Theres definitely some multiverse shit happening, but I don’t think this was that.
I think that whole section just showing his fucked up mental state. He’s not able to accept the fact that he didn’t save her. And just like he created the false reality about himself of being a Soldier, he’s doing it again with Aerith. That’s why he acting so funny on the part where they all sitting around moping about it, and he seems to be unaffected, …they showed quick flashes of what really happened and he did the water burial thing.
Even Sephiroth told him he still couldn’t see the truth with clouded eyes, while he flicked her blood off his sword.
Dude in denial.
Even at the beginning of that battle in his mind, with him and Aerith vs Seph, she said “I saw what you TRIED to do… thanks” or something like that. They laying the groundwork for his full psychotic break in the 3rd one, where he give the black materia to Seph.