Could you recount the story of how Sai Baba lit lamps with water in Shirdi?

Certainly. Chapter 0 describes a famous leela where Sai Baba demonstrated his divine power. He was fond of lighting many lamps in the Masjid and would get oil from local shopkeepers. One day, the grocers and oil-men refused to give him any, claiming they had none. Unperturbed, Maharaj filled the lamps with water instead of oil. As people watched, expecting to confirm their belief in his madness, he lit the water-filled lamps with a match, and they burned brightly all through the night. This miracle astounded the villagers, who then surrendered to him and apologized.