I, too, have never heard the term before. However, here is the excerpt I think is key from the linked to page:
In this proposal, the hosts that execute the contract code are the
same as the “oracles” that in other systems might only be set up to
provide contracts running outside of their systems with information
about the outside world.
To give a concrete example, a smart contract for betting on the outcome of a horse race might query a regular oracle and then credit the winner(s) of the bet based on the return value from the smart oracle. It might even do some complex computation to determine the amount to credit (for example, different payouts for correctly betting on first place, runner up, placing, etc.). In a smart oracle, all the code execution can take place on the oracle machine; the only thing that gets recorded into the blockchain is a call to the oracle and the final balance modification. This particular scheme means that you can even have secret closed-source code performing actions on the blockchain -- assuming, of course, that you trust the smart oracle. Essentially, smart oracles are centralizing code execution in addition to the oracle portion. This seems like an anti-pattern to me (separate concerns are being entwined into a single entity). Some additional exposition from the authors:
The execution of untrusted code should be decoupled from the consensus
databases and other services that track and transfer asset ownership.
The separate contract system can handle untrusted code execution and
interact with the consensus databases through cryptographic
signatures. These signatures are already native to consensus protocols
so no modifications are necessary. Decoupling contracts from consensus
networks gives the added benefit that contracts can interact with
multiple networks at once as well as virtually any type of online
service. This means that a single smart contract could interact with
Bitcoin and Ripple, web-based services like PayPal, Google, Ebay, etc.
or even other Internet protocols, such as SSH, LDAP, SMTP and XMPP.
To emphasize, this is just my interpretation of the link you included.