Some others have implied this but I am going to flat out lay it on the table:

The game itself:
What type of game do you want it to be? Puzzle? Adventure? RPG? Survival? (I'm seeing survival since you talked about RPG character development and you could find ways to increase the skill of the player to possibly get off of the island) How will your game control? What makes people wont to play it? I think you should nail this down first then start on the story.

Now for the story:

First, when you think about this place, what type of things do you see going on in this world? You mention heavy use of steam and metal fixtures and things (steampunk). Are there others on this island? What makes this place so special? Is it the last land on the earth? (Is it on earth?) Think these little details out and they will help you start to envision a story.

When your writing or trying to write a story for a game the best thing ever you can do is limit yourself. (Others will argue but oh well)

What I mean is say "Ok, in this story there can be no hero with a troubled past who meets a mysterious stranger whos most likely an orphan and they cant go defeat an evil empire after they join a rebellion"

So now that that overdone plot is out of the way You can concentrate on something different and unique.. I usually start with a big outline of starting and ending goals, then refine the outline by adding major plot points, then further refining those plot points until I get the story I want.

I hope this helps, it works great for me.

Though I haven't posted again in this thread since starting it, I have been reading it and thinking about what people are saying. First thing I can say for sure I know is that this game will be set on a planet that is earth-like, but not earth. Past that, I have been mulling over ideas of what sort of gameplay I want and other details before I try to figure out the plot. I am still uncertain if this will be a puzzle game, RPG, survival game, or what. I'm leaning away from puzzle as I dont think it offers enough of the gameplay elements I like, and I had another more appropriate idea for a survival/action game today that I'll save for later. I'm thinking on how to form and RPG out of a limited world right now.
Anyway, thoughts are mulling in my mind and past ideas might be combined with this one. I'll probably start another thread when I have a more certain grasp of where I want this gameplay to go.

There is plenty you can come up with to form an RPG. Is there something under the surface of the volcano that comes up from under the water at night (enemies or something)? Are there warring factions on this atoll? What happens if a boat full of who knows what invades this area when they stumble upon it. Since its an earth like planet but not earth maybe when the moon (or moons) rise at night something strange happens to the landscape.

Those are just some seeds to hopefully get the ball rolling for you.