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If you aren't taking levels you are missing out on all of those bonuses. And since you can now distribute your level up points however you wish there's really no reason not to. In addition you are blocking yourself from being able to cast the next level spells, obtaining the next level of armor etc.
Rando encounters and encounters with rando elements do scale with the player, but some set encounters don't or only scale a little from their designed level.
The few things level effects are attribute increases, what loot you can find in the world (except some static items that will always show up no matter the level), and the level/gear of certain types of npcs like bandits. Aside from that, with the right build you can still cast most everything, gain skill perks, etc. There are downsides most definitely, but the bonuses you get from attribute increases are just incremental (bigger numbers, not new abilities) and don't increase your ability power nearly as much as skill gain does. The advantage is that a great deal of the time, combat is super easy because you are fighting things that are WAY under your power level.
For more info, read through this: https://en.m.uesp.net/wiki/Oblivion:Under_Leveling
I would maybe edit this post a bit so you are not passing off incorrect information?
-Better weapons and armor drop from enemies and can be found in chests.
-Different enemies will spawn at higher levels and provide more alchemy ingredients.
But yes, it's always been a sticking point that enemies get stronger with you as you level, if you stay at level 1 the game is much easier but you'll have access to less items and spells.
Nope, not correct. Enemies in default Oblivion always scale.
It's a mechanic that is supposed to provide you a constant challenge, but in actuality makes impoverished thieves and bandits run around in expensive glass armor as you level. In other words, the mechanic doesn't work.
You're much better off getting an overhaul of the gameplay that makes it so that there are plenty of bad guys out there that can one-shot you, that you should fear, and allow you to progress in your ability in order to take them on.
People who don't understand this concept in Oblivion probably played on console and never experienced a quality overhaul that gave the gameplay actual depth.