En is a pronoun in this case. It replaces nouns used with the preposition de, often a partitive (le partitif) pronoun. That can be a noun that takes the indefinite article de, du, de la, de l’, and des. In general, when you see a form of de, it gets replaced with the pronoun en.

Here, the pronoun en goes with the verb frotter + de to replace de la serviette because you can use frotter quelque chose de, to cover something by rubbing it with something.

Le Robert gives the definition:

Frotter qqch. de, avec…, enduire par frottement.

From this definition, we see that the pronoun en is used with frotter de when the direct object means a person or part of a person:

[Le compl. d’obj. dir. désigne une pers. ou une partie d’une pers.] Le divin vieillard trempe un peu de coton dans une huile consacrée; il en frotte les tempes d’Atala (CHATEAUBR., Génie, t. 2, 1803, p. 256) TLFi

So it applies (literally) to L’s hair being toweled off.

Effectively your translation of "with it" works. I might say "Z took the towel and used it to rub L’s hair before wrapping it in a turban around her head."

More information on the pronoun en here.

The second en is a preposition, which like you said can be translated as in, into, or as or like (sorry I didn’t see it in the question at first, thank you user LPH). It is not related to the pronoun.

To keep it simple, the pronoun en replaces a groupe nominal preceded by de unless it is a person, e.g Il parle souvent de ses aventures becomes Il en parle souvent, that’s the first en. The second en is a préposition, it can usually be substituted by comme or like in English: "…. avant de la nouer en turban" which is equivalent to "…. avant de la nouer comme un turban".