A PIPELINE TO PROFITS AND TERRITORIAL TENSION
April 25, 2006 20 21 GMT

Stratfor
April 26 2006

Summary

As the Baku-Tbilisi-Ceyhan oil pipeline moves toward operational
status, the Azerbaijani government stands to make a lot of money very
quickly. Most will likely go to President Ilham Aliyev, his clan and
the country’s defense budget (probably in that order). Meanwhile,
hostilities between Azerbaijan and Armenia, which occupies the
Nagorno-Karabakh territory within Azerbaijan, will likely escalate
and eventually erupt into renewed conflict.

Analysis

The Baku-Tbilisi-Ceyhan (BTC) pipeline, which will bring oil from the
Caspian Sea to the Mediterranean, is scheduled to become operational
within two months. The income the pipeline will bring to Azerbaijan,
along with other energy projects, will reach approximately $2.8 billion
by the end of 2006. Though much of the money will go to President
Ilham Aliyev and his clan, the defense budget will benefit as well.

Any increase in military spending has been dismissed by Baku as purely
defensive, but the longtime ethnic and territorial conflict within
Azerbaijan suggests a future arms buildup and increasing hostilities
with the Armenian-populated Nagorno-Karabakh enclave.

During a bloody conflict in the early 1990s, Armenians gained control
not only of Nagorno-Karabakh but also of a buffer zone and corridor
to Armenia. A tenuous cease-fire has been in place since 1994.

However, there has been some shooting over the Line of Control, and
the atmosphere is palpably tense. A recent meeting in France between
the presidents of Azerbaijan and Armenia, as expected, brought the
two no closer to a solution.

With the influx of cash, Azerbaijan might purchase armaments and
vehicles from France, the United States or the former Warsaw Pact
countries, and the Azerbaijani military could receive instruction
from its U.S. ally. While the intensity of Armenian nationalism —
and the inferiority of the Azerbaijani military — has usually made
up for the smaller Armenian defense budget, the obvious imbalance in
funding will likely shift the equilibrium.

In 2005, Armenia’s national budget was $930.7 million, while the
Azerbaijani national budget was $2.986 billion. Azerbaijani defense
expenditures in 2005 reached approximately $300 million, according to
numbers from the Jamestown Foundation, and Aliyev has been quoted as
saying that Azerbaijan’s defense budget will soon match the entire
national budget of Armenia. While Armenia’s defense budget for 2005
was $100 million, it will increase in 2006 to $160 million.

Upon completion, the BTC pipeline, along with the already-operational
Baku-Supsa oil pipeline and the South Caucasus (Shah Deniz) natural
gas pipeline (which comes online in the fourth quarter of 2006),
will be the major contributor to the Azerbaijani economy. And the
BTC is ramping up quickly — currently, the pipeline fill is complete
through Azerbaijan and Georgia and is in the final stages in Turkey.

In 2007, production is expected to increase significantly as new
platforms come online in the Caspian Sea. The BTC will reach its full
capacity of 1 million barrels per day as early as 2008. Without even
including projected income from the Shah Deniz natural gas pipeline,
this will result in a dramatic increase in income for the Azerbaijani
economy.

Although it looks as if an Azerbaijani attempt to incorporate the
secessionist enclave is imminent, there are several factors that could
temper any aggressive move. Not the least of these are the many large
multinational corporations that have set up camp in the country,
running the numerous energy operations around Baku. Anything that
could jeopardize the extraction operations or the pipelines will
not be looked upon kindly by the people who brought Azerbaijan all
this income.

There are other vulnerabilities that could be exploited. The BTC and
the South Caucasus pipeline both come close to Nagorno-Karabakh and
secessionist regions within neighboring Georgia. Sabotage is quite
possible on the 1,094-mile-long pipeline, despite high security.

Moreover, all secessionists in the region are supported by Russia in
one way or another, and the patron might decide to cast a complacent
eye toward any sabotage, since the BTC circumvents Russia’s own
pipeline network.

The Armenians have shown they are willing to fight. They are also
quite politically powerful — the Armenian community in the United
States, which outnumbers Armenians living in their own country, has
an influential lobby in Washington. The delicate balance of the U.S.

alliance with Azerbaijan and U.S. support for Armenia will cause
Washington to do everything within its means to prevent the
remilitarization of the conflict.

However, nothing can prevent the escalation of an age-old blood
feud in a region where history means everything. Any quarrel can
be escalated to trigger renewed bloodshed. Slowly but surely, the
conflict will again come to a head, but this time, the Azerbaijani
side will be better-prepared, better-armed and better-financed,
gradually shifting the balance to its side.

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