Is water pipe grounding achieved thru pipe or thru water?
The grounding is accomplished through the metal pipe, not through the water.

Pure water is an effective electrical insulator. It's only conductive when there are dissolved salts in it (not just NaCl, but any metal salts creating free ions floating around in the water). In that case, water can become a very good conductor. But it isn't really the water doing the conducting.

That PVC pipe is not creating a suitable path to ground.

You need to drive at least one grounding rod (probably an 8' copper or galvanized steel solid rod, which you can buy at your local home improvement warehouse), and run a #6 copper wire from that rod to your main service panel, where you'll bond it to the grounding bus. You also need to leave all of your copper and/or iron pipes bonded to the grounding bus in your main panel.