The synthetic fuel industry, using technology that helped fuel the Nazi Luftwaffe, is slowly being reborn on a dusty mesa outside Rifle, Colo., and in a dozen other towns. Its mission is to turn the arid American West into a fountain of a trillion barrels of oil.

Its proponents are considerably less optimistic than they were six months ago, however, because of the Reagan administration's decision to cut $1.2 billion in direct federal subsidies to the synfuels industry from the budget. Although $17.5 billion in federal loans and guarantees will be available, the cost of building and starting up the enormous synfuels operations raises the question of how far in industry can progress without an all-out government commitment.

If it comes close to its advance billing, the synthetic fuels industry, part of the effort to reduce America's dependence on imported oil, will be unprecedented in cost and size and in its impact on the West. It seeks nothing less than the transformation of coal into 500 billion barrels of oil and gray shale rock into 600 billion more barrels, more oil than is known to exist on the rest of the planet.

This eventually could mean the construction of about 30 massive plants, each costing about $3 billion and pumping out 50,000 barrels of oil a day, a total of about 1.5 million barrels daily. At that rate, synfuels would account for about 9 percent of U.S. domestic oil production and could cut imports by about 20 percent by the year 2000.

Although synfuels technically include fuels from manure or farm products, as well as oil from heavy tar sands, the developing commercial industry primarily involves the production of oil from oil shale and coal liquefaction and a form of natural gas from coal gasification.

It's under way but it still faces severe hurdles -- enviromental, organizational and economic. Oil and gas from shale and coal always have been more expensive than natural gas and oil from petroleum, and the cost of producing the synthetics always seems to rise fast enough to maintain the gap.

And, while synthetic fuel is the first major industry born with environmental safeguards already on the books, the environmental problems it will entail, including the creation of new carcinogens and mountains of shale waste, are enormous.

As a sophisticated conservation movement watched closely, Exxon and The Oil Shale Corp. (TOSCO) started work a year ago near Rifle, in western Colorado, on the side of an 8,000-foot mesa where a layer of oil shale 100 feet thick runs through the mountain like frosting through the middle of a birthday cake. Working under the rules that control surface mining, the bulldozers of the Colony Shale Oil Project are shouldering an access road up the hillside and building a sort of shelf there, the future workspace for huge mining machines.

Sometime in the late 1983, if all goes as planned, diesel-powered drillers and front-end loaders will bore into the shale, creating the familiar rooms and pillars of deep mines. But the rooms will be 60 feet high and 60 feet square, vast caverns compared to the cramped coal pit rooms, and the pillars holding up the mountaintop will be 60 feet across.

The shale will come out of the mine in 85-ton trucks, be crushed fine on the shelf and loaded onto conveyor belts for the trip up the mountain to a plant on top of the mesa, where the oil will be extracted through a heating process. The plant was located according to the provisions of the Clean Air Act.

"The basin here has temperature inversions," explained Ron Jarvis of Colony."If you put the plant in the valley, the pollutants wouldn't dissipate and you wouldn't get your PSD permit."

PSD stands for "prevention of significant deterioration" of clean air, a goal of the Clean Air Act and the Environmental Protection Agency. The technologies and alphabet soup of laws, regulations and watchdog groups concerned with oil, gas and coal are partly relevant to synfuels, but there is a lot that isn't covered. That's partly because it is hard to grasp the size of what is coming, despite the historical precedents.

Hitler's Third Reich built 22 plants to liquefy coal into gasoline that supplied the Luftwaffe, but subsequent U.S. efforts were flooded out by Mideast oil and the powerful lobbyists of the U.S. oil industry. As early as 1813, the British had processed coal with steam to produce a gas they first used to light the London Bridge. Street lights in East Coast cities in the United States used "town gas" from coal until the 1930s. They switched to the higher-heat, cheaper natural gas when pipelines were laid after World War II.

A process to wring oil from shale by heating it was patented in England in 1694, and the Ute Indians taught the American pioneers about "the rock that burns." Nearly 50 companies were using the shale heat process in the eastern United States by 1850, but they drowned in the gusher of the nation's first oil strike in 1859 in Pennsylvania.

These relatively modest beginnings will spawn giant offspring. The only final synfuels environmental impact statement out so far is for the second-stage Solvent Refined Coal (SRC II) liquefaction plant proposed for Morgantown, W. Va., which is fighting for its life in the Reagan budget. As a first-stage demonstration plant, it would be more than half a mile square and could process 6,000 tons of coal a day, 60 rail cars' worth.

