Yes, you need the Illithium Ore for the upgrading.
There are two options for you:
1. Give the real ore to Sir Sarles, solve the quest and then kill/pickpocket him to get the ore back and take it to Cromwell
2. Give Sarles fake Illithium ore (the ore merchant can make it for you) and take the real Ore to Cromwell.
If you choose 2 though, you'll get less XP from temple quest...plus they wiull have a crappy statue
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Melusine, High Queen of Fluffies, Archbabe of the OHF, the LH,
the HADB and the SPAE(Society for the
Prevention of Acronym Extinction) &
Official Entertainer Elf of the BG2 Bar
Your voice is ambrosia