Looks like the problem definitely has to do with the HKLM\System\Setup\SystemSetupInProgress registry key. Setting it to 1 in a normal windows environment reproduces the problems with explorer.
Looks like both dwm.exe and explorer.exe check the value of SystemSetupInProgress when starting up. I tried patching the string in the exe but it looks like both dwm.exe and explorer.exe get that value from some other loaded dll or exe.
So its starting to look like Microsoft may have deliberately prevented explorer from running in winpe this time around.