Faust, the closest thing to Israel shutting down water that I could find in reliable news sources (rather than blogs that just cite each other) is that, due to blockades, the water systems (and sewer, and electric) basically get to the point where they cease functioning. It appears that the situation is not that Israel shuts off water to Gaza like the water company might shut off water to you if you don't pay your bills; rather, it appears to be closer to water being shut off because the water company went under and no one is working there. However, even that much was difficult to find and I am not sure how trustworthy it is.
Israel is in a lot of no win scenarios. They need to have Jewish settlements in non-Jewish land removed, but it is REALLY bad press for any nation to be attacking its own citizens (even when those citizens are in the wrong). A government can't stay in power long if the news agencies can show its military forcing its citizens out of their homes.
Israel is trying to establish a peace with groups who are supported by nations that refuse to recognize the state of Israel and have vowed to erradicate it off the face of the planet.
Israel has to appease the western nations of the world, even when the western nations are full of crap, because it can't survive without external lifelines.