(Reuters) - Iranian state firms have started preparations to revamp Venezuela's largest oil refinery, the 955,000-bpd Paraguana Refining Center, four people close to the talks said, following a contract to repair its smallest facility.

A deal would deepen an energy relationship that has become a lifeline for Venezuela's dilapidated oil industry amid a crisis caused by decades of mismanagement and underinvestment, and aggravated by U.S. sanctions on the South American country.

The Middle Eastern nation, also sanctioned by the United States, has supplied President Nicolas Maduro's government with fuel and diluents for making exportable crude grades, and since 2020 has provided parts to repair and update Venezuela's 1.3 MMbpd refining network.

A unit of state-run National Iranian Oil Refining and Distribution Company (NIORDC) this month signed a 110 MM-euro ($116 MM) contract with Venezuelan state oil firm PDVSA to repair and expand the 146,000 bpd El Palito refinery, in the country's central region.

Its next project is Paraguana, a two-refinery complex that is among the world's largest, through a contract now being negotiated, the people said. The center, known as CRP, operated at just 17% of capacity in April, according to independent estimates.

"In about a year, Iran should be able to bring its people to Paraguana," one of the people said. "They have been very focused on preparations, including housing for the workers."

Earlier this year, Iranian state firms supplied Paraguana with parts for restarting a gasoline-making unit. The equipment, manufactured in North America, arrived in Venezuela from China after the Iranians handled procurement and transport, a person with knowledge of the purchase said.

Many Chinese firms avoid direct business with Venezuela to reduce sanction-related risk or unpaid bills, only agreeing to deals if a third-party handles orders and payments, that person added.

PDVSA, which has not publicly disclosed details of recent pacts with Iran, did not reply to a request for comment. NIORDC did not immediately reply to a request for comment.

PDVSA has in recent years tried and failed to attract foreign investment for its refineries, including a scrapped deal with Chinese firms. It has been more successful with oilfield services and maintenance firms willing to accept payment in crude and fuel to avoid Venezuela's notorious unpaid invoices.

But million-dollar capital injections increasingly are needed to secure an adequate fuel supply for the country, whose demand is slowly recovering to pre-pandemic levels.

As Iran Oil Minister Javad Owji was visiting Caracas in early May, two supertankers carrying Iranian oil were discharging in Venezuelan waters as part of a swap arrangement the state companies kicked off last year.

At El Palito, a crude distillation unit restarted in May after months of shutdown. The refinery is operating at about half capacity mostly due to equipment supplied by Iran, but more work is required.

Iran delivered the new parts under a services contract to provide major maintenance and expand the facility, reimbursable through fuel from the same refinery, two of the people said.

Before it can expand El Palito's core deep conversion units, workers must modify and increase its water and gas supply, and upgrade the electrical system, one worker said. Only then, could it reach its 175,000 bpd target.

"The major projects PDVSA was supposed to do and couldn't, will be done by Iran," another worker said.

(Reporting by Mircely Guanipa in Caracas, Marianna Parraga in Houston and Tibisay Romero in Valencia. Additional reporting by Deisy Buitrago and Bozorgmehr Sharafedin. Editing by Marguerita Choy)