Also check the file system permissions on the folders where the system databases were installed to verify that the local windows group has the correct permissions.
Jeffrey - That did it. Thank you.
I gave full control to the local Windows group SQLServer2005SQLAgentUser$ServerName$MSSQLSERVER on the E:\MSSQL\LOG folder. These are the same permissions as the default folder: C:\Program Files\Microsoft SQL Server\MSSQL.1\MSSQL\LOG. Weird, I thought I tried this.
The strange thing is, I did not have to do this on the E:\MSSQL\LOG folder or the F:\MSSQL\DATA folder for the SQL Server Service which uses the SQL_Srv1 domain account. I verified that SQL_Srv1 is NOT a local administrator.
Hopefully some can explain why.