First, a quick note on technique - start with a coarse grade sandpaper on the floor sander and work down to the the finer grade.
The coarse grade removes the old finish and levels out the imperfections, then the fine grade makes it nice and smooth. If you go the other way around, you'll definitely curse every time you see the grooves in the sunlight. Fixing this means stripping off the nice new finish, not fun.
In passing, an obvious-in-hindsight but sometimes-missed point is to go with the grain, i.e. sand along the boards, not across them. In any case your sander will complain bitterly if you don't.
Also, give the boards an incredibly good wash before you start with e.g. Sugar Soap - you want to try and strip off everything gungy to stop the sandpaper clogging too often. Leave for at least 24 hours to dry nicely.
Be sure to hire an "edge sander" too, this will help you get to the edges that a drum sander won't get to. If you can, remove the skirting boards (baseboards) as then you can get right underneath; only do this if you know you're redecorating the walls too and don't mind patching up the woodwork. You'll inevitably end up doing the fiddly bits around the door frame and right in the corners yourself by hand with a scraper or sandpaper, which takes longer than you could possibly imagine.
While doing the sanding, remove everything from the room (obviously) and get heavyweight dust sheets to tape around the door. Wear airtight goggles as this is an insanely dusty process. You'll also need ear defenders as this is an insanely loud process too.
Regarding stain, it's a matter of personal preference. I've done both and prefer the more uniform result that stain gives.
Regarding finish, I've used both oil-based and water-based finishes. Both are OK, but the oil-based one looked richer (can't say why, can't say how) -- and took about three days to dry. Somewhat inconvenient for a hall, and our puppy left nice pawprints.
Follow the instructions on the tin; in general thinning probably isn't worth it, as you'll find the second and subsequent coats will go further anyway. I applied three coats of the oil-based finish, and five of the water-based finish, but this depends on the state of your boards. It's handy to rent good bright work lights so you can see where you've been, especially for the second and subsequent coats.
What is important is that you get flooring-grade varnish, regular varnish won't stand up to the first party, and yacht varnish will cost so much you won't have the first party...
Fisrt, DON'T REPLACE THE FLOOR, that would lead to a lot of headaches and is probably un-nessassary. That floor shouldn't absorb oil that quickly if it had been sealed properly. My guess is that the floor either wasn't sealed correctly or it's been so long since it has been that it's all been worn off.
Try getting a wood oil soap (like Murphy's or Old English) these soaps have oils in them that are meant to be absorbed into wood. This won't take out the oil, but it might help to make it blend in. I don't think that stain is comming out, even if you sanded the floor, the stain would have absorbed into the wood too deeply.
It's important to remember that wood is pourous and the natural oils that are in it are evaporated over time and have to be replaced, or else the wood becomes discolored and brittle, which is probably the case here. I wash all my wood floors twice a year with an oil soap to help keep them hydrated.
Best Answer
Yes you absolutely need to treat spruce and pine with something or they will weather and splinter ferociously. You've got two basic options 1: a protective finish such as a varnish or polyurethane or 2: a penetrative sealer like linsead oil, water sealer, etc. Both have merits and weaknesses but either properly applied will get the job done. More important than the product you choose is the construction of the structure and the maintenance of the product in the future. If the structure doesn't shed water properly it won't matter what finish you use, it will rot and fail. Likewise if you don't maintain your finish it will allow infiltration and will rot or dry out and splinter. Another issue to account for is u.v. rays, direct sunlight can wreak havoc on your wood work. Spar varnish is the traditional choice of boat builders but Sikkens is my personal preference as it combines the added protection of a varnish with ease of reapplication of an oil. Also it has a built in u.v. protectant. Hope this helps, cheers!