I'd like to know too. Especially reflections look awful in the distance. I recall seeing some kind of mod that improves that but I can't remember what it was.
Maybe the Oblivion Graphics Extender can do something? The Morrowind Graphics Extender made crazy improvements to Morrowind's water, making it better than Oblivion's current water. I'd love to see waves, or at least less blocky reflections in the distance, for Oblivion's water.
http://www.strategyinformer.com/pc/theelderscrollsivoblivion/mod/22090.html is the one you're thinking of. Downside of it is that you lose near-distance water quality.
http://tesnexus.com/downloads/file.php?id=23064 is one of the best water mods out right now, but is still limited to working on the existing water. To move beyond that, we'll have to keep our eyes on the OBGE development thread