We had a horse at our barn that had that happen but I COMPLETELY forget what it ended up being.... so helpful i know :-/ but at least you can rest assured he didn't end up having to have a vet out or anything, so whatever it was wasn't serious. I know the girl cleaned the sheath and there was a lot of gunk in there, but I forget if that's all that was wrong or not.
Clean it, like others have said, if he will let you, and keep fly spray on it. :( ouchy... poor fella!
Proud owner of 13yr old Paint Gelding, Bali! <3