Keothavong edged out in three hour epic
The British player, who had to win three matches just to qualify for the event, lost 7-5 4-6 6-3 in a match that last over three hours.
In a high quality contest, both players had first serve percentages of over 70 per cent but there were still 13 breaks in the match.
"Gutted about the result but I was up against a brick wall. Fought my heart out, it just wasn't to be," Keothavong tweeted afterwards.
It is the second year running that Keothavong has been beaten in the semi-finals in Luxembourg.
Meanwhile, it will be a first career final for 24-year-old Romanian Niculescu.
In the decider she will meet top seed Victoria Azarenka who defeated sixth-seed Julia Goerges 6-3 6-3.