There are two aspects...
1. Does dowsing work? Yes. Most drilling for water companies around the world use dowsing even today as the preferred or only method of locating water. There are thousands of wells that are evidence of that fact. Even in certain areas in India where the water table is pretty low and we have to dig nearly 80 to 100 feet, dowsing has been the method used for locating water.
2. How does it work? No idea. Saying that our subconscious mind somehow identifies subtle environmental conditions that indicate the presence of water...is nonsense. Water has been located through dowsing in large parched fields where there is no indication of water anywhere. Finding specific tiny spots for drilling bore wells of a couple of feet in diameter, cannot be through such subtle environmental observations.
I agree that we do not know how it works. However it is possible that our sub/unconscious mind is able to detect changes in the biofield which could indicate presence of water. After all,our mind, intuition and instincts are connected to the biofield which helps in coordinating the activities of the eco system as a whole.