In ensemble Kalman filter, space localization is used to reduce the impact of long-distance sampling errors in the ensemble estimation of the forecast error covariance. When two variables are not physically correlated, their error covariance is still estimated by the ensemble and, therefore, it is dominated by sampling errors. We introduce a "variable localization" method, zeroing out such covariances between unrelated variables to the problem of assimilating carbon dioxide concentrations into a dynamical model using the local ensemble transform Kalman filter (LETKF) in an observing system simulation experiments (OSSE) framework. A system where meteorological and carbon variables are simultaneously assimilated is used to estimate surface carbon fluxes that are not directly observed. A range of covariance structures are explored for the LETKF, with emphasis on configurations allowing nonzero error covariance between carbon variables and the wind field, which affects transport of atmospheric CO2, but not between CO2 and the other meteorological variables. Such variable localization scheme zeroes out the background error covariance among prognostic variables that are not physically related, thus reducing sampling errors. Results from the identical twin experiments show that the performance in the estimation of surface carbon fluxes obtained using variable localization is much better than that using a standard full covariance approach. The relative improvement increases when the surface fluxes change with time and model error becomes significant.