In the 1988-1994 war between Azerbaijan and Armenia over the disputed territory of Nagorno-Karabakh, populated by Armenians but located within the Azerbaijan SSR, the latter lost 20 percent of its territory. Armenians established the Nagorno-Karabakh Republic (NKR) which declared its independence from Azerbaijan on January 6, 1992. The Caspian oil boom since 2005 has strengthened Azerbaijanís hand in the conflict. However, this advantage is doomed to disappear in 2011-2019 with the dwindling of Azerbaijanís oil reserves.



The Current Status of the Conflict

Since the death of Heydar Aliev in 2003, tensions between Armenia and Azerbaijan have taken a turn for the worse. His son, the new Azeri President Ilham Aliev, has threatened to resort to force to retake Nagorno-Karabakh and exchanges of fire along the frontline have increased. One explanation for this escalation is the rapid growth of Azeri defense expenditures, driven by the influx of petrodollars, which shifted the military balance in Azerbaijan's favor. Azerbaijan's defense budget alone, at US$3 billion, exceeds the whole state budget of cash-strapped Armenia.

On the other hand, Alievís threat of military buildup comes in the wake of Kosovo's declaration of independence from Serbia on February 17, 2008, which he fears could set a dangerous precedent for mutinous secession. This fear was reinforced by Russiaís subsequent recognition of Abkhazia and South Ossetia as independent states after the war with Georgia in August 2008.

Armenian President Sarkisian responded to Aliev's warnings on December 2, 2010 during the OSCE summit held in Astana. Sarkisian threatened to formally recognize the NKR as an independent state if Aliev tries to use force to win back the enclave and other Armenian-controlled territories around it, saying, "If Azerbaijan resorts to military aggression, Armenia would not have any other choice but to recognize the Nagorno-Karabakh Republic de jure and to invest all its capabilities into ensuring the security of the people living there... Nagorno-Karabakh has no future within Azerbaijan."

How real is the danger of resuming this war in Transcaucasia? The victorious Armenian side is quite content with the status quo in Karabakh where it had achieved all strategic goals prior to the 1994 armistice. (Armenian ideologues have lately started to talk about the return of Nakhichevan, the Azeri exclave within Armenia, but the Azeri status of this territory is protected by Turkey under the 1921 Treaty of Kars). The potential of the losing Nagorno-Karabakh Azeri side depends not only on its military buildup and patriotic bluster, but more on the civic morale and social welfare of its population, which is profoundly unwilling to wage a re-conquest of Nagorno-Karabakh given the present political situation and social injustice in Azerbaijan.

Azerbaijanís Petrodollar Dependency

Modern Azerbaijan is a typical Middle-Eastern petrostate ruled by a classical Middle-Eastern despotia, where political (and economic) power is concentrated and inherited within the ruling family. The extended family includes, along with the kinsmen of Azeri president and his wife, the top bureaucrats who, apart from their government duties, run vast business empires in every industry and trade, and enjoy a virtual monopoly in their respective fields and import operations. The petroleum export operation belongs to the ruling family Ė a fact that has been clearly revealed in the series of Wikileaks of American embassy dispatches from Baku.

In 1994, Heydar Aliev gave the largest oil concession in the Azeri sector of Caspian Sea for 30 years to a Western consortium led by British Petroleum, which has persuaded Western governments to overlook the glaring violation of human rights, the poor imitation of democracy, and the egregious conflating of business and political interests in this petrostate for the sake of unhampered pumping of one million barrels of Caspian oil daily through a pipeline built in 2005. The family receives in return 15 billion to 20 billion petrodollars annually, which it mostly spends on prestigious construction projects and other grandiose displays of independence, such as the recently erected tallest flagstaff in the world, turning the city of Baku into a Dubai-style amassment of futuristic skyscrapers by demolishing European quarters built during the first Baku oil boom of 1907-1915 and brutally evicting its citizens from their privatized homes.

