1: You are not going to be selling the work, so you don't have to worry about that.
2: You're right. Anything sexual you'd put in here wouldn't be for public consumption, which would include a sexy story with song lyrics. As long as you note the copywright at the bottom/top of the story, shouldn't be a big deal. I would think that as far as the song's involved, your story would fall under a 'comment' - in your opinion, it's a good song to dance to, and catchy, and you obviously like it. 'Cause I can tell you from personal experience, it's freakin' hard to dance erotically to a song you just cannot stand.
3: Substantiality? Any artist will tell you that even if the damned thing is a capella, much much more goes into a song than just the words of its lyrics. You're nto ripping off the entire song - at worst, you're listing words and describing instrumentals.
4: Effect of its use upon the potential market would be minimal, since potential market would be the general public, especially those most likely to buy CDs. Again, your fiction would not be out for public consumption.
Also note that if it's a song you've purchased, either on mp3 or CD or whatever, describing it falls under fair use, too, otherwise where wouold the music reviewers we never listen to be, eh?
Honestly, I personally think that if you're worried about it, you may find it a relief to try to rework your story so that you just put in vague references to what's playing - "The seductive lyrics of the song seemed to slide down her skin as she writhed against the pole, the throbbing, nearly subsonic bass line vibrating through her and" blah blah blah blah, I'm not going to finish that. You get the idea.
In short, I don't know how Lil feels about it, but I personally don't see where it would be a problem for you to quote song lyrics, so long as you don't claim them as your own.