While there were and are a good number of practical engineering challenges for algae-fuel production, as far as I know, there is one and only one reason why we didn't do this long ago: The price of crude was too low.
When the Aqautic Species Program concluded,
http://www.nrel.gov/docs/legosti/fy98/24190.pdf it was estimated that biodiesel from algae might be competitive when diesel was over $2 per gallon. At that time, diesel was about $1 per gallon. Now that the price of crude has a floor near or above the critical threshold for biodiesel to be competitive with petrodiesel, we are seeing a growing interest in viable alternatives to crude oil.
I have yet to see any alternative that offers the range of benefits found in using algae derived biodiesel as our primary energy source. After studying this option for about six months, I began to see that it is truly the elegant solution to our energy problems:
1). Does not need to compete with food crops
2). Does not need to use fresh water
3). Highest energy conversion rate of any plant [with qualifer stated earlier]
4). Greatest yield per acre-yr of any biofuel option
5). About 1.6 times the energy density of ethanol, and as good as gasoline
6). High lubricity of biodiesel allows for more efficient operation of engine [as seen in the Boeing test flight]
7). Diesel engines are about 1.4 times more efficient than internal combustion enginers
8). CO2 neutral
9). Clean diesel cars are already sold in Europe. The Honda diesel gets better mileage than the Honda hybrid. The proof in in the pudding!
10). Compatible with existing energy infrastructure.
11). The conversion to a biofuel economy can be implemented relatively quickly
12). Algae can be used to produce diesel, ethanol, and Hydrogen. So the development of algae technologies could be a stepping stone to a Hydrogen Economy.
13). Having a value of ~ $600 Billion annually - money sent to foreign oil suppliers - a domestic algae program would eliminate at least 60% of the trade deficit [depending on the current price of crude].
14). Can be used to remediate CO2 as well as toxic and other waste products from agriculture, industry, and municipalities.
15). While not necessary, it could be scaled-up to provide 100% of the required energy for the world.