Good background on the situation, from ICG, published last December:

Ethiopia and Eritrea: Preventing War
The 1998-2000 war has frequently been described by pundits as being as pointless as “two bald men fighting over a comb”, but for the belligerents the issues are deadly serious. Ironically, it is the peace process itself that has produced a stalemate from which renewed fighting is now feared.

The disputed border was the proximate cause of the war. Arguably, however, the root causes went deeper, including to the legacy of friction between the two former allies from their struggle against the regime (1977-1991) of Ethiopian dictator Mengistu Haile Mariam and the overdependence on relations between leaders and parties rather than institutions in managing bilateral relations.

Many differences arose between the neighbours over migration, labour, and trade. Particularly controversial was Eritrea’s introduction of its own currency in November 1997, despite Ethiopia’s strong protest. Tension also developed over the use of the port of Assab, which Ethiopia had ceded to Eritrea at independence. Its loss cost a suddenly landlocked Ethiopia significant revenues, and resentment smouldered.

On both sides, however, the dusty border village of Badme, where the war began, has now acquired a symbolic importance entirely out of proportion to its size and population...