The amount of heat
lost by an engine to the air around it is trivial. Virtually all the heat is carried away by the
water cooling. The only part of a typical small
diesel engine that
requires air
cooling is the
alternator.
Yes, under the blanket will get hot. Maybe as much as 200F (95C) if not ventilated. As long as you feed the engine with cool combustion air, and a source of cool air for the
alternator to cool itself, the surrounding ambient temperature really doesn't matter. But those cool air sources are critical.
I would check out carefully the temperature rating of the attached
electrical wires, especially any added to the engine that were not part of the original engine manufacturer's
wiring harness.
If there are any
electrical parts you want to keep cool, you can simply extend the wires and mount them off the engine.
It might be a good idea to check with the engine manufacturer. It is possible they have an ambient temperature rating that you would not want to exceed.