I'm using the http://www.nexusmods.com/oblivion/mods/15568/?tab=2&navtag=http%3A%2F%2Fwww.nexusmods.com%2Foblivion%2Fajax%2Fmodfiles%2F%3Fid%3D15568&pUp=1 mod and using the custom dark elf that comes with it. Only, when I I start a new game, the dark elf across the way doesn't initiate dialogue with me. I'm guessing it's because the game doesn't know what race I am. I know in TESIII Morrowind there is a racecheck script and you simply add your custom race to it and assign it a number that corresponds with one of the vanilla races, so that NPCs will say the appropriate "Greeting %Race".

Will someone help me on what to do here? Thanks.

You really should think about using the http://www.nexusmods.com/oblivion/mods/5296/? It fixes a whole boatload of things (including this one). But if you don't want to use the Unofficial Patch you can get around this problem by using the http://www.nexusmods.com/oblivion/mods/1815/? instead.

I'm reluctant to post links because nexus for some reason redirects to the main page so you have to search manually. Essentially you need either a custom race fix that adds generic dialogue to the Dunmer in the starting dungeon, or a quickstart mod that takes you right to the sewer exit. Let me try a couple of links;

http://www.nexusmods.com/oblivion/mods/1947/?

http://www.nexusmods.com/oblivion/mods/1815/?

Other option is to start as one of the plain vanilla races, then change race at the prison sewer exit.

Okay, I have the Unofficial Oblivion Patch installed and it makes Valen Dreth say something like "What a rare species to look upon..." or something like that. But I want him, as well as all NPCs in the game, to recognize me as a dark elf. How do I achieve that?

You could try looking at what the Race Balancing Project did. They added certain races to different dialogue and reaction lists. It's a bit complicated, but you might be able to make a patch for yourself if piggyback off of that info in TES4edit or in the Construction Set.

You can use http://obse.silverlock.org/obse_command_doc.html to have your race recognized as Dunmer. You'll need to use OBSE for this.