It wasn't so much mouse lag as it was keyboard lag. And running it at medium fixed the problem (at the expense of image quality). So are there any other things it could be aside from that joystick var? I'll test it as soon as I can (I don't think my friend is computer-savvy enough to perform an .ini mod by himself), but both me and my friend have been pretty busy lately and it's been weeks since I've visited. I'll try to get myself invited next weekend, but until then, the more contingency plans, the better.
Also, what about outdoor slowdown? Any things I should try to do to resolve that?
Here are two pages that've helped me, they both contain heaps of tweaks to fine tune how Oblivion runs:
http://www.atomicmpc.com.au/article.asp?CIID=36222
http://www.tweakguides.com/Oblivion_1.html
Outdoor slowdown is just part of the game, but you might be able to minimise it by tweaking the cell and grid variables.