The District of Columbia is nearing a decision on whether to construct a $150 million waste disposal system that could put the city in the energy business by January 1981.

Under a plan that has the backing of top officials in Mayor Barry's administration, the city would burn its trash and sewage sludge in a giant incinerator that would produce steam. This, in turn, could be used as heat or converted to electricity.

The project could produce annually the energy equivalent of about 1 million barrels of oil, worth more than $20 million at today's market prices, according to Jean B. Levesque, administrator for water resources in the city's Department of Environmental Services.

In seeking proposals from companies that construct such facilities, the District of Columbia has identified three possible sites. They are at Fort Totten near Catholic University, where the city now collects trash for later disposal; the site of the present trash incinerator on Benning Road NE, and the Blue Plains regional sewage treatment plant, which produces all the sludge that would be burned. Sludge is the residue of all the filtering processes used to clean waste water.

Burning waste -- such as discarded napkins, crumpled memos, and other forms of trash -- is part of a new national trend to develop valuable resources from garbage.

The trend, already well established in Europe, has been hastened by the rising costs of energy and the diminishing amount of space available for dumping waste. The federal government is providing a powerful incentive for cities to build and use such plants by offering to pay up to 85 percent of the construction costs.

If D.C. chooses incineration, the city is almost certain to avoid going to the still-experimental, Rube Goldberg-like process involving pyrolysis, which has been a costly failure in Baltimore. Pyrolysis involves high-temperature burning of trash in an oxygen-free kiln. Baltimore ran into problems because it had only one kiln, and when there was a breakdown, the whole operation was halted.

Instead of imitating Baltimore, the District of Columbia is likely to use what is called mass burning -- a process that has been proved through long years of operation in Europe, and is being used on the new projects under way in this country.

Steam is being produced from trash incineration at two recently opened plants -- one at Hempstead, L.I., and the other in Saugus, Mass., near Boston. The Hempstead plant has had odor problems, but the Saugus operation is working well and is preparing to expand, according to Alan F. Cassel, an engineer for the U.S. Environmental Protection Agency.

Operations similar to the one the District of Columbia would like to start up are either just getting under way or in the advanced planning stage in Duluth, Minn., Harrisburg, Pa., and Memphis, Tenn. All three projects have received EPA funding, heightening the hopes of D.C. officials who would like to get similar aid.

Washington produces an average of 1,200 tons of sludge a day at the Blue Plains plant. When the plant soon begins using more advanced treatment methods, the volume will increase to 2,000 tons daily.

According to some officials, the Benning Road site may be the first choice because it already has an incinerator, there are no nearby residential neighborhoods and Potomac Electric Power Co., a potential customer for the energy has a generating station close by.

Any plan to burn sludge, which contains traces of heavy metals and other potentially harmful substances, is likely to arouse some opposition from environmentalists. But D.C. City Council member Willia J. Hardy, who represents Ward 7, which includes the Benning Road site and other northeast and southeast Washington neighborhoods, said:

"I have no problem with burning sludge if the operation meets all health standards. My constituents are very intelligent. If they felt there would be no violations, they would support the operation."

Although the District of Columbia government will not make a decision until after Dec. 10, when all the competing proposals must be in, Levesque said: "My hunch is that we'll probably go to incineration with energy as a by-product."

The only other alternative, as the city seeks a long-range solution to its mountainous waste problem, would be to compost trash and sludge into a soil conditioner. But the market for that product has been poor lately because of restrictions on its use by some health officials.

Getting rid of sludge is expensive.Most is buried in trenches on farms in Prince George's and Montgomery counties, the jurisdictions that also use Blue Plains, and with the District disposal. The average cost of disposing of sludge is $42,000 a day now and is expected to rise to at least $70,000 a day by 1983.

The three jurisdictions face a Jan. 1 court deadline for coming up with a long-range solution for sludge disposal -- a predicament that makes incineration look attractive because land that can be used for trenches fast is disappearing.

In addition to its sludge problem, the District of Columbia must also cope with a growing pile of trash. Each day the city generates 2,000 tons of trash -- paper, plastic and cloth and a lot of metal -- everything from paper clips to refrigerators.

About half the city's trash is burned at the Benning Road incinerator, and the other half is hauled to the regional Lorton landfill in southern Fairfax County. At its present rate of use, the Lorton site will be filled in 15 years, forcing the city and other users (Fairfax, Arlington and Alexandria) to look for another site, a difficult, if not impossible, task.So that prospect also makes incineration look good to city officials.

The city's only operation for recovering useful resources from waste -- the daily conversion of 275 tons of Blue Plains sludge into compost -- has turned into an economic fiasco. Instead of getting paid for it, the city actually has to give the "buyer" 90 cents a ton to haul the product away. The hauler, Brevard Brothers, has been unable to sell the compost because of the concerns of Maryland health officials. D.C. contends that the compost is perfectly safe.