A former director of the Central Intelligence Agency has said that the

Option (B) is incorrect.
"that graze ..." indicates a defining relative clause.
It means that surveillance would enable one to distinguish Guernsey cows from those Hereford cows which graze in a meadow - this is illogical.

Actually, as per (A), one would be able to distinguish between Guernsey and Hereford cows grazing in a meadow - which means distinguish between the two kinds of cows while they will be grazing in a meadow.

And yes, distinguish X from Y is fine. (E) is incorrect because it compares Guernsey cows (notice the use of Guernseys) with Hereford cows which would be grazing in a meadow. The word "cows" has to be coming to both so we need to use "Guernsey" and "Hereford".