The amount of sawmill residue available in Canada to support the emerging cellulosic ethanol industry was examined. A material flow analysis technique was employed to determine the amount of sawmill residue that could possibly be available to the ethanol industry per annum. A combination of two key trends—improved efficiency of lumber recovery and increased uptake of sawmill residues for self-generation and for wood pellet production—have contributed to a declining trend of sawmill residue availability. Approximately 2.3 × 106 bone-dry tonnes per year of sawmill residue was estimated to be potentially available to the cellulosic ethanol industry in Canada, yielding 350 million liters per year of cellulosic ethanol using best practices. An additional 2.7 billion liters of cellulosic ethanol might be generated from sawmill residue that is currently used for competing wood energy purposes, including wood pellet generation. Continued competition between bioenergy options will reduce the industrial sustainability of the forest industry. Recommendations for policy reforms towards improved industrial sustainability practices are provided.