Trip Report: Zephyr Dragon versus Mountain Dragon in skirmish mode: Zephyr Dragon gets completely and utterly owned in seconds, every time.
Yes, the AI needs to be improved quite a bit.
Given the state of the ground AI, I don't think that there will ever be any Dragon AI. The manual also specifically mentions that things are strong or weak against the Player Dragon, and that specific wording seems to preclude the possibility of an AI Dragon.
The AI seems to vary on how well it does based on difficulty. It is pretty aggressive on the Default difficulty. I'll have to try adjusting the Campaign difficulty again to see if it gets better at higher levels, because Default isn't that great on the campaign map.