Success! ...but not by changing the esm into an esp.
While changing the esm into an esp did work, I was left with two separate esps which meant that if the user didn't read the load order instructions (as they never do), they could end up with ctd's instead of missing land. Which is probably worse.
So I tried merging the two esps together and ended up with a monster 35 MB esp that crashed everything it touched. Oblivion and the CS doesn't seem to like such huge esps it seems.
Re-reading the infamous "Creating Large Worldspaces" tutorial, I noticed a paragraph that didn't seem to make much sense:
Once you have trees and other content, you will also need to clear out all the VWD flags for your world space using TES4Edit in order for your world space to show correctly when loaded anywhere other than the 01 index. You would need to do this cleaning after every change which adds more trees, but thankfully, you only need to clean out those things which were added/moved. (Note: This final note has still not be verified in recent testing.)
Figuring it was worth a shot, I fired up TES4Edit and removed the VWD of every tree and rock in each of the 1200 or so cells. It took a good two hours, but once I loaded it up in Oblivion, there was nice solid ground under my feet!
As I mentioned, it makes no sense why VWD flags would counter-intuitively cause custom worldspaces to not work. Thankfully, TES4LODGen ignores the VWD flag and generates a record for anything that has a _far.nif mesh.
For those who need to go through this exercise, I wasn't able to find an automated way to do it, but I was able to reduce the process to "almost brainless" allowing watching of TV while doing it. I filtered all the references "By Visible When Distant" and checked "only Visible When Distant". I used a keyboard macro to expand all the blocks, subblocks and cells in order to view the individual references. Once that was done, it's possible to highlight large numbers of references, Right-Click on them and select "not Visible when Distant".
tl;dr Remove all VWD flags from all objects in any worldspace in an esm.