It seems that PS3 Linux's gelic wireless driver is not designed to work with wpa_supplicant, instead it provides services (through hypervisor) to enable WPA & WPA2 security. I got nice tip from author of the original driver on how to setup it. Only problem seems to be that from that last screenshot of iwconfig, I installed new firmware upgrade (1.82)... This does not seem to report WPA2+AES correctly anymore. During debugging it, I noticed that current driver does not seem to handle association reporting correctly to Linux wireless stack so I had to add some code to report associations correctly. When I figured this out, I tried WPA+TKIP and got connection up... Now lets see if we can get fix for this WPA2+AES issue in future firmware.
I would like to remind people wanting to get WPA or WPA2 working to wait a moment and lets fix problems before getting this on mainstream. (eg. do not ask patched driver from me ;))