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Yes, you suspect correctly - this is because you've got a 32bit OS, and qemu thus won't go about 2GB. Switching to KVM is the solution as you note - I'm not sure why qemu's starting based on the output you've provided, but the sole change is in the nova-compute.conf file:

virt_type = kvm

The only other things you need to do after making that change are toenable the kvm_intel kernel module (which it seems like you've done) and - finally - restart the nova compute service. Nova's full logs should then at least tell you why kvm isn't being used!