However, this second Baku oil boom of 2005-2013 is doomed to end in a few years without any significant economic achievement as all the petrodollar revenue is being spent in a construction frenzy on ostentatious "white elephants" without modernizing even the city's basic infrastructure, such as the water and sewage systems, let alone creating non-petroleum industries that might become useful in the future with the end of big oil. Almost all the factories and manufacturing plants, left over from the Soviet industrial past, have been grazed down to clear the ground for economically useless hotels and convention centers, magnificent mosques and shopping malls, and opulent office and residential buildings for Azerbaijan's new petrodollar elite. This leaves little room to live or work for the rest of population, which is emigrating in large numbers: presently 3 million of Azerbaijan's 9 million citizens live and work abroad.

††††††††† Petroleum production provides 85 percent of Azerbaijan's state budget revenues, accounts for 78 percent of the country's GDP and 92 percent of Azerbaijan's export. In other words, Azerbaijan completely depends on oil revenue in its standoff against Armenia, in military expenditures, in the food import-based welfare of its populace, and in ensuing political stability. The lion's share of oil revenue is provided by one single cluster of three offshore oil fields, Azeri-Chirag-Guneshli, discovered before Azerbaijanís independence by Soviet geologists in the Caspian Sea. These three platforms presently supply 42 million of Azerbaijan's 50 million tons of annual oil production. Since then, 23 exploration contracts signed with foreign oil companies have failed to find any new oil deposit in Azerbaijan and its sector of the Caspian Sea.

Therefore, any speculation about Azerbaijan's prospects, both domestically and in Karabakh, is made simple by the country's complete dependence on these three oil fields: with their inevitable depletion Azerbaijan's economic strength will attenuate, which will in turn diminish its chances of resolving the Karabakh issue by force. The reserves of these fields are a state secret in Azerbaijan, but numerous foreign oil industry sources give evidence that, at the current rate of extraction, the three main fields will be depleted by 2019.

 

The End of Oil Boom

In 1992 the oil deposits of Azerbaijan were estimated at 7 billion barrels, 5 billion of which were under the Azeri-Chirag-Guneshli cluster. The total Caspian Sea reserves, including Kazakhstan, which possesses 80 percent of Caspian oil, were around 25 billion barrels. Since then, nothing new has been found in the Azeri sector of the sea, while the giant Kashagan oil field was discovered in the Kazakh sector. Suppose that during the 16 years since the signing of concession, the Consortium has been pumping half a million barrels of oil per day on average, i.e. 182 million barrels per year. (In fact, since 2005 the daily output has been 1 million barrels). Multiply that number by 16 years and it is evident that from its total stock of 7 billion barrels Azerbaijan has already pumped out about 3 billion, leaving only 4 billion barrels of oil.

Now generously presume the remains of Azeri-Chirag-Guneshli to be 3 billion barrels (of the initial 5 billion) and divide that by 365 million barrels a year: the resulting estimate gives only nine more years of production at one million barrels per day (which the Consortium plans to increase up to 1.2 million per day). Thus, it is easy to calculate the end of Azeri-Chirag-Guneshli in the year 2019. Given that 2010 was the peak year of Azeri oil production, the descent begins as of 2011. (The IMF predicts the beginning of descent in 2012). Of course, the output will not stop immediately, but its reduction by 10 percent a year will be a severe blow to this petrostate.

This is only my generous calculation; the real decline may be even steeper because Azeri officials routinely inflate their oil assets, which are mysteriously increasing instead of decreasing, in spite of the one million barrels pumped out daily. According to them, Azerbaijan's oil reserves rose last year to 923 million tons, an equivalent of 6.7 billion barrels. In other words, the stock of oil in Azerbaijan, after 18 years of extraction and no new discovery made, has declined by only 300 million barrels, which is Azerbaijan's production in one year. Where the output in the remaining 17 years has vanished to is unknown.

