This probably sounds like a cop-out, but the last area being unfair and completely out of left field was intentional. The "deposit yourself into the machine" ending was more like a bonus than an actual resolution to anything (or even a cutscene on par with the actual bonus scenes) since it wouldn't make sense to put something crucial to your understanding of the level in a part nobody will reach. If you tried and struggled for exceptionally long in that area - especially if you were there long enough to hear the music slowly fade away to the lava ambience - you've experienced the level as intended, no matter whether you've "completed" it.
The mood conveyed by the first few screens is, like you mentioned, intended - you're expecting this goofy Orange Grass adventure, then the second screen is as featureless as the first screen and you suppose it's still an intro, then it gets awkward and you start noticing there's no water, creatures, sunrays, or anything else that would make it realistic. Then what little decoration there is left gets covered up by the arch from the gray building, and the level implied by the screenshot never actually starts.
The dark blue area is my interpretation of what the surface looks like in Knytt Underground. (Though what I think is a more effective interpretation, in a different unreleased level of mine, has no presence of Hulton and significantly more empty barren space. If I could revise this and defy the 50-screen limit, I'd add two or three more screens of eventless trudging between the gray building and the Hulton pipes.) So the intro area is a large room within the gray building meant to preserve the botanical ecosystem from before times. The lack of waterfalls or anything organic aside from plants is meant to allude to that.