Water agencies in California, Arizona and Nevada also will buy water from Mexico, which will use some of the money to upgrade its infrastructure.
U.S. Interior Secretary Ken Salazar called the agreement the most important international accord on the Colorado River since a 1944 treaty.
"We have chosen cooperation and consensus over discord," he said.
The agreement, coming in the final days of the administration of Mexican President Felipe Calderon, is a major amendment to the 1944 treaty considered sacred by many south of the border. The treaty grants Mexico 1.5 million acre-feet of river water each year enough to supply about 3 million homes making it the lifeblood of Tijuana and other cities in northwest Mexico.
Mexico will surrender some of its allotment when the water level in Lake Mead drops to 1,075 feet and reap some of the surplus when it rises to 1,145 feet, according to a summary of the agreement prepared by the Metropolitan Water District of Southern California, which will buy some of Mexico's water.
The agreement expires in five years and is being billed as a trial run, potentially making it more palatable in Mexico.
"These are big political steps for Mexico to take," said Jeffrey Kightlinger, Metropolitan's general manager. "Chances are we won't have a surplus and we won't have a shortage but, if we do, we'll have the guidelines in place on how we're going to handle it."
In 2007, facing an eight-year drought, California, Arizona and Nevada agreed on how much each state should sacrifice during shortages on the 1,450-mile river that flows from the Rocky Mountains to Mexico. That same year, the U.S. and Mexico promised to work on ways to jointly address shortages.
The negotiations gained a sense of urgency for Mexico in 2010 after a magnitude-7.2 earthquake damaged canals and other infrastructure, forcing it to store water temporarily in Lake Mead.
"They have some storage but it's not enough for drought and emergencies," said Halla Razak, Colorado River program director at the San Diego County Water Authority.
Roberto Salmon, Mexico's representative to the International Boundary and Water Commission, said the pact was the latest sign of improved cooperation with the U.S.
The Colorado River is also a key source of water for Colorado, New Mexico, Utah and Wyoming.
River pact may mean more waterin Lake Powell
For Utah, the most direct effect of a new Colorado River agreement between the United States and Mexico may be a rise in the water level at Lake Powell.
"The direct benefits will be more in the lower basin, but it will back water up to Lake Powell because of the coordinated reservoirs operating criteria," said Robert King, interstate streams section chief for the Utah Division of Water Resources.
He said releases out of Lake Powell are coordinated with Lake Mead. If Lake Mead stores water for Mexico, as provided by the agreement signed Tuesday by the two countries, that will leave more water in Lake Powell. Should Mexico, over time, store the maximum 1.5 million acre feet allowed under the new pact, that could roughly translate into a maximum 7- or 7½-foot rise in the water level at Powell, he said.
Taylor Hawes, Colorado River Program director for The Nature Conservancy, said environmentalists should be pleased with the new compact. For one thing, she said, it provides for more water to flow to the Colorado River Delta's ecosystem in Mexico, which has seen little if any water for many years. The last time the river reached the sea was in 1998, she said.
Under the agreement, the environmental community and the U.S. and Mexican governments are each contributing 5,000 acre feet of water per year to send to the delta. That will allow the Colorado River to reconnect with the Río Hardy, which flows into the Gulf of Mexico. Hawes said.