The urban water demand in Southwest Texas has grown rapidly in recent years due to the population increases in urban areas, which caused conflict between municipal and agricultural water use. Deficit irrigation is one important measure for solving this problem. A field experiment with seven different irrigation treatments and four cotton varieties was conducted at the Texas AgriLife Research and Extension Center at Uvalde in the summers of 2008 and 2009 to examine the water saving potential and related phenological/physiological responses in Southwest Texas. The results showed that: 1) The threshold deficit ratio for a traditional deficit irrigation scheme falls between 0.7 and 0.8 for cotton production in Southwest Texas under a low energy precision application (LEPA) sprinkler irrigation system. The 70% evapotranspiration (ET)-initialled regulated deficit irrigation scheme (70R) performed well in maintaining lint yield in most cotton varieties tested. The significant changes detected in lint quality failed to introduce premiums or discounts in cotton price. 2) The phenological parameters (plant height, node number and flower/fruit number) showed clear trends that illustrate the relationship between increased stress level and decreased plant growth and development. The observed inconsistency of the physiological responses in the two growing seasons may imply that physiological parameters are not good direct predictors of lint yield if measurements are conducted only on a point basis. The partitioning coefficients of boll dry weight in both years failed to show a significant difference between deficit irrigation treatments and the control, indicating that reallocation of carbohydrates may not be the major factor of maintaining lint yield for the deficit irrigation treatments. 3) Economic analysis showed that due to the low water price, it is not currently profitable to adopt deficit irrigation. In case that water price is increased, it may become more profitable to adopt deficit irrigation. This work provides reference information to water authorities and policy makers to set quotas for municipal and agricultural water use and to value water properly through setting different water prices.