Magician, what you have would be a huge advance. The wheel in Oblivion was worse than absurd. There was a mod that completely changed the system. Huge improvement but still nowhere near what you are proposing. I would love to see something that moves in the direction of your proposal.
Well, depending on a lot of factors, I might rebuild it for Skyrim. I spent months on it and lost all of my scripts (or at least a lot of them) in a hd crash. Then they announced Skyrim and I decided to hold off. If the script guys can get most of the functionality back, I should be able to redo it with a lot less fuss. Of course, I was using AddActorValues to implement the extended AI, so I don't know how soon all of this will be possible again.
Anyways, I have envision speech menus like this:
canned option 1
canned option 2
canned option 3
other
The canned options are perhaps not completely fixed, but are intended to represent "likely" avenues of discussion. Also, if there is any implied sub-text, it should be clear here (sarcastic, friendly, angry, whatever).
And "other" would be an escape hatch -- it would be sort of like the blunt "flatter/bribe/taunt/intimidate" options, but instead of being designed for simplicity -- the canned options give you simplicity -- it's a statement builder interface, where you can declare your emotional tone, the kind of discussion you want to have, and so on... and, most of the time, it might be futile or result in not-so-great responses. So I would also want to be able to save my own "canned requests" so I did not have to build them over and over. "Hey, have you seen Olfrid Battle-Born?" or "That's great. [sarcastic]" would probably tupically yield the NPC equivalent of "Whatever" or "You may have already won..."
Unfortunately, computers are dumber than ants, so there are always going to be unsatisfying conversational sub-trees. But I keep wishing for something different.
The way to get around that is to use an intelligent menu system that learns from your responses. For example, at the start of the game you have a set of canned replies: Good, Neutral, Evil. If in your first response, you choose Evil, in the next set of options you have Good, Neutral, Evil 1, and Evil 2. Evil 1 might be a cold, brutal response; Evil 2 might be a playful, yet cruel response. If you choose Evil 2, your next set of options is Neutral, Evil 1, Evil 2, and Evil 3. The "good" option has suffered extinction and been dropped from the tree, the Neutral option is still there so you can always push dialogue back in the direction of being good if you want, and the Evil options have expanded to 3 possible variations. You could extend this indefinitly, of course, but time + budget will dictate a limit.
This creates all sorts of interesting possibilities. For example, characters who habitually lie. Every dialogue can be given lie responses that are only exposed in the tree if the player has previously demonstrated that they want to lie. This can take something that is context sensitive (eg. a quest where you are forced to decide whether to lie or not) and turn it into a character trait that is available all the time. That's how I was planning on integrating the context sensitive stuff with the generic dialogue options. Essentially, different characters would have different options based on previous dialogue choices that they'd made.
This also makes it possible to have fairly refined personality for your character and appropriate responses from NPCs. One half of that equation is behavioral, and the other half is aesthetic.
In the system I was designing for Oblivion, NPCs would remember if you lied to them and they caught you in the lie (ie. you failed the Speech test). Every time they detected a lie, they trusted you less and were more likely to detect a subsequent lie. It also changed their behaviors. An NPC who trusted you wouldn't follow you into the next room, but one who didn't, would. Also, guards would be more likely to follow you if they knew you were a liar. That's a behavioral response.
An example of an aesthetic response is when the NPC responds in an appropriate way that doesn't change gameplay (to a significant degree). For example, in my system, NPCs were given a sense of humor. If you used humor in dialogue, NPCs with a high sense of humor would respond by laughing and being more friendly. NPCs with a low sense of humor would be curt and act less friendly.
I could go on, but I think you get the idea.