After finally performing a compression test I've decided to replace my engine with a rebuilt one. Chances are my piston rings are shot and a couple of local shops quoted me at least $3000 to rebuild my current engine. I found a place on the internet (http://www.vwdieselparts.com/index.html) that rebuilds my engine (1.6L) and will ship it cheaper than I can get it rebuilt. I have some friends lined up to help me swap the engine which I only expect to take a couple of days.
I have no reason to believe that running alternative fuels is what caused the damage. Looking back on the purchase of the vehicle I'm not convinced that the engine was rebuilt as I was told it was. Knowing what I know now I would've asked a lot more questions about the vehicle.
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