As isherwood mentioned in a comment, that round pipe is the flue. It's what takes the hot, toxic, exhaust gasses from the burned fuel and gets them out of your house so you don't asphyxiate and die.
You can insulate the flue with an appropriate high temperature insulation and ensure that all the heat left in the flue gasses is piped directly out of your house and into the atmosphere, or, you could let more heat radiate from the flue into the house and use that heat (even if less efficiently) within the insulated envelope of your house. I'd open the basement door to let all that heat escape up the stairs and help heat the first floor.
As for the sensor on the ceiling. Is that a temperature sensor or is it a CO detector?
If it is a thermal sensor, that does seem to be an unusual location for it, but it may have been that a previous owner found that the furnace room was getting even warmer than it is now, and installed that as a backup cut-off switch.