The upstream area of Fenhe River, as an independent drainage unit in the ecologically vulnerable loess plateau, is the only source of water conversation and clean water for Taiyuan City. The ecological security of the area has great significance. The paper provides a brief introduction to the area and analyzes the deteriorating ecological damages. The paper holds that legal means should be applied to coordinate the relationship between economic development and ecological protection. After arguing for the necessity of establishing an ecological compensation system for the upstream area of Fenhe River, the paper proposes the specific methods to establish a reasonable system for ecological compensation. With the help of this system, it is hoped that effective methods can be used to protect ecology and provide a guarantee for the ecological security of the upstream area of Fenhe River.