The smoke pellet heating element will work with both pellets and liquid smoke fluid as long as the element is not clogged with un-melted smoke pellet material.

There is no reason the smoke element should be glowing red, and your engine should not be dead with the smoke element disconnected. Double check the wiring to the e-unit and motor.

Here is a wiring diagram for locomotives to check your wiring against.
http://pictures.olsenstoy.com/cd/locoinfo%5Cloc-e-p1.pdf

Larry