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That hose going down the block, that should be your flame trap hose. The other end should go to the intake manifold. There's also a vacuum line to the trap holder. Make certain you can blow through that- if it's clogged, replace it or pick the blockage out with a wire. The trap itself is probably dirty. A new one is only a couple of bucks, with a new holder, either from a parts supplier or Volvo.
I'd say you've got a rear main seal leak. It's going to be dripping out of the little vent grids on the bottom of the bell housing. I assume that it's oil you're finding- the transmission can leak in basically the same place. ATF is red, though.
The rear main seal may leak less when the trap is fixed and it's breathing right. It's not going to get better by itself- sooner or later the trans will have to come out so it can be replaced.
I doubt that the distributor is leaking that much oil, but 740 distributors are known to leak. With a new cap, it should now be obvious if there is a leak- it will be oily inside!
Cleaning the engine will be the only way to tell for certain what the source of the leak is. Good luck!
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Rob Bareiss, New London CT ::: '87 244DL/M47- 221K, 88 744GLE- 202K, 91 244 181K, 88 244GL 145K
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