Neverwinter Nights 2 was unofficially announced on April 1, 2004, when an Atari employee listed the names of several games in development, including a "NWN2" in response to an inflammatory comment on Atari's forums. The company officially announced the game on August 4, 2004. Obsidian Entertainment handled development of the game, and BioWare, the company that created the first Neverwinter Nights, offered support and guidance to Obsidian. The two companies collaborated in a similar manner on Star Wars: Knights of the Old Republic II, an Obsidian–developed sequel to a BioWare game. BioWare joint CEO Ray Muzyka said "Neverwinter Nights remains one of the most important titles BioWare has ever created. We certainly plan to remain involved in the production and development of Neverwinter Nights 2". Obsidian employed several game designers from the defunct Black Isle Studios, which developed other Dungeons & Dragons role-playing video games such as Planescape: Torment, the Icewind Dale series, and the Baldur's Gate series. Development of Neverwinter Nights 2 began in July 2004, when Obsidian assigned several staff members to work on the project. Staff included Darren Monahan, the producer of several Icewind Dale and Baldur's Gate: Dark Alliance games; Marc Holmes, art director of the first Neverwinter Nights; and Chris Avellone, lead designer of Planescape: Torment and Knights of the Old Republic II.
BioWare provided its Aurora Engine from Neverwinter Nights for the sequel. One of the decisions to use Aurora rather than build a new engine from scratch was the toolset—Obsidian wanted players to continue to be able to make content for the game, which may not have been possible with a new engine. BioWare made itself available to Obsidian with technical support on the engine, but Obsidian planned on completely overhauling Aurora, including its code. The designers wanted to improve the visuals of the first game with additions such as better lighting and textures, which required significant changes to the engine. The upgraded engine was referred to as Electron. Electron was designed to incorporate DirectX to make it compatible for a potential Xbox 360 release, but Obsidian eventually abandoned plans for a port to the system for financial reasons. The toolset that was used to create the game was also revamped, and included several additions like a customizable interface, a new dialogue format, and building assistants—similar to the wizards found in Microsoft Word and Excel. Like Neverwinter Nights, the toolset was included in the game's release for players to use.
Obsidian drew on older computer RPGs for inspiration on the storyline and gameplay, like Fallout and the Ultima series. Obsidian CEO Feargus Urquhart said "We've been thinking about a lot of older RPGs, and we have this feeling that something has been lost with recent RPGs." He compared Neverwinter Nights 2 to Baldur's Gate II, stating that he wanted to expand upon the city of Neverwinter as Baldur's Gate II had done with its setting, Athkatla. "We're looking at how to make Neverwinter a really intriguing place to be, and make it a place where you go and come back to and go and come back to and have it really be a center for the game," Urquhart said. The game's story, while still revolving around the city of Neverwinter, would be unrelated to Neverwinter Nights. Instead of starting the game as a powerful, important character, players would begin Neverwinter Nights 2 as nobodies. Obsidian wanted realism in the game and concrete consequences for the player's actions. The story would be centered on the player character, who would have to gradually earn the respect of Lord Nasher and the city of Neverwinter."At the beginning of the game, the main character will run into a person of importance and be ignored like any other lump of crap with legs. The powerful simply don't notice those weaker than themselves. It's this kind of philosophy that promises a more cohesive story." —Dan Adams, IGN
Instead of the henchmen system used in Neverwinter Nights, Obsidian overhauled the game's party format to mimic Knights of the Old Republic II. Like the Neverwinter Nights expansion Hordes of the Underdark, the player would be able to recruit more than one party member. Each character could be directly controlled, but party members would also be able to come to a player's aid even when not controlled, such as summoning a rogue to open a locked chest. Companions would have distinct personalities and their own agendas, but it would be possible for the player character to influence them. Characters can leave the party permanently under certain circumstances. Other changes from the first game include the addition of prestige classes and more exotic races, like planetouched and Elven subraces.
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