The "All-gas" project will cultivate fast-growing micro-algae by using the nutrients in wastewater and then by further processes generate biomethane which can be captured and used in transport fuel.
The biomass obtained from the algae crop showed high energy potential with a methane production capacity of 200-300 litres of gas per kilogramme of biomass processed, water company FCC Aqualia said.
"This original new approach to bioenergy means that Spain's 40 million population could power 200,000 vehicles every year with a single toilet flush," said Frank Rogalla, the project's coordinator and director of innovation and technology at FCC Aqualia.
Some €7.1 million of the scheme's initial €12-million development funding came from the EU, which is aiming for 10% of its energy used in transport to be derived from renewable sources by 2020.
However, development is still at a very early stage, there is no large-scale production in Europe and, along with the progress announced on Thursday (8 August), FCC Aquilia has also ruled out some of its earlier ideas for producing biodiesel after it proved unsustainable.
Experts say costs must be cut dramatically to make production commercially viable.
In June, French genome engineering company Cellectis said it had six months to prove the effectiveness of its technology to produce biofuel from algae if it is to move on with the investment with partner Total.
Assuming the Spanish project, launched in May 2011, continues on track, construction of a 10-hectare plant in Chiclana, southern Spain, is planned for completion by 2016, FCC Aqualia said.