So I went round my friends house to play this today. Turns out he used the exploit at the start of the game to max sneak and get 50 or so in one handed and two handed. Obviously this levelled him up quite a bit. He also seems to be having quite a bit of difficulty early on in the game, and so when I gave it a go on his character I felt as if the game was a lot more difficult compared to my lower level character on my own xbox. I know that in this game enemies don't scale with you as they did in Oblivion, but could anybody explain the levelling system a bit more?

There's a little bit of scaling that happens in the game, but think about it logically.

Your friend got really good at sneaking and one-handed/two-handed (the second one being pretty useless if you're a stealthy character). Where did he spend his perks? What crappy gear is he currently decked out in?

The point of the game is to experience the world, not grind out levels. There's no benefit to leveling faster, and if you use exploits to do it, you just end up screwing yourself over. Like your friend.

That's what I thought originally. You end up being a level 20 warrior say, with 100 sneak but no points in armour, etc. He went down in 1-2 hits from bandits and dragurs (sorry I don't know their spelling!), even with my expert playing skills.

The fault is that you built a "warrior" with no armour. Nothing is wrong with sneak leveling as well, but you have to balance yourself. My Khajit is 14 right now and I play him towards stealth, pickpocketing, lockpicking, light armour, and one handed. I went heavy sneak then a little pickpocketing, grabbed novice locks, then went towards the fighting aspects of armour and one handed. You have to base your choices around balance if you want to end up balanced, or you could get 100 sneak and go do sneak things.

You guys automatically assume, if he just reaches level 10 with sneaking/2 hands exploits, he will be left without any other skill.
But you can just reach level 10 at the very start of the game. And then continue leveling up your skills, just like any other player. So you wouldn't have any disadvantage by doing so.

And it's not really an exploit. An exploit would be, like you have discovered a "special NPC", where you can grind all your skills. But this isn't an exploit but the game system, it encourages you to do so. Why should I kill the NPC's, if I can overheal them? And by doing so, I gain Restoration, Armour skill ups, as well as leveling up like crazy, with fighting only 1 (single) NPC.
This isn't exploiting, the game system itself is an exploit and broken. How should I know the "limit" what should be consideried exploiting or not? Should I just 1-shot all NPC's? Let them hit me 2 times before killing them? What is it?