Westwood needed a victory at Valderrama to have any chance of claiming his second European money title, but shot a 1-over 72 to finish four shots behind winner Kjeldsen.
Karlsson lifted the Harry Vardon trophy despite finishing 32nd at Valderrama ' 17 strokes behind Kjeldsen ' after shooting a 75.
Kjeldsen became the third wire-to-wire champion at the Volvo Masters after a 71 gave him an 8-under 276 total for a two-shot victory over Englands Anthony Wall (69) and Martin Kaymer (68) of Germany. Westwood finished tied for third with Spains Sergio Garcia (72).
It was the fifth straight year a different player had claimed the Order of Merit, with Karlssons consistent season providing the difference.
The Ryder Cup player said it was the most difficult weekend of his 17-year career as he spent most of the weekend watching a scoreboard missing his own name.
It was definitely affecting me. (But) Im not going to feel ashamed by finishing where I did, definitely not. The Order of Merit is played during the entire season, not one tournament, said Karlsson, who put his improved play in 2008 down to patience.
But he said that peaking for the majors was his next priority.
Im not going to start focusing on the results when I got to where I am by focusing on what I can do, and I will keep doing that, said Karlsson, who finished outside of the top-20 in only six of 23 events he competed in while winning twice.
A poor start by both Padraig Harrington and Miguel Angel Jimenez left Westwood as the only serious threat coming into the final round.
But the Englishmans charge fell flat at the seventh after he sprayed his shot from beneath one of the twisting cork trees into a side bunker and missed a 3 1/2-footer to save par.
Sand came into play again at the short par-4 eighth when the 2000 Order of Merit winner sent a pitch into the front bunker and came out short. Westwood missed right from 15 feet for a second straight bogey to fall four back of Kjeldsen, who was even at the turn.
Kaymer made a charge from No. 9 as he ran off three birdies over the next four holes to get to within one of the Dane thanks to some deft chipping at No. 11 and a 15 foot birdie putt at the par-3 12th.
It was very nice to see Kaymer doing very well, Karlsson said. Its much better to see a few guys up their challenging than just one.
But Kjeldsen, who lost to Justin Rose in a playoff last year, pitched to within 6 feet at No. 11 for a birdie and to within 10 feet at the next hole for another birdie.
Kaymer saw a 10-foot birdie chance at No. 14 lip out and then missed a par putt to drop three back with three holes to play. Although Wall made a late charge, there was never really any doubt as to the winner and Kjeldsen kept his nerve for a second career victory and first for five years.
Harrington, winner of both the British Open and PGA Championship this year, needed a top-two finish to claim his second Order of Merit title in three years but never really got going.
I left myself with all of the shots out there, all the way through today, especially the last three rounds. I probably wasnt quite prepared coming into it and thats it. The game was not quite there this week, said the Irishman, who bowed out with a best round of 68 to finish at 2 over for the week ' 10 behind Kjeldsen.