I think 720p video would look great on the iPhone, especially since I crop most movies and TV shows I watch. The SD content is compressed at a mediocre quality, at best. If you encode the videos yourself from a great source, then it looks really good on the iPhone, and at a lot of times, great. There would be a huge difference between SD and HD on the iPhone, despite the fact that it's only a 3.5" screen at 480x320. Movies can start to look washed-out on the iPhone up close when cropped in, having it in 720p would fix that and then some. I wouldn't mind watching HD videos on my iPhone, the battery life should still hold up pretty well. The better quality would be worth taking up so much extra space, at least to me.
I doesnt matter what source you get it from SD or HD it all about the compression to iPhone res. you must have watched badly compressed movies to think that HD is the way to go. remember ITS ALL ABOUT RESOLUTIONS!!! SD is 480 while HD is 720, both are more than the iPhone. Also remember since digital SD signals (talking uk here) SD is progressive.