Can Oblivion books have images added to their pages? I thought I had seen this somewhere but after looking through 50 books I couldn't find any in the game. Is this possible?

Yes, graphics can be placed in books. Illuminated capital letters at the start of some paragraphs are an example of this.

For details: http://cs.elderscrolls.com/constwiki/index.php/Book_Formatting

Reference tags paragraph. http://cs.elderscrolls.com/constwiki/index.php/Book_Formatting#.3CIMG.3E