* Peugeot pledges to avoid plant closures in 2014-16
* CEO Varin says capacity cuts likely at some sites -unions
* Workers being prepared for cuts to small car production (Adds progressive end to domestic small car production, union comment)
By Gilles Guillaume and Laurence Frost
PARIS, Sept 25 (Reuters) - PSA Peugeot Citroen pledged to avoid further factory closures in talks with French unions on Wednesday but suggested it may halt production lines at sites including Mulhouse.
The carmaker, which has already closed one assembly plant as it struggles with excess capacity left by Europe's crippling auto sales slump, is preparing the ground for further politically sensitive cutbacks.
In the latest round of talks on a new labour deal, CEO Philippe Varin said the shrinking of factories to one production line from two "can be envisaged at plants below 250,000 vehicles (annual output)", two of the people present told Reuters.
The company forecast production of 190,000-230,000 vehicles in Mulhouse, eastern France - effectively earmarking the site for cuts - and 240,000-270,000 at Poissy, said CFTC union official Franck Don and Jean-Allart Gillet of the CFDT.
A Peugeot spokesman declined to comment on the remarks or on an upcoming round of talks on possible restructuring.
The Paris-based company lost 5 billion euros ($6.6 billion)last year but said on July 31 it expected to beat its 2013 goal of halving industrial cash burn to 1.5 billion euros.
Varin told analysts the same day that further cutbacks were on the way as the company targets a 100 percent plant utilisation rate across Europe by 2016.
Peugeot is seeking union concessions including wage restraint, working time flexibility and increased used of internal transfers between sites. The company opened the talks in May and hopes to reach a deal next month.
In return, Peugeot on Wednesday offered workers guarantees that every French production site will remain open for at least three more years and get work on new vehicle models.
Overall French production investment will rise to 1.5 billion euros from 1.1 billion in the preceding three-year period, it said.
But according to the same union officials, the carmaker also suggested it would progressively end domestic production of all but the priciest versions of small cars such as the Peugeot 208 and Citroen C3 - assembled in Mulhouse and Poissy, near Paris.
"We are being prepared for the idea that the future of subcompact car manufacturing lies outside France," Don said.
Peugeot also announced a pledge to assemble 1 million vehicles in France annually in 2014-16, a 7.5 percent increase on its forecast for this year.
That still amounts to just 54 percent of the company's domestic production capacity of 1.85 million vehicles, based on 2012 data excluding the idled Aulnay plant north of Paris.
"The commitment to maintaining and increasing production output in France goes hand in hand with a critical need for flexibility in our plants and (the) target for capacity utilisation," Peugeot said. (Editing by James Regan, Greg Mahlich and David Evans)