Integration of anaerobic and aerobic conditions in a single bioreactor is a good strategy for the complete mineralization of azo dyes. In order for this strategy to work, azo dye reduction should occur in biofilms exposed to oxygen. Therefore, the effect of oxygen on the azo dye reduction by methanogenic granular sludge was studied using Mordant Orange 1 (MO1) as a model. Azo dye-reduction rates by two different granular sludges were determined in batch assays with various concentrations of oxygen in the headspace. Azo dye reduction occurred in the presence of oxygen if co-substrates, either ethanol or acetate, were added. The rate of dye reduction was highly positively correlated with the oxygen-consuming activity of the sludge. The results suggest that co-substrates stimulate oxygen respiration, which lowers oxygen penetration into the biofilm and thereby creates anaerobic microniches where azo dye reduction can occur.