AllThumbs,
All that shifting of the needle from 3:00 to 6:00 to 9:00 is way too much movement on the needle. When leaning out the needle, make small adjustments, and make them slowly. The engine will not respond instantly. It's quite possible that the peak is somewhere around 1:30 (or somewhere), and you are going right from too rich to too lean with no stopping in between.

You want to run a new ABC engine a temp, but you still don't want to overly lean it out and overheat it. The old break-in for a ringed engine calls for running the enigine in a sloppy-rich "4-cycle", that's what you don't want for ABC, but you don't want to peak it out either. You want to get the engine to just break in to a "clean" sounding 2-stroke whine and leave it right there.

Some of the comments I've seen are from guys who say "well, it ran well yesterday, but not today". The correct mixture setting will vary quite a bit with air temp, humidity, and pressure. So it's always good to richen up a 1/4 turn or so in the morning, start the engine, and re-adjust the needle for the weather of the moment. Or at least start the engine and do a pinch or nose-up test to check the mixture, and go from there. Usually, the weather doesn't change much during a day, but if you do go out early and stay long enough to bake (say, 75 with dew on the grass and a light fog at 7 in the morning to mid-90's and bright and dry by 2pm, you can be sure you're going to have to adjust the needle at some point during the day).

Flight Risk,
I agree that it's unlikly that your fuel is bad, but it is possible. You can make fuel go bad in one steamy humid afternoon by leavig the cap off it all day. Fuel will absorb water right out of the air. On the other hand, fuel can be stored for years sealed up, and be just fine. If the fuel looks cloudy in the bottle, it's absorbed water, and is garbage. It can still make running hard if it has a little water in it, but not enough to look cloudy, but frankly, I'd suspect the fuel later on, after other things are ruled out better. I pump back and forth, in and out of tanks all the time, and it does't hurt anything. Yes, a little oil goes up the muffler vent line and back in to the tank, then back in to my gallon, but it's totally ignoreable.

As for how the fuel got in your engine, I'm going to guess it syphoned in there from the tank. I have a couple of airplanes where the tank is high enough that with a full tank, if the lines are primed, the tank will hapily empty itself in to my engine all by itself. Other than that, some oily residue in the engine is normal, and not to be worried about.

It does sound like you're flooded though, so emptying the engine by tiling it up so it drains out he muffler isn't a bad idea.