What I know about the Oblivion AI development was that 'supposedly' they had to nerf it, otherwise all the A.I. controlled creatures were too unpredictable. i.e. if you left the goblin cave for late game, the goblins would have all move out, or attacked a town and been slaughtered by the rediculously overpowered guards that beat anything the touch
Too bad, since it could have been a great game, though it has a few other problems (compass too powerful, fedex quests, fast travel reduced imersion etc) It's still an okay game though, just not dominions quality. And the graphics are sweet.