Apparently libdvdread only works with UDF file systems. I tried to point VLC to an ISO 9660 image file, but libdvdread only complained:

$ vlc dvd://foo.iso
libdvdread: Using libdvdcss version 1.2.10 for DVD access
libdvdnav:DVDOpenFileUDF:UDFFindFile /VIDEO_TS/VIDEO_TS.IFO failed
libdvdnav:DVDOpenFileUDF:UDFFindFile /VIDEO_TS/VIDEO_TS.BUP failed
libdvdread: Can't open file VIDEO_TS.IFO.
$ file foo.iso
foo.iso: # ISO 9660 CD-ROM filesystem data 'CDROM

However, after I extracted the image file to a folder, everything went as expected. (Of course also with an image file containing an UDF file system :-))