JASPER, TENN., SEPT. 12 -- The Energy Department, the taxpayers and believers in a bright future for alternative fuels suffered a nasty setback today when auction bids on a mothballed ethanol plant came in so low that federal officials rejected them.

The former Tennol Energy Co. plant, which cost $91 million to build and which the Energy Department acquired when the owners defaulted on a federally guaranteed $64 million loan, attracted only two bids in an auction that had been extensively advertised.

One was for $8.3 million, the other for $2.7 million. It took Energy Department officials less than 15 minutes to decide not to accept the higher bid.

"This isn't the result we were hoping for, but it'll turn out all right," said David A. Lindahl, director of the department's office of alcohol fuels. "The plant will get more valuable over time." He said there was "keen interest among the people here today, but they just chose not to make their move at the present time."

Auctioneer Richard W. Oliver did not identify the bidders. The Energy Department did not announce a minimum bid, but officials had been hoping for a lively competition.

Energy Secretary James D. Watkins has been promoting ethanol, or grain alcohol, as part of the government's response to the latest oil crisis.

Newspaper advertisements in several countries urged prospective buyers not to miss "this opportunity to get in on the cutting edge of the rapidly emerging clean motor fuel trend!"

The ethanol industry generally has been in an upbeat mood even though approximately 17 percent of the nation's 1.1 billion-gallon-a-year production capacity is idle. Prices have been rising in step with gasoline prices since Iraq invaded Kuwait.

The prospect of legislation to strengthen the Clean Air Act that would require some use of alcohol fuels and the possibility of increased use of ethanol as a way of saving gasoline have even stirred talk of expansion. A study released last week by the St. Louis-based National Corn Growers Association projected annual demand of 3 billion gallons by 2,000.

Before the auction, Lindahl had expressed optimism that the Energy Department would at least recoup more than it would have a year ago.

But he also said that prospective bidders face the same uncertainty that has plagued the alternative energy industry for almost two decades: Investments that might be profitable when crude oil costs $30 a barrel, as it does now, might not be if oil prices recede to $20 or less.

When blended with gasoline, ethanol enhances octane and reduces the emission of pollutants. But it is more expensive to produce than gasoline, and the industry has survived in an era of cheap oil only because it is subsidized by the federal government. The unhappy history of this plant provides a good example of the difficulties the government faces in trying to encourage the development of alternative forms of energy.

It is one of three built with government loan guarantees under the 1980 Energy Security Act, enacted after the 1979 oil shock. Only one of the three is operating.

Tennol, a partnership of Combustion Engineering Inc. and Halbert International Corp., experimented with a new technology for processing corn into alcohol, tinkered with the engineering and the chemical process, and put the plant into production at exactly the wrong time: 1986, when oil prices were at their lowest in many years and corn prices were high because of the nationwide drought.

The plant never produced at more than 50 percent of its 25-million-gallon annual capacity, according to a technical report made available to bidders. It has been closed since 1988.

The plant includes 155 acres, computerized controls, river frontage and a railroad siding. Sales brochures billed it as "completely re-engineered" and "state of the art," but industry sources said doubts about its engineering may have discouraged bidders.