Thanks all who replied. I ended up investigating some more and noted that the wires inside the nut that melted were barely connected. I checked the elements resistance in the water heater and visually checked the electrical wire going to the breaker box. Everything looks clean with no indication of an issue besides that wire nut. I’m concluding it was a loose connection and hoping that is right. I redid the connection and installed a fire alarm right above the water heater. I then let the water completely warm up and checked the wires (after turning off power) to make sure they were not hot. So far it is all working as expected.