Stem cells have the ability for prolonged self-renewal and differentiation into mature cells of various lineages, which makes them important cell sources for tissue engineering applications. Their remarkable ability to replenish and differentiate in vivo is regulated by both intrinsic and extrinsic cellular mechanisms. The anatomical location where the stem cells reside, known as the "stem cell niche or microenvironment," provides signals conducive to the maintenance of definitive stem cell properties. Physiological condition including oxygen tension is an important component of the stem cell microenvironment and has been shown to play a role in regulating both embryonic and adult stem cells. This review focuses on oxygen as a signaling molecule and the way it regulates the stem cells' development into mesenchymal tissues in vitro. The physiological relevance of low oxygen tension as an environmental parameter that uniquely benefits stem cells' expansion and maintenance is described along with recent findings on the regulatory effects of oxygen on embryonic stem cells and adult mesenchymal stem cells. The relevance to tissue engineering is discussed in the context of the need to specifically regulate the oxygen content in the cellular microenvironment in order to optimize in vitro tissue development.