Palacios lives inside the lightweight kernel host. Applications that want to run natively on the lightweight kernel without virtualization can at *no* penalty. Applications that are willing to pay the performance penalty of Linux can run Linux as a guest at a nominal additional virtualization cost. That way, applications that demand peak hardware performance get it, applications that need more complex OS services get it, and the downtimes associated with a complete system reboot are avoided.
In addiiton, the costs of something like Linux to a scientific application can be much higher for than many might expect. Cray's target was to get application performance on their Compute Node Linux within 10% of Catamount performance; they did so for most (but not all) of their apps as I understand it, but had to spend a significant effort to even get within 10%.
We're happy to leverage their hard work, however, so that users who want CNL can boot it on top of our VMM, while users who don't can get done faster or save some of their allocated cycles. I sometimes wonder if ORNL wished they had been running a VMM/LWK on Jaguar when Roadrunner beat them on the SC 2008 Top 500 list by 0.5%. Being able to use the lightweight kernel for Top500 Linpack runs and CNL for running apps that needed it might have come in handy for them then. :)
Finally, our experience has been that a small, simple, open-source LWK/VMM combination is a very powerful platform for OS and hardware HPC research - it provides a simple, understandable, and powerful base for addressing HPC systems problems (e.g. fault tolerance) without the complexity of trying to do that in, for example, Linux.