Alchemy level 1 allows you to combine different potions to make a new one
Level 2 let's you create minor potion by dragging small empty flasks over herbs
level 3 allows you to create normal potions by dragging empty flasks over herbs
Level 4 allows you to create super potions(IIRC) by dragging large empty flasks over herbs
Level 5 allows you to use augmentor, dragging a potion over it will increase the potion one level: minor potion becomes a normal one, normal becomes super potion.

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