When we talk about encryption in relation to the OSI Model we usually hear about encryption at Application (Email - PGP), Transport (SSL), Network (IPSec) and even Data Link Layer (WPA). But I have never heard of something in relation to the Physical Layer.
If you choose to implement encryption at the physical layer, it might be because:
The only current use-case I could imagine for such purpose would be radio-communication, and mostly military grade radio-communication. For instance, there are systems obfuscating the communication as to appear as electromagnetic blank noise while being actual communication (trying to avoid detection and localization issues). Such encoding does not process bytes, it directly processes the electromagnetic waves so it needs to be located at the physical layer.
In all case physical layer encryption would bring quite a high complexity, and therefore higher cost, so most chances are that its usage is limited to military & co. As far as I know for civilian usage using a standard physical layer with encryption implemented no lower than layer-2 is usually sufficient.
The job of physical layer is to transmit the data over some channel(cable or wireless medium). If encryption was done at the physical layer, then all the data, including the application data, the destination IP address, port number, different headers, etc. will be encrypted as well. When this encrypted data will be transmitted, the next node(router,switch, or some other link) won't be able to determine the destination address(since even the destination address is encrypted), and it won't be able to forward it. Hence, encryption is not done at physical layer.
You could think of Quantum Cryptography as a form of cryptography at the physical level. Quantum Cryptography uses the properties of quantum mechanics to send messages that can't be intercepted by a 3rd party. It's not cryptography in the strictest sense, but it serves the same purpose of preventing 3rd parties from intercepting data.
Of course, it doesn't follow the OSI model since quantum cryptography is inherently point to point.
Sure, Powerline adapters have done this for years.
For example the Belkin Surf POWERLINE NETWORKING ADAPTER employs 128-bit AES encryption.
Encryption is the use of mathematical constructions to ensure data confidentiality. As such, arguably, it doesn't happen at the physical layer, as a matter of terminology.
However, analog encryption does exist, and for us bit-shoveling types, anything that works at the analog level can be considered physical. Analog encryption was important for secure voice transmission but as far as I know it's died out in this all-digital era.
There is a field called physical layer security. As outlined by WhiteWinterWolf, the basic idea is to arrange communication over a channel so that the legitimate parties receive less noise than any eavesdropper, either thanks to natural interference or through active jamming. In theory, the channel between the legitimate parties has a higher bandwidth than the channel with any eavesdropper, and so the eavesdroppers get less information than the legitimate partner. The information that the eavesdroppers don't get is a shared secret. An immediate application of this is to exchange a shared secret.
There is a considerable distance between theory and practice, and I haven't seen this in the wild.
Some reading on physical layer security:
The data link layer is the lowest layer where actual data is exchanged, the physical layer immediately below that is the mechanism for passing that data.
You could insert an encryption layer in between your physical layer and your data link layer that flips bits on the wire in a manner that a device at the other end would be able to decode, but really all you've done there is added a new data link layer IMO.
