I'm trying to install this mod, http://www.tesnexus.com/downloads/file.php?id=40367 and the directions say drop the texture folders into the oblivion data folder and over-wright? Mine say's their is already a folder named this would you like to merge them, do I say yes?

Ya, when I install mods it asks if I want to merge ALOT.

You won't get duplicate files, if thats what you are concerned about

Usually it says them when you place for example:

'texture' into the Oblivion folder that has the same 'texture'

Yes you do.

Merging the folders means that you will overwrite files that have the same names with the new ones from the mod.

I would recommend using a utility program like Wrye Bash or OBMM (Oblivion Mod Manager) to install mods though. That tends to be cleaner than adding them manually like you are.
Wrye Bash especially makes it far easier to remove the mod if you decide that you don't like it after all.

Hmm, I've been using OBMM but it doesn't seem to work with graphic enhancing mods for some reason and I don't know why?