for ground and air transport without any modification to refineries, pipelines or vehicles, Pyle said.

“Drop-in solutions that don’t require retooling the nation’s fuel delivery system are the only way to make the biofuel industry successful,” said Pyle. “That’s the future Sapphire is working to build.”

Major investors are betting heavily on Sapphire. The company formed in May 2007 and has raised more than $100 million in venture capital. Backers include financial powerhouses, such as ARCH Venture Partners, the Rockefellers’ Venrock, and Cascade Investment LLC – an investment holding company owned by Microsoft founder Bill Gates.

The company has recruited top scientists and industry leaders. BP Global Refining’s former vice president, Cynthia Warner, became Sapphire’s president this year. Brian Goodall, who led the team that conducted Virgin Galactic’s groundbreaking 747 flight in 2008 with biofuels, is now Sapphire’s vice president of downstream technology.

“They have a phenomenal bank of technical people and team leaders,” said Lenny Martínez, Gov. Bill Richardson’s policy advisor for rural economic development. “Their project is technically very feasible.”

Still, like all biofuel startups, Sapphire faces major challenges.

Steve Loring, associate director of New Mexico State University’s Agricultural Experiment Station, said a lot of research is still needed to reach commercial viability, particularly in regard to water use, environmental impact and economic sustainability. In fact, NMSU is now conducting a study on biofuel production costs and potential ways to profitably scale up to commercial levels (see related article on page 1).

“It all has to be sustainable environmentally and economically, although I think those things can be addressed,” Loring said. “They’re not show stoppers.”

Among the companies pursuing biofuels, Sapphire has inspired more confidence than most, said Vaughn Gangwish, executive director of the Southwestern Biofuels Association.

“Like all new technologies, biofuels must be proven, but I think Sapphire will meet its goals,” Gangwish said. “They’re clearly on the leading edge.”

Sapphire has invested $8 million in a test-and-development facility that began operating in December at the West Mesa Industrial Park in Las Cruces. The center experiments with algae seed varieties developed at Sapphire’s headquarters in San Diego.

The facility operates nine algae production ponds to map growth rates and other characteristics. It conducts wet and dry oil productivity and processing tests in 15,000 square feet of lab space, said Operations Manager Bryn Davis.

“We’re the boots-on-the-ground operation for the science coming out of California,” Davis said.

Pyle said Sapphire’s planned 300-acre facility will be a pre-commercial demonstration site to prove market viability. Sapphire has the money to build this first stage, but it needs a lot more capital to later expand to 1,200 acres.

“If we’re going to generate more than $800 million in new private investment, investors first need to be convinced that the economics of the facility are guaranteed,” Pyle said.

Construction of the first stage will start in summer 2010 and conclude in early 2011. It will employ at least 400 permanent workers, and thousands – if the facility’s expansion moves forward. The facility’s location has already been sited and permitted, but it remains confidential, Pyle said.

U.S. Sen. Tom Udall, D-NM, announced in late February, however, that the Department of Energy approved a $951,000 grant for a Sapphire Energy algae-to-fuel demonstration project in Portales.