Firstly a few words of caution: that game has been in development for over three years already. It isn't likely to be released for another year to a year-and-a-half so won't be expected to run on much less than a 3-4GHz PC. Also, note that the linked image has been described as an "in-game screenshot", a "cut-scene screenshot", and also as "concept art" - so exactly how much of that image is an accurate representation of their current technology is anyone's guess!
But moving on, I agree - that background looks static to me. There definitely appears to be some serious LODding of the trees, but how much of that is down to JPEG artifacting, I don't know.
From what I can see, games are trying to move entirely away from the "cell loading" problem, and as that was so heavily criticised in Morrowind, I expect Oblivion will use some kind of continuous streaming of data. Note that this just means you have a continuous stream of visibility issues rather than a big block of them at once!
The biggest problem with LOD systems is when the low-detail representations (of textures, meshes, sometimes even sounds) differ significantly from reality. The two main ways to deal with this are: firstly, to make sure your low-detail data closely follows the high-detail data; secondly, to handle the differences gracefully. Clever people have implemented LOD systems where high-detail meshes exactly match low-detail meshes at the point of coming into range, but rapidly morph into the "proper" data as time goes on.
Another issue with LOD is that it assumes that everything past a certain point is largely irrelevant and to be ignored. If you have interesting details a long distance away that are likely to attract attention, then performing any viable LOD on them becomes a knotty problem. The usual approach, I believe, is to give up.
EDIT: In case anyone's interested, the original graphic can be viewed here