Smoking Arrow does not require getting your party members hit by its fire AoE; rather, it generates a stationary field of smoke roughly the same size as the fire AoE that persists for roughly 10 seconds. It is coming in contact with this field of smoke that confers the Obscure effect, which itself lasts for a comparable 10 seconds. Thus, the upgrade is entirely safe to use on Nightmare difficulty, provided companions run through after the initial blast has snuffed out.
If the Obscure effect is shed by an ability such as Lingering Shroud, it can be renewed by simply running through the cloud again before it dissipates. Note that being in the cloud when the effect sheds will not instantly re-apply it, the party member must cross the margin of the smoky field and back in. The renewed effect has the same 10-second duration as the initial effect, thus with proper timing it can be used to maintain Obscure status for much longer than this ability's smoke cloud persists or even other abilities that confer the status.