Basically what we’d do is take any “quest” or story element and break it down into its components, each component then has activating conditions that are as dynamic as possible. An NPC decision that is specific to a situation would still be subject to various weighted factors that support that decision, it would have to contend with other decisions, including general ones not specific to the situation, for priority. Each decision has associated risks and rewards that vary in dregrees and the NPC’s personal characteristics or mood also weigh in.
This is EXTREMELY difficult to do in all honesty. Parts of what they want to do are feasible by themselves. Such as NPC Attitude or mood affecting an action. I have played many games and mods and even contributed to a few as well where you can use a moral system or time of day, previous action flag, or a global action to make changes to a specific character NPC and then have that behavior changed or removed again. However what it sounds like they are aiming at is taking what might be 10 outcomes and changing that to more like 50 outcomes.
Maybe on a small map with 20 NPC's total it may be possible to write a story tree that massive to allow for Player freedom to engage in quests based on the dynamics of the world as a whole. They did say the map would be small but jam packed full of things for the Player to do. This is fine, Diablo 1 was successful with this model.
So basically we could see some truly impressive World to Player interaction or just the opposite, deep but simple interaction. What I mean by deep is you could engage in a 10 part quest but the interaction is simplistic... ie: talk to Jim, talk to Ted, kill Fred, find an object, return to Jim (what we are used to).
I would love to see an interaction where you come across an NPC and they may ask something of you or blow you off depending if they are being attacked, their town being destroyed, or they are drunk and think your ugly
Here is hoping!