James, 34, began his career at Neath before joining Ospreys when Welsh regional rugby was formed in 2003.
The ex-Wales Under-21 captain is the only remaining member of the original squad and has made 194 appearances for the team.
Ospreys head coach Steve Tandy described James as "a fantastic role model".
"He's tough, uncompromising, with a huge amount of experience, and he cares passionately about this region," he added.
"The Ospreys mean a lot to me," said James, who spent 2012-2015 at Bath.
"I'm enjoying being back home and being involved with a young squad that I think can do really well this season."
Wales loose-head prop Paul James has signed a contract extension to keep him at Ospreys until 2018.