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UPDATE 3-Panama Canal expansion work to resume after deal with consortium

* Consortium starts work while talks continue

* Talks focused on how to finance rest of project

* Spain likely to help Sacyr get backing for loans

PANAMA CITY/MADRID, Feb 20 (Reuters) - Work on the multibillion dollar Panama Canal expansion was restarting on Thursday after a partial agreement between the Canal authorities and a Spanish-led consortium, raising hopes for the programme after a two-week hiatus due to a cost row.

An agreement announced late on Wednesday allows work to restart while the two sides continue talks on how the project is financed through to completion, a process which they have given themselves 72 hours to complete.

The dispute between the GUPC consortium led by Spanish builder Sacyr and the Panama Canal Authority had threatened delays that could cost Panama millions of dollars in lost shipping tolls, as well as being a setback for companies worldwide that want to move larger ships through the waterway that links the U.S. Gulf Coast to Asian markets.

"The parties are engaged in intense discussions and made progress Wednesday on key issues that would allow funding, resumption of works and payments of subcontractors and workers," the consortium, which includes Italy's Salini Impregilo , said in a statement on Thursday.

A key part of negotiations is the role that insurer Zurich plays and whether it will convert a $400 million surety bond, taken out by the consortium in case the project wasn't completed, into backing for a loan to help raise the $1.6 billion funding needed to finish the project, sources with knowledge of the matter said.

The dispute between the two parties over $1.6 billion in cost overruns and how to continue financing the ambitious and expensive project halted work for two weeks, delaying expected completion until at least December 2015.

Zurich does not want to put money into the project but has asked banks to do so, another source familiar with the matter said. The banks are asking for counter-guarantees, the source said. The parties of the consortium are each liable for their own obligations, not jointly, the source said.

Sacyr and Salini Impregilo declined to comment beyond the consortium's statement. Shares in Sacyr were 3 percent higher after news of the agreement to restart work. The project represents a quarter of the company's international revenue.

Salini Impregilo shares were up 1.9 percent.

Zurich said it was in talks with both parties and was comfortable with its level of exposure to the project, which it said was limited due to reinsurance mechanisms and was well within its risk tolerance.

"As the discussions are still ongoing we are not in the position to provide any further details," it said in a statement.

SPAIN STEPS IN

The Spanish government is likely to agree to change the status of a $200 million state-backed guarantee it gave heavily-indebted Sacyr in 2009 when Panama awarded it the contract, turning it into backing for finance to finish the project, sources told Reuters late Wednesday.

The guarantee was originally drawn up by Spanish state-backed insurer Cesce as a counter-guarantee to the Zurich bond. The government insurance bonds must be changed if Zurich changes its insurance into backing for a loan.

Cesce and Spain's Economy Minstry declined to comment. Italian state-backed export credit agency Sace, also a part of the guarantee scheme with Zurich, was not immediately reachable for comment.

There has been disagreement within the Spanish government over whether to interfere with the private project, one source with knowledge of the matter said, but it is likely to tweak the conditions of the guarantee because the Sacyr-led contract is such a high-profile one for Spanish business.

Spanish builders are working on big engineering projects around the world, from a train linking the Islamic holy cities of Mecca and Medina, to a metro in Riyadh, Saudi Arabia. Overseas construction has been one of the few bright spots for companies as the domestic economy splutters.

Wednesday's agreement was reached in phone calls between top executives from the companies and Panama Canal Authority officials, the Canal's statement said.

When work restarts, the Canal will pay the consortium $36.8 million to cover work done in December, it said.

The project to expand the near 50 mile (80 km) transoceanic cargo route was originally expected to cost about $5.25 billion, but that could increase to near $7 billion.

Officials and diplomats expressed concern in 2009 when the contract was awarded to the consortium over its ability to complete the work, since its winning bid for the work was $1 billion lower than that of the nearest competitor.