This paper investigates the effect of the surface oxide layer of Fe nanopowder synthesized by plasma arc discharge (PAD) process on the densification process in hydrogen atmosphere. The densification process was divided into two steps: rapid densification at low temperature and densification retarding at high temperature. The reduction process of the oxide layer was quantitatively analyzed, and it was observed that the reduction process dominantly affected the initial densification process at lower temperature. The volume shrinkage due to the reduction of the oxide layer corresponded to 75% of the initial volume shrinkage at low sintering temperature. The volume shrinkage of the reduced oxide layer and the densification rate were discussed in terms of microstructural evolution.