In Fedora 10 and earlier, there's a special case in yuminstall.py (see line 401 in current git) for handling "repo=hd:device:/path" when the system is booted with "preupgrade" on the commandline:

      (device, fstype, path) = m[3:].split(":")

  if flags.cmdline.has_key("preupgrade"):
      self._baseRepoURL = "file:///mnt/sysimage/%s" % path

As you can see, the device name is discarded and yum is instructed to get its packages from the given path, on the mounted system. Hence preupgrades are booted with:
  
  preupgrade repo=hd::/var/cache/yum/preupgrade [etc]

The new anaconda storage code needs to handle this special case, or provide another way for preupgrade to specify that the upgrade should get its packages from a certain path on the filesystem being upgraded - for example, "repo=file:///..."