Articular cartilage covers the surface of synovial joints and enables joint movement. However, it is susceptible to progressive degeneration with age that can be accelerated by either previous joint injury or meniscectomy. This degenerative disease is known as osteoarthritis (OA) and it greatly affects the adult population. Cell-based tissue engineering provides a possible solution for treating OA at its earliest stages, particularly focal cartilage lesions. A candidate cell type for treating these focal defects are Mesenchymal Stem Cells (MSCs). However, present methods for differentiating these cells towards the chondrogenic lineage lead to hypertrophic chondrocytes and bone formation in vivo. Environmental stimuli that can stabilise the articular chondrocyte phenotype without compromising tissue formation have been extensively investigated. One factor that has generated intensive investigation in MSC chondrogenesis is low oxygen tension or physioxia (2–5% oxygen). In vivo articular cartilage resides at oxygen tensions between 1–4%, and in vitro results suggest that these conditions are beneficial for MSC expansion and chondrogenesis, particularly in suppressing the cartilage hypertrophy. This review will summarise the current literature regarding the effects of physioxia on MSC chondrogenesis with an emphasis on the pathways that control tissue formation and cartilage hypertrophy.