CloudDrive in the 1.1 SDK only supports NTFS formatted VHDs. The overhead on NTFS is large - so for smaller VHDs there's a lot of space lost. For example, a 20 MB VHD formatted as NTFS only has 7.9 MB of space left right after formatting. A FAT formatted VHD has 19.8 MB left right after formatting.

I have a whole thread on this in the forums: http://social.msdn.microsoft.com/Forums/en-US/windowsazure/thread/3e02f6f8-30a4-4b33-acc1-980aa1a82432