Setting up an external clock source on an ATmega8
CKSEL typically stands for clock select.  There are several choices that can be selected via an internal multiplexer-- some for test, others for alternate sources.

Since you are using a xtal, you can provide the code to select that option: which are in the first 2 rows of p 26.
You can use 3 bottom rows of table 4 for a crystal. Each is tuned to a particular range of frequencies as shown.If your crystal reference was design to oscillate around 4MHz, you would set the sel bits to code, 111, for example. 16Mhz only works with CKOPT low using any of the three select codes shown in row 4 of the table.

External caps should be 12-22pF not 22uF for the xtal according to the same table.  It also only specifies a max oscillator limit of 16MHz, so I would not use a 20MHz xtal.  

Looks to me like the watchdog timer functionality is internal.

*note xtal and crystal are used synonymously here.