In the combat screen, I saw this in my last game and now its popped up again. I can click on that sabotage button and even select something, but it doens't seem to do anything.
You can sabotage structures from orbit during a combat encounter if you have a spy ready in that system. What do you mean with "it doesn't seem to do anything"? Did you choose to destroy a particular building or ship? If so, what happened?
Ah perhaps this is again part of my ignorance with features of the game, as I had no idea you could use sabotage outside of the spy mission area. So how does it work?
You set up a sabotage job and let it be there, waiting. So, you don't act on it right away when the spy is ready. Then, when you attack the colony where the spy is in, you can instruct the spy to take out a star base, an airspace facility or some other asset on the ground while in the combat encounter screen. Even if you don't opt to use it yet, you can also wait a bit further and if you then assault the colony, you can also give instructions to the spy from inside the planetary assault screen, at any time.