What is the physiological mechanism behind the diuretic effect of caffeine?
Caffeine inhibits the secretion of the antidiuretic hormone (ADH), so it increases diuresis, but this effect is small and transient. http://en.citizendium.org/wiki/Vasopressin
Caffeine in amounts up to 400 mg/day (~4 cups of coffee) does not results in net dehydration, since the amount of water lost due to slightly increased diuresis is much smaller than the amount of water in coffee. http://www.ncbi.nlm.nih.gov/pubmed/19774754
In some people, caffeine may irritate the bladder and thus trigger more frequent urination, but this is not increased diuresis and the total volume of the urine is not increased.