Lordono:
I'm pretty sure it is the LED as they are lit even on sleep modes to indicate that they are still powered.
Must just be a power indicator LED? Guess I was thinking of the RSSI and "associate" LEDs some boards have. For a low power design, obviously the whole lot should be eliminated.
Do you have a way to operate Xbee with an Arduino which is at 5V?
Yes, but it always involves a separate 3.3V supply for the XBee.
I'm thinking of using resistors to make a level converter, will it work?
A resistive voltage divider can be used to adjust logic levels, although this would not be my preferred approach. If you mean to use resistors to change the supply voltage, then no, that will absolutely not work.
Top on my list would be to run everything on 3.3V, and a custom circuit (i.e. not using an actual Arduino board) designed for low power consumption.