"I thought the air actually traveled through the oil but that doesn't make a lot of sense"
Typically, the air inlet tube (in the case of your setup, the area where the round holes are) IS below the surface if the oil in the cup when the engine has been shut off for a while and the oil has drained down from the mesh into the cup.
That would mean there must be a fair amount of oil in the bottom cup.
Yours must be missing a gasket or a seal ring, I think it would make quite a mess in operation as the oil returns from the upper housing to the cup, or when it sloshes around.
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