Ok let me sum it up for you.
First of all, nero automatically converts all of the files into a file that is recognized by ps3. Some files work and some don't due to it's size, streaming issues and other issues that you may have.
Second of all, avi s are supported on ps3. (Majority of them any ways.)
Here is the complete list. (props to vuzuw)
These are the supported codecs your PS3 is able to read:
-MPEG-1 (MPEG Audio Layer 2) (.MPG)
-MPEG-2 PS (MPEG2 Audio Layer 2, AAC LC, AC3(Dolby Digital), LPCM) (.MPG)
-MPEG-2 TS (MPEG2 Audio Layer 2) (.MPG)
-MPEG-4 Part3 (MPEG-4 AAC Low Complexity (unprotected)) (.MP4)
-MPEG-4 Part2 (MPEG-4 SP; MPEG-4 ASP) (.MP4)
-MPEG-4 DivX (in AVI) (.AVI)
-MPEG-4 H.264 (.MP4 / .M4V)
-MPEG-4 AVC (.MP4)
DivX (.AVI / MPG)
XviD (.AVI / .MPG)
-Motion JPEG (Linear PCM)
-Motion JPEG (μ-Law)
AVCHD （.m2ts / .mts )
Note - The DivX, XviD & VC-1 (.WMV) only work if you're on v2.10 or more.
Checking your video's codec: (Sent in by mick)
If you are unsure about what your video' codec is download gspot. GSpot is a program which checks your video's codec. You don't even need to install anything, and it's very easy to use.
I hope that this cleared some issues and questions that people might have had.