Thanks PRR:
I assume this is US/Canada. I do not know other places.
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yes, USYou should have dirt-rods, but this is more for safety against external trouble, not inside the building.
I can't see it from here, and do not know your experience. I can't know what you may NOT be seeing/reporting because you don't know.
There must be something odd because the white wire should not spark.
You MUST have solid "ground" bond from the heater shell, though this sub-panel, thru main panel, to utility "Neutral" and dirt-rods. It should be impossible to have any voltage on touchable metal, a fuse would blow.
If this sub-panel once linked to a time-meter, and that is discontinued, who knows what they did in that change? Trace the run, open the boxes.
A conventional water heater does NOT take a Neutral, it is normally run on 240V across the two hot legs. You need two hots and a ground.
With 2-G cable you get a black and a white. You mis-use the white as a HOT. You are strongly encouraged to re-mark the ends of the white so later workers know it is not a Neutral.
With 3-G cable, you use the black and red as Hots, and connect the Bare as ground, both ends. The white should be idle and tucked away from trouble.
- This 2nd feeder comes in the house as 2- #6awg with a twisted ground right to a small box that only has one 2 pole, 30 amp breaker. On the input side of the box there is a small ground/neutral buss bar where the supply ground is connected.
They had the white and bare copper conductors from the 10-3 water heater feeder attached to that bus, which I get...
But over at the heater they did not use the bare wire and had the white connected to the frame of the heater with a green screw.
With the breaker off - there was a small arc from white wire to frame of unit. 
Is the breaker for the water heater 2-pole? It normally should be. In some cases a 240V heater may be wired on 120V power (my fixerupper was this way). Heating time is 4X longer, but that may be OK for light use.
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Yes, 2 pole breakerWater heaters (on 240V) run 3500-4800 Watts. Nominal demand is up to 20 Amps at 240V. Because the load may be "sustained", the 80% rule applies, we wire for 25A. This is a 25A-30A 2-pole breaker and #10 wire. If a 1-pole breaker, it better be 120V connection and will draw 10 Amps. A very sharp Home Inspector will find the 120V connection and call it out as a shortcoming. (Most won't notice.)
Jimbo, I hope you see your answers in there also. And yes, there are some ungrounded outlets to be found. I have been going around and upgrading them because luckily they do have ground conductors in the wire. I don't see any water line ground clamps, but I'll look harder.
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Any chance I might have been seeing a capacitor discharge from inside the water heater power supply?