Embryonic stem cells (ESCs) have the potential to be used as an unlimited cell source for cell transplantation therapy, as well as for studying mechanisms of disease and early mammalian development. However, applications involving ESCs have been limited by the lack of reliable differentiation methods in many cases. Mesenchymal stem cells (MSCs) have also emerged as a promising cell source, but as suggested in recent studies, these cells display limited potential for proliferation and differentiation, thereby limiting their usefulness in the clinic and in the laboratory. Unfortunately, effective methods for induction of MSCs from pluripotent stem cells have not been established, and the development of such methods remains a major challenge facing stem cell biologists. Oxygen concentration is one of the most important factors regulating tissue development. It has profound effects on cell metabolism and physiology and can strongly influence stem cell fate. Here we demonstrate that severelow O(2) concentrations (1%) can function as a selective pressure for removing undifferentiated pluripotent cells during the induction of MSCs from rabbit ESCs (rESCs) and that MSCs induced under severe hypoxic conditions function as normal MSCs; that is, they repopulate after cloning, express specific markers (vimentin, CD29, CD90, CD105, and CD140a) and differentiate into adipocytes, osteoblasts, and chondrocytes. Furthermore, we demonstrate that these cells can contribute to cartilage regeneration in an in vivo rabbit model for joint cartilage injury. These results support the notion that exposing ESCs to severe hypoxic conditions during differentiation can be used as a strategy for the preparation of functional MSCs from ESCs.