Quoted:
Also, as mentioned, I would run a good long test on that muffler to make sure that the pipe doesn't get too hot to cause a fire on the wood of the wall. I'm pretty concerned that the pipe might cause a fire. I'd want to see a greater distance between the pipe and the wood. Maybe some insulating/fireproof rope too.
Insulation sounds like a good idea, but it's not. Insulation just slows heat flow, it will flow to the wood, and heat the wood up, until the wood is hot enough to dissipate the heat transfered by the insulation, and it will remain at this temperature.
An air gap will actually stop heat flow. As the pipe heats up the air it rises and will rise out of the area between the hole and pipe to be replaced by fresh cool air. The only danger is heat radiation, but the gasses should not be hot enough for this to be a big problem. Were this an exhaust manifold, the radiation would be a concern.
Somone posted that the exhaust backpressure will only rob a bit of power (I think it was in the alpha rubicon link) This is only partially true, The exhaust backpressure will make the valves and manifold run hotter, which may reduce like, and will make the shed warmer.