Here's something that I came up with. The proposition below is what you're asking for but I've also encapsulated the main idea behind these results in the following lemma in case that's more helpful.
Lemma: Let $S \subseteq X$ be path-connected and $x^1 \in \overline{S}$. Suppose there exists a countable decreasing (i.e. $U_{i+1} \subseteq U_i$) neighborhood basis $\left( U_i \right)_{i=1}^{\infty}$ in $X$ at $x^1$ such that for each $i$, whenever $s^i \in S \cap U_i$ then there exists a path in $S \cap U_i$ from $s^i$ to some element of $S \cap U_{i+1}$. Then $S \cup \left\lbrace x^1 \right\rbrace$ is path-connected.
Remark: Note that we are not assuming that for all $i$, there exists a path between any two point of $S \cap U_i$. The sets $S \cap U_i$ need not even be connected so this is weaker than requiring local connectivity of $\overline{S}$ at $x^1$.
Corollary: Let $S \subseteq X$ be path-connected. If the condition of the above lemma is satisfied at each $x^1 \in \overline{S}$ (or slightly more generally, if each path-component of the boundary of $S$ contains some point satisfying this condition) then $\overline{S}$ is path-connected.
Prop: Let $S \subseteq X$ be path-connected. Suppose that each path component of $\overline{S} \setminus S$ contains some $x^1$ for which there exists a countable decreasing neighborhood basis $\left( U_i \right)_{i=1}^{\infty}$ in $X$ at $x^1$ s.t. for each $i$ and each path-component $P_i$ of $S \cap U_i$, there exists a path in $\overline{S} \cap U_i$ whose image intersects both $P_i$ and $S \cap U_{i+1}$. Then $\overline{S}$ is path-connected.
Remark: In this proposition, you can replace "of $\overline{S} \setminus S$" with "of the boundary of $S$ in $\overline{S}$". Also, to prove that $\overline{S}$ is path-connected, it may be easier to find some other path-connected $R \subseteq X$ such that $\overline{R} = \overline{S}$ and then apply these results to $R$ in place of $S$.
Proof of lemma: Pick any $s^1 \in S \cap U_1$ and any $0 = t_0 < t_1 < \cdots < 1$ s.t. $t_i \to 1$ and let $\gamma_0 : [t_0, t_1] \to S$ be the constant path at $s^0 := s^1$. Suppose for all $0 \leq l \leq i + 1$ we've picked $s^l \in S \cap U_l$ and for every $0 \leq l \leq i$ we have a path $\gamma_l : [t_l, t_{l+1}] \to S \cap U_l$ from $s^l$ to $s^{l+1}$ (where observe that this holds for $i = 0$). By assumption, we can pick $s^{i+2} \in S \cap U_{i+2}$ and a path $\gamma_{i+1} : [t_{i+1}, t_{i+2}] \to S \cap U_{i+1}$ from $s^{i+1}$ to $s^{i+2}$.
After starting this inductive construction at $i = 0$ we can use $\gamma_0, \gamma_1, \ldots$ to define $\gamma : [0, 1] \to S \cup \left\lbrace x^1 \right\rbrace$ on $[0, 1)$ in the obvious way and then declare that $\gamma(1) := x^1$. For any integer $N$, $l \geq N$ implies $\operatorname{Im} \gamma_l \subseteq U_l \subseteq U_N$ so that $\gamma([t_N, 1]) \subseteq U_N$. Thus $\gamma$ is continuous at $1$ so that $S \cup \left\lbrace x^1 \right\rbrace$ is path-connected. Q.E.D.
It should now be clear how the idea behind this lemma's proof led to the above proposition's statement.
Proof of prop: Let $x^1$ and $\left( U_i \right)_{i=1}^{\infty}$ have the properties described in the proposition's statement, let $0 = t_0 < t_1 < \cdots < 1$ be s.t. $t_i \to 1$, and let $\gamma_0 : [t_0, t_1] \to S \cap U_1$ be any constant path. Suppose $i \geq 0$ is such that for all $1 \leq l \leq i$, we have constructed a path $\gamma_l : \left[ t_l, t_{l+1} \right] \to \overline{S} \cap U_l$ such that $\gamma_l(t_l) = \gamma_{l-1}\left( t_{l} \right)$ and $\gamma_l\left( t_{l+1} \right) \in S \cap U_{l+1}$ (note that this is true for $i = 0$). Our assumption on $\left( U_i \right)_{i=1}^{\infty}$ allows us to construct a path $\gamma_{i+1} : \left[ t_{i+1}, t_{i+2} \right] \to \overline{S} \cap U_{i+1}$ starting that $\gamma_i\left( t_{i+1} \right)$ and ending at some point of $S \cap U_{i+2}$. Exactly as was done in the proof of the above lemma, we may now define a continuous map $\gamma : [0, 1] \to \overline{S}$ such that $\gamma(1) = x^1$. Q.E.D.
As to 2: $C$ contains a neighbourhood of $x$ means that there is an open subset $U$ containing $x$ (this is what neighbourhood of $x$ means in your text, I gather) such that $U \subseteq C$ ($C$ contains $U$).
If you allow for neighbourhoods to be non-open you could more succinctly say that "$C$ is a compact neighbourhood of $x$".
And yes there is a subtle distinction in the "local" versions of connectedness and compactness. In practice, spaces are often Hausdorff ($T_2$) and then a locally compact (in your definition) Hausdorff space indeed obeys the stronger
for every open neighbourhood $U$ of $x$ there is a compact neighbourhood $C$ of $x$ inside it, or equivalently some open $V$ with $x \in V \subseteq \overline{V} \subseteq U$ with $\overline{V}$ compact.
And the latter property is what's most often used in proofs.
The simple definition of having a compact neighbourhood (or compact set containing an open neighbourhood) has the advantage that it's immediately clear that compact spaces are also locally compact (just take $C=X$ everywhere), and locally compact is meant as generalisation/loosening of compactness, whereas for connectedness it's meant as an extra refinement (a space can be connected and not locally connected, e.g.), so the requirements are stricter. The local compactness in your variant is easier to check and Hausdorffness will make it strong and more useful (in analysis e..g.) as in the highlighted version.
Best Answer
The question was answered in the negative by user "Taras Banakh" at Mathoverflow:
https://mathoverflow.net/questions/416561/is-projection-of-locally-connected-compact-subset-locally-connected
Here are some of my own observations.
As mentioned in the question, the result holds when
In both of these cases the result follows because the restriction is then a quotient map, as shown in the linked question.
Projection of intersection of compact, closed, locally connected subset and an open subset may not be locally connected
One may wonder whether the result holds when $C$ is the intersection of a compact, closed, locally connected subset $A \subset Z$ and an open subset $U \subset Z$. In this case the projection restriction may not be a quotient map. However, that still leaves open whether the projection is locally connected or not.
The following counterexample shows that the projection of such $C$ may not be locally connected:
Let
Then $A \subset Z$ is compact, closed, and locally connected, and $U \subset Z$ is open. Let $C = A \cap U$. Then $f[C]$ is not locally connected; it consists of a union of disjoint open intervals which converge to $0$, together with $0$.