indicating that the Windows Azure Tools - Development Storage Service failed to initialize, then please perform the following steps to resolve the error. Aperently by default the service is searching for SQLExpress.
Run Windows Azure SDK Command Prompt (as Administrator)
Enter DSInit /sqlinstance:[your sql instance name]
As a result this will perform a couple of automated steps for ports, tables, etc. and create your development storage database.
When it is finished the screen will look like this:
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