If you plan to buy a 256GB USB, it's ok for the PKG, but the problem here is that the ISO format is a format that emulates a disc, hence you should have it present + the installation.
Think it like this: using ISO you need 2 times the space of the game (more or less), using PKG you only need the space of the game.
And yeah, PS2 classics can be used to play PS2 games, but not PS2 discs. Converting a PS2 game to a PKG means you're adding the emulation layer to the game. On the other hand, you can insert PS1 discs directly and they will work. For more info, you have a compatibility list of the PS3 emulator for PS2 classics:
Playstation Development Wiki - PS5, PS4, PS3, PS2, PS1, PSP, Vita Information
www.psdevwiki.com
Retroarch will give you some fun, but PS3 is a limited hardware and probably a low budget mini PC or second hand SSF cheap computer would give you much more power to do the task.