I'm trying to do this again an Oracle 10 database:
cursor = connection.cursor()
lOutput = cursor.var(cx_Oracle.STRING)
cursor.execute("""
            BEGIN
                %(out)s := 'N';
            END;""",
            {'out' : lOutput})
print lOutput.value
but I'm getting
DatabaseError: ORA-01036: illegal variable name/number
Is it possible to define PL/SQL blocks in cx_Oracle this way?
Yes, you can do anonymous PL/SQL blocks.  Your bind variable for the output parameter is not in the correct format.  It should be :out instead of %(out)s
cursor = connection.cursor()
lOutput = cursor.var(cx_Oracle.STRING)
cursor.execute("""
            BEGIN
                :out := 'N';
            END;""",
            {'out' : lOutput})
print lOutput
Which produces the output:
<cx_Oracle.STRING with value 'N'>
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