@nicholaelaw - Leveled (according to the area) from what I can tell. Each area has a 'level' and drop is calculated according to the area level.
[Edited by KW33D, 11/5/2007 12:09:16 PM]
Ok, so they're not leveled to the character then. I wish there is a construction set or something like that in the singleplayer mode. 'cuz I kind of miss the console commands in Oblivion. Damn online games....