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The Telus store at at 2187 Queen St. East in Toronto's Beach neighbourhood is photographed on March 5 2014.Fred Lum/The Globe and Mail

The Conservative government is prepared to cut Telus Corp. out of a valuable auction of cellular frequencies if the big wireless player doesn't abandon repeated attempts to acquire spectrum that was set aside for new entrants, government sources say.

This warning of unprecedented action is evidence tensions between the federal government and major telecom players are nearing a breaking point. Relations between the Conservative government and the Big Three incumbent carriers have eroded in recent years over the manner in which the Tories have tried to inject more competition into the wireless industry.

The latest showdown between Ottawa and one of the Big Three telecom firms began this month when Telus announced that it's trying, for a third time, to buy Mobilicity, a small Canadian wireless company that filed for bankruptcy in September and which the government has already twice blocked Telus from acquiring.

"If Telus doesn't drop efforts to acquire spectrum set aside for new entrants, the Harper government is prepared to change the rules of the upcoming wireless auction that could effectively bar Telus or any incumbent from acquiring that spectrum," a senior government source said.

Mobilicity owns spectrum that was earmarked for new entrants in 2008 and the Conservatives have been adamant they don't want to see this gobbled up by the big telecom players. Access to spectrum, the invisible radio waves wireless companies use to provide a range of services, is controlled by Ottawa.

Federal government sources say Industry Minister James Moore will reject this latest bid for Mobilicity and if Telus persists in trying to acquire Mobilicity's spectrum, Ottawa will redesign a coming auction of 2,500 MHz frequencies to make it even easier for new entrants to gain spectrum. This could have the impact of excluding Telus from bidding, they say.

Telus has defended its actions in recent weeks, saying it's playing by the rules. It has pointed out that a five-year moratorium on buying the AWS spectrum set aside for small players in 2008 has expired and that this attempted $350-million purchase will not have a major impact on overall ownership of spectrum.

Analysts have expected Telus would be a big beneficiary of the 2,500 MHz auction, scheduled for 2015, because Bell and Rogers, the other two big incumbents, already own significant amounts. The auction rules put caps on how much spectrum companies can own in each region and Bell and Rogers are currently at or near their cap in most areas, government sources say.

This leaves Telus as the only major incumbent eligible to acquire significant portions of the 2,500 Mhz spectrum in the auction.

Federal government sources say Industry Canada and the Privy Council Office, the bureaucratic arm of the Prime Minister's Office, are examining how the 2,500 MHz auction might be redesigned.

Officials are considering several options, including increasing the total amount of spectrum that would be earmarked for new entrants or even completely changing how they allocate the 2,500 MHz frequencies. They're also considering reviving an earlier "beauty contest" method where companies submit bids with plans for the spectrum to Ottawa and then Industry Canada selects the best one to achieve the government's objective of better promoting competition.

Federal government sources say they are concerned Telus could tie up the future of Mobilicity's spectrum in court challenges – spectrum they want to be made available for new entrants instead – and that's why they're considering extra measures.

"If companies like Telus think the government will allow them to stockpile spectrum that was set aside for a fourth player, and access new spectrum in future spectrum auctions, they are kidding themselves," a federal government source said.

The government's rationale is that Telus tying up AWS-type spectrum through legal battles will upset its plans to foster new fourth players in each region. Revising the 2,500 MHz auction to earmark more spectrum for new entrants would be a way to rebalance the equation. AWS spectrum can be used by the latest broadband technology and Ottawa doesn't want it sitting idle.

"The rules of the 2,500 MHz auction were designed under the assumption that AWS spectrum for new entrants would remain in the hands of new entrants. If that changes, we'll need to go back to the drawing board of the 2,500 MHz auction rules," a source said. "Telus should reflect on that."

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