This is all hypothetical based on the small amount of things we do actually know and my own intuition. Valve was probably working on Episode 3, expecting it to come out just like Episode 2 did. For whatever reasons, it began to take longer than they expected plus the extra time spent on the Portals and Left 4 Deads. As the end to the Half-Life 2 story arc (They have said Episode 3 is not the end of the Half-Life franchise by the way), that probably had something to do with it. The game got too big. Eventually they decided that this needs to be a full game. The Source engine is showing its age, even though they have done a lot to prolong it. The reason why we haven't seen anything beyond a few pieces of concept art is because Episode 3 is being made with a brand new engine, and if they were to show a video or screenshots, we would all know it to no fanfare. A new engine would be a very big deal (it affects all of their games) and I think it's pretty reasonable that they would want to make some kind of big announcement to show off the new Source engine instead of having it drizzle out. On February 20th Gabe said:
"Part of the reason that we backed off talking so much about what was happening in the future is that when we've done that in the past, you know, with Half-Life 1 it was a year after we originally said it would be, Half-Life 2 basically if you go and read the forum posts apparently took us 50 or 60 years to get done, so we're trying to be careful not to get people too excited and then have to go and disappoint them... So we're sort of reacting in the other direction and saying, 'okay, well let's have things a little more baked before we start getting people all excited about it.'"
Both Half-Life 2 and Team Fortress 2 changed massively since when they were both being shown off.
I'm going out on a limb here but I'm going to guess that the new Source engine will use fluid dynamics first experimented with in Portal 2. It will be called WaterSource.