At 46 mpg highway, the new Chevy Cruze Turbo Diesel gives even hybrids a run for their (gas) money.

It’s the stuff of dreams for some environmentalists: a fuel you can make from renewable sources as diverse as algae and used cooking oil. But for some automakers, bio-diesel is a nightmare so worrisome one major maker has pulled out of the Illinois market after lawmakers there approved incentives meant to boost demand for bio-diesel.

Mercedes-Benz isn’t the only maker worried that bio-diesel could have a downside far different from the green image proponents present. The German maker warns that if poorly blended, the fuel could gunk up its engines and worsen air quality. That led the maker to recently stop selling diesel models like the new E250 BlueTec diesel in the land of Lincoln.

Illinois lawmakers recently approved a plan to drop the state’s 6.25% sales tax on fuel with a bio-diesel content of at least 10%. Mercedes, which has been one of the strongest proponents of diesel fuel in the U.S. market, has set a limit of 5% biodiesel content, or B5.

Diesel itself has long been on the outs with American consumers who recall the noisy, smelly and rough-riding vehicles of the 1970s and 1980s. Modern diesels, however, are far quieter, have little to no smell and are as smooth as conventional gasoline models. But they also yield as much as 30% better mileage.

Mazda, the first Japanese maker to offer a modern diesel in the U.S. market, claims its new Skyactive-D version of the Mazda6 delivers fuel economy all but matching a hybrid. General Motors’ new Chevrolet Cruze Diesel isn’t far behind, at 46 mpg on the highway. Such numbers have begun to resonate with consumers and automakers are beginning to respond, the number of diesel models in the U.S. market expected to double in the coming year – Audi alone planning to add four new offerings to its lineup.

That said, diesel is still a petroleum-based fuel and that’s spurred a growing interest in renewable alternatives – much as there’s been a push to add a higher amount of ethanol into regular gasoline.

There are a number of different sources that can be used for bio-diesel. A number of advocates have been making their own from things like soybean oil, even used oil from fast food fryers. A quick search on the Internet reveals a variety of homebrew kits, including one 40-gallon unit available for about $1,400.

More professional operations are popping up around the world, including San Francisco-based Solazyme, Inc., which is using algae as its feedstock. The start-up recently began selling a B20, or 20% bio-diesel blend, at four service stations in the Bay Area and hopes to open more if consumers accept the fuel – which it is selling for about the same price as conventional diesel is going for in the San Francisco area.

Part of the problem is that not only do various bio-diesel blends differ in the level of renewable content, but there’s also a concern that poorly made blends will degrade more quickly than regular, 100% petroleum blends.

(Algae-based bio-diesel is gaining acceptance in California. Click Here for more.)

There are also concerns by some experts that some bio-diesel blends may actually lead to an increase in smog-causing oxides of nitrogen, or NOx, one of the most difficult problems to resolve with any diesel engine.

Ironically, one of the other issues is that bio-diesel can function as a solvent. At one level this can be a good thing, helping clear out engine deposits much like the detergents used in regular gasoline. But some blends are too effective in this task and the loosened deposits can jam up a fuel filter or other components. The solvent property also can break down fuel lines and seals in some older diesel vehicles.

As a result, most makers echo Mercedes’ stand that motorists should fill up with nothing higher than B5, or 5% bio-diesel – though so far, the German automaker is the only one to specifically take steps to stop selling its diesel models in Illinois. According to state projections, about half of the diesel sold in Illinois is now at least B11.

(Click Here to read more about Mazda’s new SkyActiv diesel trials.)

But owners of other diesel vehicles who experience problems from using higher-level bio-blends could wind up facing a challenge if they need warranty work, several sources have cautioned.

There’s at least one exception. That new Chevrolet Cruze Diesel has been engineered to run on blends up to B20, according to GM, as have the maker’s diesel-powered heavy-duty trucks.

(After dumping diesels, GM is resurrecting them with the Cruze. Click Here.)

Bio-diesel isn’t the only renewable fuel the industry is worried about. A number of automakers – along with manufacturers of power tools and recreational vehicles – have been sparring with the EPA over plans to mandate the use of a higher level of ethanol in gasoline. That move has, in turn, been spurred by the need to comply with measures Congress passed a few years back to boost ethanol usage substantially.

Critics contend the proposed E15 blend could also cause severe engine damage, especially to older vehicles and power equipment not designed to protect against the more corrosive alcohol additive. The measure has been working its way through the courts.