The Yamaha rider clocked a fastest lap of 1min 29.401sec to put himself on track for the 65th pole of his career ahead of Spaniard Marc Marquez of Honda and Italian teammate Valentino Rossi.
"This was my final gift to Yamaha", Lorenzo said.
Iannone, in his final race for Ducati before heading to Suzuki Ecstar, passed Marquez at the start and was involved in a thrilling battle for second with Rossi, but the Spaniard regained the position with 11 laps to go.
Three-time world champion Jorge Lorenzo posted the fastest lap during Friday's opening two practice sessions ahead of Sunday's season-ending Grand Prix of Valencia.
Lorenzo who won at Valencia previous year en route to his third MotoGP world title will be joined at the front of the grid by new world champion Marc Marquez.
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Eventually, with ten laps remaining, Marquez would get past Rossi to begin his chase of Lorenzo at roughly half a second a lap - helped by his hard front-tyre which provided the extra grip he needed in the closing stages, as Lorenzo struggled with a graining medium.
Maverick Viñales (Team Suzuki Ecstar) heads the second row in his final appearance for the Hamamatsu factory, ahead of Sepang victor Andrea Dovizioso (Ducati Team) and Monster Yamaha Tech 3's Pol Espargaro in his final appearance for the Tech 3 squad.
Both Honda riders Dani Pedrosa and Cal Crutchlow crashed out. Aleix Espargaro took the second of the Suzukis to ninth on the grid. "I suffered in the last 10 laps because he was pushing and attacking".
Yonny Hernandez (Aspar Ducati) also ended his premier class career with a crash-induced DNF.