Derivation of articular chondrocytes from human stem cells would advance our current understanding of chondrogenesis, and accelerate development of new stem cell therapies for cartilage repair. Chondrogenic differentiation of human embryonic stem cells (hESCs) has been studied using supplemental and cell-secreted morphogenetic factors. The use of bioreactors enabled insights into the effects of physical forces and controlled oxygen tension. In this study, we investigated the interactive effects of controlled variation of oxygen tension and chondrocyte-secreted morphogenetic factors on chondrogenic differentiation of hESCs in the embryoid body format (hESC-EB). Transient hypoxic culture (2 weeks at 5 % O2 followed by 1 week at 21 % O2) of hESC-EBs in medium conditioned with primary chondrocytes up-regulated the expression of SOX9 and suppressed pluripotent markers OCT4 and NANOG. Pellets derived from these cells showed significant up-regulation of chondrogenic genes (SOX9, COL2A1, ACAN) and enhanced production of cartilaginous matrix (collagen type II and proteoglycan) as compared to the pellets from hESC-EBs cultured under normoxic conditions. Gene expression profiles corresponded to those associated with native cartilage development, with early expression of N-cadherin (indicator of cell condensation) and late expression of aggrecan (ACAN, indicator of proteoglycan production). When implanted into highly vascularized subcutaneous area in immunocompromised mice for 4 weeks, pellets remained phenotypically stable and consisted of cartilaginous extracellular matrix (ECM), without evidence of dedifferentiation or teratoma formation. Based on these results, we propose that chondrogenesis in hESC can be synergistically enhanced by a control of oxygen tension and morphogenetic factors secreted by chondrocytes.