I had this problem and solved it
if you run out of time to update everything before it starts the kernal panic error this will help:
two options 1- doing a little soldering 2 - waiting a few hours
My situation was that I had a dead (1.1) xbox with an locked retail HDD and no easy means of getting the TSOP bios without physically removing it and putting into a good motherboard with the help of mod chip.
I had a replacement (1.0) motherboard with 128mb ram upgrade and a new 200gb unlocked HDD plus a Xenium ICE mod kit.
The problem was that after a few minutes of use the Xenium ICE bios kept producing the Kernal Panic error whenever I tried selected options to flash the bios or format, etc the HDD. These options did work for a few minutes and I managed to getr a TSOP backup onto the Xenium before all access stopped due to this error - basically I could do nothing after a few (literrally 3-5) minutes. The only option seemed to be getting my modchip flashed with a bios from a friends modded xbox and duplicating their HDD. However, I did find a solution to my problem and one that might help those of you experiencing the Kernal Panic error. Hereís what I did:
Having searched all over on the Kernal Panic error it seems that this is generally caused due to the system clock being incorrect after a period of no power (i.e. no mains). Iíve no idea why this should happen.
From my Xenium experience I guessed that initially the clock issue canít be affecting the xbox so access would be available if I could reset the system clock. I discovered from searches that the clock doesnít use a battery but a capacitor which takes about 3 hours to drain when mains is disconnected (it never drains if you leave the mains connected). I left the box overnight unplugged and voila, I had access the next day for a few minutes. It wasnít enough time to sort out my issues and I lost access again.
Frustrated by waiting 3 hours each time I searched on anything about where this capacitor is located (there are hundreds on the board). Fortunately a very clever person (Bunnie) had a site describing his amazing work on understanding the xbox internals check this link http://www.xenatera.com/bunnie/proj/anatak/xboxmod.html
. I saw him describe the capacitor in question (a 1 Farad 2.5V Aerogel capacitor at location C7G10).
The usual Disclaimer
The method described here involves opening up your xbox and modifying it which will void your warranty I will not hold responsibility for anything that might happen as a result of reading this. All actions you take as a result of reading this are done so at your own risk.
Once I found the capacitor and its solder points on the rear of the board I connected up a switch on two wires to the two solder points to short the capacitor (with the mains unplugged to avoid it getting current of course) and hence reset the system clock. I found this took a few minutes whilst monitoring with a meter but sure enough a few minutes later the xbox allowed me to flash the bios and access the HDD to lock it, format it etc etc.
Once I got a bios in place (X2 4981 for instance) and put a slayers CD in the drive I was then able to rebuild the new HDD with all the usual apps.
Iíll be submitting this as a guide to xbox-scene with detailed pics if anyoneís interested. Itís probably not a very useful mod to do but it saved my bacon.