Sure you can - you need to make sure its made of flame retardant materials and avoid the flue area. Water heaters generally are well insulated anyway, and have a double-wall system so the outside doesn't feel that hot to the touch. If you heater is really that old, it wouldn't be a bad idea to replace it. You'd probably make up your cost in energy savings. You also can always lower the heater's thermostat and it will use less energy.
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