The proposed strategic alliance between the Los Angeles Department of Water and Power and Duke/Louis Dreyfus has sprung a serious new leak one that could sink the long-awaited partnership before its launch.

The prospect that the DWP’s crucial public-private alliance may be unraveling could jeopardize the agency’s ability to survive in the fast-approaching deregulated power industry. And survival of the nation’s largest municipal utility is a matter that affects the costs of hundreds of thousands of local businesses and residences that rely on the agency for power.

In short, the DWP is in a race against time to slim down its operations and become more competitive before the electricity industry deregulation begins next year. For-profit, investor-owned utilities are already swooping in to snatch a share of the L.A. market, where the DWP has enjoyed a monopoly.

To fend off that incursion, the DWP has undertaken substantial layoffs and a series of strategic alliances with private industry partners to sharpen its marketing and management operations.

The first of those alliances with Duke Louis/Dreyfus was announced with much fanfare in February, but is now in peril of collapsing.

The latest problem stems from major changes taking place at Duke/Louis Dreyfus, a joint venture which is being acquired by one of its partners, Duke Power from its other partner, Louis Dreyfus Energy Corp.

As a result, Duke/Louis Dreyfus has lost several key players who helped craft the original framework of the strategic alliance with the DWP.

That development prompted DWP General Manager Harry Sizemore to inform L.A. City Councilwoman Ruth Galanter in a letter dated June 5 that “recent events have prompted the Department to determine that further evaluation of the agreement with D/LD is necessary.”

Galanter chairs an ad-hoc committee on energy deregulation, which was originally slated to consider the alliance last week, but postponed consideration following the DWP’s request for more time.

“I know they have some serious questions, but I don’t know what they’ve done to answer them,” said Galanter.

It was deregulation of the electric power industry nationwide and the prospect of new competition in L.A. that drove the DWP to seek a strategic alliance partner. That search began with a bidding process last year and ended with the selection of Duke/Louis Dreyfus in February.

Ironically, it’s that same deregulation that could undermine the proposed strategic alliance, which is already months behind in an approval process that was expected to take a month or two.

The latest problems are arising from changes taking place at Duke Power, which is on the verge of acquiring PanEnergy Corp. of Houston. The merged company, Duke Energy, will acquire most of Duke/Louis Dreyfus. Duke’s intent is to merge D/LD with PanEnergy’s own trading and marketing arm to form a new entity, Duke Energy Marketing and Trading.

Duke/Louis Dreyfus will lose its current chief operating officer, Simon Rich, as well as its Co-Chairman William Louis-Dreyfus, both of whom were instrumental in putting the DWP deal together. Earlier this year, Duke/Louis Dreyfus also lost Paul Addis, a top executive who was also an important player in the alliance’s early stages.

Rich said he and William Louis-Dreyfus will be available to assist the alliance on a consulting basis, and Duke/Louis Dreyfus officials said their original team slated for L.A. has remained intact throughout the Duke/PanEnergy merger, which is expected to close this month.

If the alliance moves forward, the D/LD team will help the DWP set up an energy trading floor, manage some of its power plants and establish a retail marketing program.

DWP officials and commissioners acknowledged that developments at Duke Power are causing concern, but they downplayed their significance.

“We were married to a partner, then there was a divorce and a new marriage, and we haven’t gotten acquainted with the new partner,” said Marcia Volpert, acting president of the DWP Board of Commissioners.

However, the alliance could be in more serious trouble than either DWP or Duke/Louis Dreyfus officials would like to acknowledge, according to one high-level industry source.

“(Duke/Louis Dreyfus) has to be scrambling big time now as to how they plug all the holes,” he said. “I just question whether the thing will hold together with all the changes that have occurred.”

Tom McGuinness, DWP director of business development, said top DWP staffers will meet this week to discuss “whether there are enough substantive concerns that we would not want to resubmit (the agreement) to the City Council.”

The latest potential stumbling block follows on the heels of questions over the legality of Duke/Louis Dreyfus, a for-profit company, profiting from DWP power plants financed with tax-exempt bonds. That issue has yet to be resolved, according to Galanter.

Meanwhile, a variety of energy companies, including PacifiCorp, Southern California Edison Corp., Enron Corp. and Pacific Enterprises, are carefully watching the situation to see how events unfold.