Prenatal alcohol exposure is the most common environmental factor leading to congenital birth defects in the United States. Although significant progress has been made in this field, the detailed molecular pathology of fetal alcohol syndrome (FAS) remains to be determined. Previously, we have shown that alcohol exposure perturbs hedgehog signal transduction in zebrafish embryos by inhibiting the post-translational cholesterol modification of Sonic hedgehog (Shh), leading to decreased levels of mature Shh ligand that is associated with the plasma membrane, and causing transient loss of Hh signaling, resulting in permanent FAS-related morphological abnormalities. In the present study, we further elucidate the mechanisms that regulate the intracellular transportation and secretion of Shh using the hepatic stellate cell line HSC8B. We have found that Shh is associated with caveolin-1 in the Golgi apparatus to form protein complexes and that these complexes are packaged as large punctuate structures (transport vesicles) that are transported to the plasma membrane in lipid raft microdomains. Alcohol exposure does not significantly interrupt translation of shh mRNA in endoplasmic reticulum (ER) or the trafficking of Shh from the ER to the Golgi apparatus. However, alcohol does prevent the entry of Shh into transport vesicles from the Golgi to the plasma membrane and specifically decreases the amount of caveolin-1/Shh complex found in lipid rafts, causing cytoplasmic accumulation of Shh and leading to a deficiency of Shh ligand secretion into the extracellular matrix.