Oooh, intriguing! Put the Shocktopus back on his home surf, so to speak? I like the dielectric angle on it, polarizable insulators could be a fun addition. I'm still trying to figure out what exactly the important lesson & game mechanic of it would be. (What is the kernel that people *need* to know about dielectrics -- and what special things can it do to the electric field, i.e. what new exciting level designs could we have?) I'm all ears if you've got thoughts on it.
As for the water + magnets question, the first thing that springs to mind is that water is diamagnetic. It's like the opposite of iron. Instead of attracting to magnets, it repels -- albeit very very weakly. You've maybe seen the video of the frog floating. Water is why.
So I guess we'd see a very tiny effect on the magnetic fields, and in the opposite direction from what we'd expect from a bar of iron. Instead of focusing the magnetic field lines through it (like iron), the field lines would be expelled from water a bit. (Again, a part-in-a-million -- but this is a game, who cares?
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I'm an OCTOPUS! I want WATER! Give me water NOW!
Ideas 
