As higher oil prices drive global demand for biofuels, Brazil’s ethanol industry—including both local and multinational companies—seems well positioned for profitable growth. The country has the world’s lowest production costs for ethanol, is its leading global exporter, and has plenty of available land to increase production.

But the forces unleashed by surging demand will challenge the industry. A McKinsey study shows that ramping up export capacity will require as much as $100 billion in new investment, depending on international demand. Brazil’s fragmented network of ethanol producers and limited distribution infrastructure will struggle to keep pace. Meanwhile, the growth prospects for biofuels are generating worldwide research efforts that seem likely to yield technologies that will lower the cost of production in other countries, making them more competitive with Brazil. In this uncertain environment, industry participants will have tough decisions to make about where, when, and how much to invest.

Annual worldwide ethanol exports now total 6.5 billion liters (about 1.7 billion gallons), but our research suggests that by 2020 they could reach 50 billion to 200 billion liters, depending on crude-oil prices and...