would I be correct in thinking the lower AFR is because H2Ovap is displacing some O2 (measured by Lambda probe)?

Since we dont have H2O sensors in our intakes....I'm guessing the ECU "assumes"21vol% O2 in the intake air ie: <0.1vol% H2O.

Subsequently when you use water, suddenly it goes up to 0.6vol% or whatever and your O2 goes down from 20.5 to sub 20's. A 5% reduction in O2 would be the same as a 5% reduction in AFR or 0.6*. But hey - you've kicked 5kW or heat out of the system - that's huge!

*based on 4.5oz/min H2O into 640cfm.