Supported palladium catalysts are the most active ones toward the complete oxidation of methane. However, the presence of relevant amounts of water hinders the catalytic activity and long-term stability, due to competition between methane and water for the active sites. Hence, understanding the inhibition effect of water on methane oxidation is mandatory to improve these catalysts. We present an in situ ambient pressure X-ray photoelectron spectroscopy study of methane oxidation on Pd/Al₂O₃ in presence and in absence of water. The inhibition effect of water is demonstrated by combining reactivity tests with electron microscopy and photoelectron spectroscopy measurements. In the presence of water, the redox activity of palladium decreases. Water competes with methane for the catalytically active sites, poisoning the surface with hydroxyl groups and hindering the generation of the coordinatively unsaturated palladium active sites. Multiple palladium oxide species displaying different reactivity are identified. A new cationic palladium species, assigned to adatoms, is detected, which shows higher reactivity with methane than particulate palladium oxide but also high inhibition by water.