I tried with a region 2 pal disc, same issue.

This is the kind of image I get.

forum.videolan.org/viewtopic.php?f=14&t=56287

Upon reading people are saying this worked

"I was having the exact same problem as the OP. I have windows XP and a region 1
DVD drive; VLC media player would play region 1 DVDs fine, but not region 2
(video output was as in the OP).

I was using version 0.9.8a of the VLC media player. I unistalled that and
installed version 0.8.6i of the VLC media player - and now all DVDs I've tried
have played fine (region 1, region 2, all-regions PAL; all legal DVDs), no
adjustments needed, and no changing my drive region!