Hi,
Personally I've never developed a water level sensor, but I'd use a rather different design approach. Firstly, I'd arrange to disconnect any d.c current source except when actually making the measurement, perhaps using another PICaxe pin (but not essential). Then I'd connect the "water resistance" (probes) directly between a PICaxe ADC input pin and Ground (perhaps with just a low series "protection" resistor). Then, the current source is from the supply rail, which could be via the internal "Weak Pullup Resistor" (about 30k), that can be enabled by software when required.
Apart from controlling the LED, the transistor (Q1) doesn't appear to offer much "added value" and severely limits the ADC input range. A water resistance (Probes) pullup of more than about 150 k won't a activate the transistor at all (not reaching the Vbe threshold), and a value below about 75k (depending on the exact transistor gain) will fully illuminate the LED and give a zero output to the ADC. For comparison, a direct 30k pullup resistor with READADC10 can give good resolution with a pulldown resistance over a range of 1k - 1M ohms, and detect the presence of anything between about 100 ohms and 10 M.
However, the first method I would try is a "Touch" input pin, with fully insulated cable(s), to measure the change in capacitance caused by the level of the water. The Touch hardware makes an Analogue measurement which could be threshold-detected in exactly the same way as an ADC input (but can be a full 16-bit value) and of course is a pure a.c. measurement. There was recently a forum discussion on detecting the water level in a (deep) well; a few observations from there are:
Ultrasonic sensing generally can't be used because of echos from unwanted surfaces (tank, walls, etc.). Low frequency audio or even sub-sonic (resonance) looks interesting and appears to have been the solution adopted. The (normal) optical reflection at a water surface is only around 1.5%, so may be difficult to discriminate from the "base/foot" using for example an optical/laser (time of flight) rangefinder. Pressure sensors are of course very popular for modest depths such as in domestic appliances.
Cheers, Alan.