They also stipulated that Microsoft's app be an HTML5 app, and not a native app (which is what the iOS/Android clients are), for no reason I was able to discern or theorize at the time. And thanks to deficiencies in the Windows Phone web engine, that proved impossible to do effectively.
They also refused to provide whatever information was necessary to allow their native app to display ads appropriately.
Basically, regardless of how Google explains their position, it really feels like their goal here was to prevent YouTube from being easily/effectively accessible on Windows Phone devices. Or at the very least, they had zero interest in getting WP owners onto YouTube.
They stipulated that the player use HTML5 so that it could show all of their ads and overlays correctly. That seems pretty reasonable.
Microsoft couldn't have just the player in HTML5 because their embedded webview can't play video -- which is where the stories of "Google wanted the whole app to be done in HTML5" came from.
IMO an embedded webview should be able to play video, or Microsoft should have been able to get something together just for youtube.