The tracheal system of Drosophila melanogaster is an interconnected network of gas-filled epithelial tubes that develops during embryogenesis and functions as the main gas-exchange organ in the larva. Larval tracheal cells respond to hypoxia by activating a program of branching and growth driven by HIF-1alpha/sima-dependent expression of the breathless (btl) FGF receptor. By contrast, the ability of the developing embryonic tracheal system to respond to hypoxia and integrate hard-wired branching programs with sima-driven tracheal remodeling is not well understood. Here we show that embryonic tracheal cells utilize the conserved ubiquitin ligase dVHL to control the HIF-1 alpha/sima hypoxia response pathway, and identify two distinct phases of tracheal development with differing hypoxia sensitivities and outcomes: a relatively hypoxia-resistant 'early' phase during which sima activity conflicts with normal branching and stunts migration, and a relatively hypoxia-sensitive 'late' phase during which the tracheal system uses the dVHL/sima/btl pathway to drive increased branching and growth. Mutations in the archipelago (ago) gene, which antagonizes btl transcription, re-sensitize early embryos to hypoxia, indicating that their relative resistance can be reversed by elevating activity of the btl promoter. These findings reveal a second type of tracheal hypoxic response in which Sima activation conflicts with developmental tracheogenesis, and identify the dVHL and ago ubiquitin ligases as key determinants of hypoxia sensitivity in tracheal cells. The identification of an early stage of tracheal development that is vulnerable to hypoxia is an important addition to models of the invertebrate hypoxic response.