But if the project goes forward, it will eventually be five times bigger, covering an area nearly two miles square and eating the entire output of a major mine producing 30,000 tons of coal to produce 50,000 barrels of oil a day, according to the statement. There will be a 235-foot tower which, if there is an emergency plant shutdown, will be used to vent gases in a plume of fire 600 feet high and 100 feet across.

"It will be a monster, not just a little bunch of smokestacks like your neighborhood power plant," said Joyce Goldstein, whose group, Citizens Concerned About Synfuels, is fighting SRC II in Morgantown.

The shale oil plants will be even larger. There will be at least six, given the financing now expected, and there could be as many as 30, according to the Synthetic Fuels Corp.

The shale mine to feed 50,000-barrel-a-day plant will have to be twice the size of the largest existing surface coal mine. Further, the waste disposal area will have to be larger than the mine, because processed shale expands to 25 percent more than its original volume. Already there are arguments over whether the companies may dump it in nearby canyons, make hills or convert it to some use.

Westerners particularly worry about the water these plants will need, the saftety of the ground water underneath them and the toxic substances that rain will leach out of the piles of waste.

The Piceance Basin of Colorado (named in a tactful misspelling for the fiery red ants that annoyed the first settlers) the Green River Basin of Wyoming and the Uinta Basin of Utah together hold an estimated 2 trillion barrels of oil chemically locked in shale, of which 600 billion are considered easily recoverable. The reserve is more than the 1.3 trillion barrels known to exist on the rest of the earth.

In addition, the West has hundreds of millions of tons of coal, enough for 500 billion barrels of oil.

The synfuels industry has OPEC to thank for its rebirth, since its financial worries are as big as the plants, each of which will cost between $2 billion and $10 billion.

Another problem is the cost of meeting environmental and safety standards. Industry spokesmen argue that the increased costs of regulation, plus inflation, high construction prices and the size of the plants mean that synfuels require federal help to get started.

Nevertheless, President Reagan has proposed killing $1.2 billion in direct aid through 1982 for five commercial-scale demonstration projects at the Department of Energy, including SRC II. The synfuels people see those projects as technological dress rehearsals, running risks industry can't afford.

"If you invest $3 billion in one of these plants, that's a quarter of a medium-sized oil company. Stockholders can take a dim view of that kind of risk," says Robert Hall of the American Petroleum Institute.

However, Reagan hasn't touched the semi-independent Synthetic Fuels Corp., which is to provide the industry with $17.5 billion in purchase commitments, price and loan guarantees, joint ventures, and direct loans, in that order of priority. So far, it has received 63 requests for that help, one from TOSCO, which recently engaged the public relations firm of Peter Hannaford, the former partner of Michael Deaver, one of President Reagan's top advisers. TOSCO wants loan guarantees to help it raise 75 percent of its share of the $2 billion Colony project.

The goal of the Energy Security Act is to produce 500,000 barrels a day of synthetic fuel by 1987. In a second phase costing $68 billion but but not yet funded, the goal is 2 million barrels a day by 1992. Critics wonder if such a pace is possible, given the corporation's organizational start-up troubles and such other problems as a pipe and sheet metal industry capacity that is already stained.

To meet those goals, according to one estimate, a new synfuels plant must be started every two to three months through the next five years.

But the synfuels corporation has yet to spell out the criteria it will use in picking projects to back. Enviromentalists want those criteria to focus on environmental performance, especially with prospects dim under the new administration for any stiffening of laws.

At the moment, there are no fullscale commercial synfuels plants in the United States. Site work has begun at only three commercial shale projects, while 10 others are in various stages of planning, according to Department of Energy figures.

Worldwide, the National Coal Association says there are 95 gasification plants, with 35 small-scale pilot and demonstration coal plants in the United States. The two South African indirect liquefaction plants, which combine gasification and liquefaction, provide 10 percent of that country's oil needs, while the Athabasca tar sands of Alberta, Canada, give up 145,000 barrels of crude a day.

Even so, a Congressional Research Service study found recently that the projected cost of synfuels always stays ahead of oil prices by 10 to 450 percent. This is partly because of the "driving effect" of oil prices on the economy.

"No matter how high the price of oil rises -- even to $100 per barrel -- a new plant built subsequent to arrival of oil at that price will not be economic," the report said. But it added that plant operating costs would rise slowly enough to allow oil prices to pass the price of synfuels, assuming oil prices keep rising. "Had such a plant been built six years ago when oil was $9 a barrel, its product cost of $28 per barrel would be economical today," the study said.

This is the argument the industry makes now. As API's Hall put it, "There are no major obstacles other than mustering the political will to get going."