Does anyone know why this is? Heck they even have San Andreas on Demand. Why not Morrowind?

Very few games from the original Xbox have been emulated to run on the 360. (Which is what's required for it to be in the Games on Demand store)

Since the main platform for Morrowind is PC, I guess Bethesda decided it just wasn't worth emulating it for the 360.

But the original disc does work in a 360 (with an update from Live) and it isn't too hard to find used copies of it.