The department for environment, food and rural affairs has withdrawn PFI credits of £100m for a new energy-from-waste facility in Cheshire.
Cheshire West & Chester and Cheshire East Councils were down to the final two bidders for the £850m joint contract: Resource Recovery Solutions, a joint venture between Interserve and United utilities, and Viridor.
However, last week Parliamentary Under Secretary of State, Lord Henley said Defra had decided to withdraw its provisional allocation of PFI credit.
Cllr Mike Jones, leader of Cheshire West & Chester, said: "I am extremely concerned by this development because after a five-year process, we were so very close to a solution to our household waste disposal problems over the next quarter of a century.
"During the next few days we will be talking to Government, our colleagues in the East and our advisors, in an attempt to clarify the situation and find a solution."
Cllr Wesley Fitzgerald, leader of Cheshire East Council, added: "We are disappointed by Defra's decision as an awful lot of time and work has gone into this joint project.
"We had great faith in this scheme, and had already achieved a lot. However, we will be making every effort to talk with key stakeholders to find alternative ways of reducing landfill."
Community and environment executive member, Cllr Lynn Riley, said: "Potentially we have some very important and difficult decisions to make after considering all the options and alternatives open to us.
"However, at this moment in time, only one thing is absolutely certain. Landfill availability in Cheshire is shrinking fast and we still have to find a way of disposing of at least 180,000 tonnes of household waste each year."