Factory Mercedes driver Engel had already topped the 40-minute qualifying session to snare provisional pole with a 2m01.053s lap, which eclipsed the 2m01.286s time set by Shane van Gisbergen in 2016.
Engel, the 2014 Bathurst poleman, then staged a thrilling battle in the second part of the Shootout with fellow Mercedes driver Broc Feeney and the pair traded fastest times as they flirted with the 2m00s mark.
It was Triple Eight driver Feeney that set the first representative time with a 2m01.671s, Engel then responding with a 2m01.253s before Feeney reclaimed top spot with a 2m01.194s on his next lap.
The battle continued on their next laps, Engel moving back ahead with a 2m01.089s despite dropping a wheel on the exit of the final corner. Feeney also improved on his next lap, but fell a hundredth of a second short of Engel's time.
While Feeney decided to call off his charge, Engel stayed out for a final run, which yielded an incredible 2m00.881s in the fastest ever official GT3 lap around Mount Panorama.
"It's amazing. I'm a bit lost for words," said the German, who was presented with the Allan Simonsen Trophy.
"The grip level this weekend has been amazing. It's partly due to the new tyres but also just he grip around this place. It's mega."
However, following the session it was decreed that Mercedes will be hit with a Balance of Performance penalty that will require it to carry an additional 10 kilos.
Matt Campbell ended up third fastest in the #912 Manthey EMA Porsche, the 2019 race winner making big gains late in the session as he closed to within a tenth of Feeney.
That car will be joined on the second row by the #75 SunEnergy1 Racing Mercedes thanks to defending event winner Jules Gounon's Shootout effort while 2018 winner Dries Vanthoor qualified the #32 WRT BMW fifth.
Those top five spots were occupied by the five cars that ran in the second part of the Shootout, with Chaz Mostert leading the way in the first of the 15-minute hit-outs.
The two-time Bathurst 1000 winner's 2m01.869s effort means his #65 Melbourne Performance Centre Audi will start sixth, best of the Pro-Am entries.
Mattia Drudi qualified the #74 MPC Audi seventh, Maxime Martin was eighth in the #46 WRT BMW, Aaron Cameron ninth in the #44 Valmont Racing Mercedes and Daniel Juncadella 10th in the #77 Craft-Bamboo Mercedes.
The 2023 Bathurst 12 Hour starts at 5:45am local time tomorrow.