Step 1: Concept
This problem evaluates two electrochemistry fundamentals: the physical nature of electrolytic conductivity and the chemical reaction profile of a standard hydrogen-oxygen fuel cell.
Step 2: Meaning
Conductivity ($\kappa$) refers to the current-carrying capability per unit volume of solution, while a fuel cell combines hydrogen and oxygen reactants to generate electricity and produce water as a byproduct.
Step 3: Analysis
* **Statement I is correct**: Electrical conductivity ($\kappa$) depends on the number of current-carrying ions present per unit volume of the solution. Upon dilution, the total volume increases, causing the number of ions per unit volume to decrease, which lowers the conductivity.
* **Statement II is incorrect**: The net chemical reaction inside a hydrogen-oxygen fuel cell converts gaseous fuel inputs into liquid water to produce power:
$$2H_{2}(g) + O_{2}(g) \longrightarrow 2H_{2}O(l)$$
The statement incorrectly provides the reverse equation, which represents the electrolysis of water instead.
Step 4: Conclusion
Statement I matches the laws of chemistry, while Statement II is wrong. This confirms option (C).
Final Answer: (C)