Air-oil Separators, typically used on rotary compressors, are located just after the compressed air leaves the compressor, installed in the compressors discharge line. The Oil Separator ensures your compressors oil is recycled back into the compressor to keep it lubricated, whilst helping to ensure the compressed air exiting the compressor is free of oil.
Of course not all the oil will be removed, as some traces of oil and vapors may pass through the air filter material and remain in your air supply. Therefore, it is important you have other filters in place downstream to ensure these do not reach your devices.
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