The first commercial acoustic telemetry system was successfully introduced in 2000 as part of a drillstem testing system. However, duplicating the success of the acoustic telemetry to environmentally challenging LWD applications at high data throughput remains a formidable task. The primary limitation arises from normal drilling operations that produce in-band acoustic noise at multiple sources at intensities comparable to the transmitter output. This noise, together with the signal attenuation along the drill string, adversely affects the data throughput. To determine the communication capacity of the drill string channel using acoustic waves, we examined the impact of channel characteristics, signal attenuation and noise in detail. Based on a communication model which incorporates the effects of both drill string acoustic channel and noise, we extensively studied the capacity of the system using the waterfilling method. For this analysis, realistic downhole transmitter power output, experimentally measured noise at the surface, and measured attenuation of acoustic waves in the drill string were used as input parameters. The results show that a typical drill string channel has a potential capacity of up to several hundred bits per second under noisy drilling conditions. Implications of the channel capacity on acoustic telemetry system designs are discussed. A communication technique that comes close to realizing a high-rate telemetry system is introduced. Methods to optimize various aspects of the system such that maximum channel utilization can be realized under drilling conditions are also discussed. Potential enhancement to data rates through application of error control coding is briefly covered.