This same kind of overstatement pertains to Azerbaijan's natural gas resources, which the officials hope will replace the dwindling oil revenues. Gas reserves, however, are insignificant: Azerbaijan currently exports only 5 billion cubic meters (bcm) of gas to Turkey, hoping that the annual production from its Shahdenis gas field will double in the future, compared to the annual export of 70 bcm of Turkmen gas, 46 bcm from Iran and 350 bcm from Russia. Even gas-thirsty Ukraine, which is entangled in a gas-import dispute with Russia, produces 20 bcm of its own gas, compared to the 15 bcm produced in Azerbaijan, of which 10 bcm is consumed domestically.

Given this negligible volume of natural gas export and the certain end of big oil, the absence of real industrial production and manufacturing base in the post-petroleum era could lead to economic plight and public frustration. Azerbaijan has not developed any alternative source of economic income comparable to the current oil-export revenue. Moreover, instead of modernizing the Soviet-era industries, it has torn down the old factories and plants to clear the ground for office buildings and shopping malls, where the petrostate citizens were supposed to spend their petrodollars. However, Baku is neither a new Kuwait nor a new Dubai: its oil boom is to end within a few years. Yet the closed political system prevents a meaningful debate on post-boom challenges and breeds a sense of apathy and complacency.

 

The Futility of International Pressure

The international pressure which the Azeri government is trying to exert on great powers in resolving the Karabakh conflict by using its oil† production as a foreign policy leverage is more important than the arms race. In 1994, Heydar Aliev hoped that the Western interest in energy resources would play in his favor on this issue. Composition of the Consortium, which included the European, American and even Russian companies, perfectly fitted into this strategy. However, Aliev's hope to relate oil development to the resolution of Karabakh conflict produced little effect. The only gain on this path was the softening in 2001 of Section 907 of the 1992 Freedom Support Act, which barred Azerbaijan from receiving American humanitarian aid until it lifts the economic blockade of Armenia.

Roughly speaking, the political clout of the one-million-strong Armenian community in the United States countervails the powerful big-oil lobby in Washington that promotes Azeri interests. Thus, the strategy of defeating Armenia diplomatically at the hands of oil-thirsty great powers has failed. Neither the European Union nor the United States have increased their support for Baku in the so-called Minsk process for settling the Karabakh conflict sponsored by OSCE. This strategic failure caused a reconsideration in Baku of the diplomatic impact of Azeri oil on the West, and both Alievs turned then to Moscow, trying to manipulate the United States and NATO by the Russian card.

Russia is still the strongest military power in the region, but its capacity to control events there is far weaker than most observers assume. Both the physical† barrier of the Greater Caucasus range and the insurgency in its own turbulent North Caucasus reduce Moscow's ability to operate in the South Caucasus. To confront the growing political and economic influence of Turkey and Iran there, Russia if anything calls for the help of local Armenians, Abkhaz, Ossetians and others nations capable to maintain the Russian interests. The 2008 Georgian war and the renewal of Russia's military alliance with Armenia in August 2010 were both evidence of this. The calm reaction in the West to both events suggests that a dose of insignificance for Western strategic interests would be very healthy for Caucasian nations since it would allow the local governments to concentrate on solving their essential problems on their own.

Transcaucasia is indeed an important transport corridor for Caspian energy exports independent of Russia and Iran. But the romantic project of a new Silk Road stretching from Central Asia to Constantinople after the collapse of the USSR was unrealistic, unduly raising the hopes of small nations along the Road of becoming essential to the West, while antagonizing Russia and Iran. Also in the 1990s, Caspian enthusiasts in the West extravagantly believed that the oil reserves of Caspian Basin (allegedly 200 billion barrels) were equal to those of Mesopotamia and the Persian Gulf. Their claims later turned out to be exaggerated almost 10 times. Due to its impending economic and strategic insignificance to the West, Azerbaijan needs to become more realistic in its claim to Nagorno-Karabakh as its ability to persuade the great powers is set to wane synchronously with the depletion of oil reserves in 2011-2019.