Can't update the OS because I'm out of space, but have 2 TB free on icloud.

There only areas of the Operating System we users have control over and that is the User Account Folder ( Home Folder )

All other areas are not accessible 

It is generally a good computer practice to alway keep at least 20% to 25% of the Total Drive Capacity’s as Empty Space.

Allowing the computer to drop below these guidelines may eventually, cause unintended consequences.

There is Purgeable Space and there is Empty Space.

Purgeable Space which is Controlled by the Operating System. When the Operating Systems decides the computer needs additional Empty Space, it will move a portion of the Purgeable to Empty space

AFAIK - there is no User Actions to hasten this transition from Purgeable to Empty Space

It can day or longer before this will occur.

The links below will assist in identifying what is taking up space on the Internal Drive and provide possible ways to remove data that is under the direct control of the User ( Home Folder ) . 

Rebuild the Spotlight index on your Mac

What is “Other” storage on a Mac, and how can I clean it out?

Free up storage space on your Mac

GrandPerspective 

How to delete Time Machine snapshots on your Mac.  

View APFS snapshots in Disk Utility on Mac - Apple Support (CA)

Often caused if the Time Machine Drive has not been attached  to the computer and TM Backup is set to run on a Schedule. 

TM Backup will make Snap Shot on the Internal Drive awaiting the TM Backup Drive to be attached. 

Only then will the Snaps Shots be transferred to the External Drive and deleted the Internal Drive.

See used and available storage space on your Mac

Locate backups of your iPhone, iPad, and iPod touch

Is there a Suite of Adobe Applications  used on this computer ?

They may create some very large cache files that can be removed. Though, the Adobe cache files will be recreated as the Applications needs them.

https://helpx.adobe.com/ca/premiere-pro/kb/clear-cache.html

The final word from Apple on Managing the " Other/ System Data “ Category

Other / System Data: Contains files that don’t fall into the categories listed here. This category primarily includes files and data used by the system, such as log files, caches, VM files, and other runtime system resources. Also included are temporary files, fonts, app support files, and plug-ins. You can't manage the contents of this category. The contents are managed by macOS, and the category varies in size depending on the current state of your Mac.

MajDamage wrote:

It seem like no matter how mush space I clear, icloud stores some files locally again filling up my drive. Is this possible? How do I move files to store exclusively on the cloud and off my HD?

As you have discovered, iCloud is only a conduit to have files on both on the Internal Drive as well as on iCloud.

It was not designed nor intended to be a Storage Place to off load files from the drive to create extra Space on the Internal Drive

That is best left to an External Drive or some Other Cloud Based Storage Service.

iCloud will have some of your iCloud files on the internal Drive for the times when Internet Connects are unavailable.

This is so you can still work on this files

Then when a Internet Connection is active and working again, the changes you have done are uploaded to iCloud with the changes you did are available to all other Devices you own can access the changed files

Suggest following a previous posting regarding " Desktop or Documents "

It seem like no matter how mush space I clear, icloud stores some files locally again filling up my drive. Is this possible? How do I move files to store exclusively on the cloud and off my HD?

Don't put them in Desktop or Documents if you have that set up to synchronize.

If you open them, it will download the file.

It was not designed nor intended to be a Storage Place to off load files from the drive to create extra Space on the Internal Drive

Sure it was. There was just iCloud Drive well before Desktop & Documents syncing. Even with Desktop & Documents sync’d you can optimize storage. However, you don’t have to sync and can store documents there without syncing.