So I suppose it's the driver version because the problem is gone now.
I used this PPA - https://launchpad.net/~ubuntu-x-swat/+archive/x-updates to 
update the X.Org packages and there the only update that actually matters is 
the radeon driver version which is 6.13.1.

Solved with:

kernel - 2.6.34 final (for Lucid from the mainline Kernel PPA)
xorg-server - 1.7.6-2ubuntu7.3
radeon driver version - 6.13.1


Regards,
Miro

-- 
[radeon driver] (regression) poor video decoding performance
https://bugs.launchpad.net/bugs/578224
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