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Well, you might not be able to extract something better than there's encoded in the video. Normally the VideoCapture captures the video frames with their full resolution, thus your video resolution is that poor.
H264 is a compression format which uses the relation between frames to cut down on file size. I'm not entirely sure how the Videocapture behaves here, I'd expect it delivers you useable frames, but might also be it just delivers the "difference"-frames. Does your code perform well on uncompressed video data?