The Nagorno-Karabakh War (1988-1994) plagued the region following the independence of Azerbaijan from the Soviet Union in 1990. Ethnic Armenians living in Nagorno-Karabakh, a land-locked region of Azerbaijan, affirmed themselves as an independent state in 1991. While a ceasefire was brokered in 1994, no peace agreement was signed.

Military spending hints at future conflict

In recent years, the ceasefire has been repeatedly breached, resulting in more civilian deaths and the use of heavy weapons, hinting at a potential return to war. For example, the summer of 2014 saw the most violent attacks since 1994, with over 60 civilian casualties.

Trends in military spending also point toward a preparation for war. Azerbaijan spent 4.64% of their GDP in 2010 on military, 4.7% in 2013, and has reportedly increased by 27% in 2015, to $3.6 billion USD. Armenian military spending has increased from 3.92% of GDP in 2010 to 4.1% in 2013. In 2014, the Armenian government increased their spending to 4.2%.

In July 2015, Azerbaijan began military exercises, with officials informing hospitals that they should "take the necessary measures to prepare for possible military action that can take place at any moment.” These exercises have also seemingly involved increased cooperation and collaboration with Turkish and Georgian militaries.

As a result of these trends, private business interests in the Caspian Sea may also be under substantial risk if the conflict were to escalate. Petroleum pipelines attempting to diversify Europe’s energy profile as well as wean it off of Russia will be threatened by a conflict in the region.

Significant regional risk for energy companies

The regional risks described above will have major ramifications for businesses, and may increase political risk in the months to come. British Petroleum (BP) began a relationship with the government of Azerbaijan in 1994, to develop the Azeri-Chirag-Deepwater Gunashli (ACG), which was further developed with a group of 11 other oil companies.

According to BP, Q1 2015 saw production reach 661,000 barrels of oil per day. Moreover, the company’s total investment as of 2014 was $30 billion, making BP the largest stakeholder of this project at 35.8%. The State Oil Company of Azerbaijan Republic (SOCAR) is the second largest stakeholder at 11.6%, followed by Chevron Corporation, INPEX Corporation, Statoil ASA, Exxon Mobil, the Turkish Petroleum Company, Itochu Corporation, and Oil and Natural Gas Corporation.

Petroleum produced through ACG is exported through the Baku-Novorossiysk oil pipeline which goes north to Russia, as well as the Baku-Tbilisi-Ceyhan Main Export Oil Pipeline, which passes through Georgia and ends in Ceyhan, Turkey on the Mediterranean coast. There is also the Western Export Pipeline, which carries oil to the Georgian Black Sea coastal city of Supsa. The intricate system of pipelines also involves natural gas exports to Erzurum, Turkey, as well as a series of proposed future gas pipelines.

Europe’s efforts to wean itself off of Russian oil under threat

In an attempt to diversify their supply of natural gas, Europe has reached an agreement to build the Trans-Adriatic Pipeline (TAP), which was approved at the end of July 2015. This project will bring petroleum from Baku through Turkey to Greece, Albania, and Italy.

The success of this project will allow Europe to begin to diversify its energy supply away from Russia, as well as circumvent Ukraine. If the TAP project is put at risk over conflict in Nagorno-Karabakh, Russia will remain the region’s major natural gas supplier, until Europe finds another alternative.

The Nabucco-West pipeline is another proposed project, which was initially set to reach Austria through Bulgaria, but was abandoned in 2013. More recently, discussions were re-kindled, especially with the intensified uncertainty over transitgas through Ukraine. The Bulgarian government has stated that it would like to continue discussions concerning Nabucco, but competition from TAP is making it difficult.

The resumption of conflict between Azerbaijan and Armenia would not only be a diplomatic failure, but would also present significant risks to many private sector actors. Petroleum companies invested in Caspian Sea oil, as well as the many pipelines and agreements for export will be threatened. Europe’s attempts to diversify away from Russia would be put on hold, which is perhaps the most significant implication of the conflict.

 

(Global Risk Insights)