In what was an even contest throughout, the Saddlers saw plenty of the ball but could not score the all important goal - knowing only a win would guarantee they moved to the next round.
A late strike from substitute Derick Osei sealed the win for Oxford and meant Walsall were knocked out of the competition.
Darrell Clarke made seven changes to the side that lost to Bristol Rovers in the FA Cup on Saturday, starting in a 4-4-2 formation.
Liam Roberts, Cameron Norman, Zak Jules, Rory Holden, Liam Kinsella, Wes McDonald and Elijah Adebayo all dropped out. A number of those also did not make the squad as Clarke rested key players - including Roberts, with Jack Rose the only goalkeeper named.
Winger Jack Nolan made his first appearance since the end of September, while Tom Leak returned from his one-month loan at Bath City to make the bench.
Karl Robinson also made seven changes, starting in a 4-2-3-1 formation.
Jordan Obita made his first Oxford appearance after joining the club on Monday, while Sam Winnall and Michael Elechi made their first starts. Only six substitutes were named.
Neither side was able to create a clear-cut chance in the opening 15 minutes, as they relied on set pieces to force a breakthrough. However, Walsall held their own against their League One opponents.
The odd shot from distance came and went, in what was an uneventful start to the game.
As the clock ticked beyond the 30-minute mark, the Saddlers dominated the ball but failed to do anything with it, while Oxford were happy to sit in and counter-attack.
The game almost sprung into life minutes later when Caolan Lavery had a free header from less than five yards after meeting a Nolan corner. His effort smashed the crossbar when the striker should have hit the target and put Walsall in front.
From that missed opportunity, Oxford countered and Joel Cooper forced a save from Rose with an effort from long-range.
With half-time approaching it was Oxford’s turn to threaten a goal, when Winnall slid in to meet Sam Long’s cross at the near post. From close-range it looked like a certain goal but Rose stood strong to palm his effort away.
After a relatively even first half, where both sides had chances to score late on, they entered the break drawing 0-0.
At the start of the second half, former Saddlers loanee Daniel Agyei was introduced for Obita. Walsall also moved to a 4-2-3-1 formation with Jake Scrimshaw out on the left and Emmanuel Osadebe behind Lavery.
The game continued much in the same vein as the first half, with the hosts seeing plenty of the ball but failing to break down a United defence determined to sit in.
Callum Cockerill-Mollett, who was making his first start since returning from injury, came close when he met a free-kick at the back post but his shot deflected just wide. Rob Hall also had a couple shots flash wide.
Holden and Danny Guthrie were both introduced after 69 minutes - the latter making his return from injury - as Walsall attempted to take control of the game and make a breakthrough.
McDonald was then brought on after 80 minutes as Walsall’s last throw of the dice, knowing only a win would guarantee their progression from the group.
In the 87th minute the breakthrough finally came, but for the visitors. Osei picked up the ball on the edge of the box, turned, and curled home a lovely effort into the top corner.
Walsall fought back but failed to score and with time against them they were knocked out of the EFL Trophy knowing that either Bristol Rovers or Chelsea Under-21’s, who play next week, will progress from the group with Oxford.
Walsall: Rose, White, Scarr, Sadler, Cockerill-Mollett, Nolan (Holden, 69), Sinclair (Guthrie, 69), Bates, Osadebe (McDonald, 81), Lavery, Scrimshaw.
Subs not used: Jules, Leak, Perry, George.
Oxford United: Stevens, Long, Mousinho, Jones, Elechi, Kelly, Henry, Cooper (Chambers-Parillon, 81), Hall, Obita (Agyei, 45), Winnall (Osei, 69)
Subs not used: Brearey, Asonganyi, Anifowose