The way I see both games, is that they're having a combined storyline, which eventually falls into place. And for Sacred 2, those storylines are more written for MP-coop as for SP.
So, let's split things up a bit.
In Sacred 1 your main char wakes up after a nightmare, showing Shaddar the Necromancer summoning a demon, who in turn breaks free. You don't notice much about it, but during your main quest, you do encounter the effects of it. Which mostly are the undead you encounter at several places; as well - if you did that particular side-quest - one encounter with the Sakkara demon summoning the undead, before leaving again.
Then there's the main quest; which has been split in two parts.
First part concerns Prince Valor and his father Aarnum, who's about to die. While looking for him, you notice the undead rising from their graves, but you don't have a particular assignment to find out what's happening. Instead, you are pulled into the civil war tearing Ancaria apart, until the moment you discover the prince; acompanied by a sorceress; who sends you on a mission to figure out why the undead are rising from their graves.
Don't ask me why it's done before finishing the usurper, as that would have made a lot more sense.
So you're off to the desert, where you discover the Sakkara horn, which in turn is taken to Braverock, where finally the usurper DeMordrey is overthrown. End of the 1st part of the main story-line.
Now the second part of the story-line starts: the search for the elements.
The sorceress sends you on a journey to capture all elements; which are needed to capture and destroy the Sakkara demon. Something you manage to do, but while doing it, Valor gets killed and his g/f the barroness kidnapped. It now turned out Shaddar has planned the destruction of the demon all along, just to make sure he could summon it again; and controll it this time.
And as savior of the kingdom, it's once again your task to find the Necromancer and kill him; something you manage to do, but it just starts the "Underworld-story line".
The Sacred-2 storyline are in fact 7 main storylines; which are all working together - or against each other - to get to the ultimate goal: to control, or the destruction of the T-energy. Some of those storylines quit before getting to the Great Machine, and some continue all the way to the point where you encounter that last Inquisitor, or to a point close enough to it, where human curiousity takes you to the last steps to finish the main quest.
There are also some bridges between both Sacred; they just have to be seen.
In S1 one of the scrolls tell about a great war between humans and demons, in which dragons were used. And what do you encounter in the Waste Lands: A war-torn countryside, with lots of dragon skelletons.
In S1 you learn - when playing a Seraphim - that the Seraphim were actually articifial creatures. With the UW-expansion we also learned about the Ice Elves; while in the original game we already faced the Dark Elves. And while the Ice Elves are using a lot of Seraphim technology, the Dark Elves are led by one!
In Sacred 2 we learn that during the war, Seraphim were ressurected and turned into "Dark Seraphim". When playing a seraphim you even have to encounter one.
This is the bridge to explain parts of the Schifm of the Elves. Both the Ice Elves and the Dark Elves were led by a Dark Seraphim. And while one faction adopted the seraphim thechnology, the other one didn't. It's also very likely that the Ice Elves in fact did embrace the T-energy; as it would explain partially where their power came from.
The schism of the Elves is a bit harder to explain, but here's what I think happened.
There were in fact 2 (TWO!!) schism's.
The first one occured not long after the end of Sacred 2, where the Elves using, and willing to keep, T-energy split from the faction who wanted T-energy destroyed. At some point the first faction got in contact with a Dark Seraphim and fled to a region they were safe, as the other faction was still stronger. Perhaps there were some sources of T-energy left in that icy region, I don't know.
The other faction returned to the nature-loving ways of their ancestors. Perhaps under guidance of the Dryads, perhaps on their own, I don't know. But eventually something happened, splitting the community again. One group remained true to the ways they've lived for the last hundreds of years, the other faction turns to a darker path, led by a Dark Seraphim, and become the Dark Elves.
As for the Dwarves; they are present in both games, but only from the side. As in: You see them, but you won't encounter them.
In S-UW you're able to play a Dwarf and it turns out he's using quite better technology as the rest of the people are doing. The fact that his "Flying machine" - which is a Gyrocopter, I think - crashlanded; while its design isn't even known to Ensign Weston, explains some things.
We also know the Dwarves used to live in some underground cities, which were captured by the Dark Elves; where most Dwarves were killed. What's left of the Dwarves fled and didn't set foot on Ancaria until the one we play in UW.
So where were the Dwarves in Sacred 2 and the period between those two games: Simple: they were hiding under the mountains, minding their own business.
There are only two pieces of evidence prooving that. 1st is a small book with a poem about a Dwarf; explaining how a Dwarf looks. But ingame all encounters show that no-one has seen a Dwarf.
2nd is that cave in Grunwald where you can kill a dragon. There's a huge sealed door at the end of the cave, mentioning something about Dwarves. Thàt's the entrance to their stronghold.
Now, if I was a Dwarf and I got a huge dragon at my doorstep, I wouldn't be going outside for a while either. But of course, I would try to mine me another way out at some point.
Leaves me one thing to mention:
When comparing both maps, they don't match. Even when turing the Sacred 2 swamp into a large lake - as it will become since it's a lot lower as the rest of the country - the maps won't match.
There are 2 explanations.
1st: The S1 and Sacred 2 parts of the map are at one another's oposite. Meaning the southsea at both maps is more likely a large inland see. However, according to some S1 scrolls, the first humans settled in the area along Silvercreek and Bellevue and they don't have a sea-coast line. And even sailing up-river from the southern sea isn't possible, since there's a mountain range between that area and the desert.
2nd: The two game-worlds are actually next to one another; sharing the same southern sea and the same mountainrange at their border. That'll mean the Sacred 2 map is actually to the east of the S1 map, explaining how the Dwarves got from one part of the world to the other - the hiden door actually leads to Verag-Nar - and the humans travelling East over the mountains, through the Gloom to the Bellevue - Silvercreek area.