Oh.. I think JAVA was recently updated. Does Arduino install its own Java?? I suspect it does, as there is no real 'Install', right? Hmmm..
Can you tell me more about how to run a compilation from command line? Would this be done after the sketch is loaded in regular IDE window?
About Java, I'm not a Windows user but I believe that on Windows the IDE installs its own version... but then at startup it looks for a suitable JVM in the system, which may not be the one it installed. For more information you may try and go to the "\Program Files\Arduino" directory (the directory where arduino.exe is installed) and run:
Then use the IDE normally. The option will create a debug file (in the current directory or perhaps on your desktop) with more information on the JVM version used, and maybe some message about memory usage.
As for the verbose output, in the IDE Preferences window there are two checkboxes, "Show verbose output during compilation/upload". If you check the compilation and verify a sketch you get the verbose log. The first lines (until the name of the cpp.o files) are the command that you can copy and paste at the command prompt (all in the same line); on a Mac it looks like this:
/Developer/Arduino-1.0.4.app/Contents/Resources/Java/hardware/tools/avr/bin/avr-g++ -c -g -Os -Wall
-fno-exceptions -ffunction-sections -fdata-sections -mmcu=atmega328p -DF_CPU=16000000L -MMD
-DUSB_VID=null -DUSB_PID=null -DARDUINO=104