The poem explores a dream-vision of the "Orient." The "Orient," as Edward Said explained in his book Orientalism, is a Western construct in which the West, among other things, projects its own shadow on the East: if the West is hard-headed and practical, then the "Orient" is a mystical, mysterious place, a land of sensuality.
The poem explores this sensuousness, the realm of the imagination, and the narrator reacts to it both with attraction and dread. The pleasure dome of Xanadu, surrounded by its incense-scented gardens, is also a place where Kubla Khan, the ruler, hears, in the crash of the waterfall, "ancestral voices prophesying war."
Likewise, the forest and "sunny spots of greenery" turn into a "savage" place "haunted" with the wail of woman crying for her "demon lover," perhaps reflecting the sound of the waterfall. The waterfall itself is fearsome, a contrast to the "mazy" and "meandering" quality of the sacred river.
In the final stanza, the narrator's longing to build that sacred dome and recreate the song of the damsel with the dulcimer hits a crescendo when it collides with the fear of actually realizing the dream: "Beware! Beware!" and "close your eyes with holy dread," the narrator says. The dream of drinking "the milk of paradise" is to him both alluring and terrifying.
While the meaning of this poem is debated, one interpretation is that it represents both the allure of opium, a drug closely associated with the "Orient" that Coleridge was addicted to, and the terror of being caught in its exotic dream world.