Cities Service Co. yesterday announced it has broken off merger negotiations with Conoco Inc. as a result of the bid by the giant Canadian distiller Seagram Ltd. to buy controlling interest in Conoco. The announcement came as Seagram increased its offer for the Conoco shares.

Cities Service President Charles J. Waidelich, in announcing the breakoff of talks with Conoco, said, "I regret that Seagram's has seen fit to interfere with the proposed consolidation." In a separate statement, Conoco said the merger talks with Cities Service "have been terminated because of an unsolicited tender offer for Conoco common stock by the Seagram Co."

Seagram's $2.555 billion bid -- for as much as 41 percent of the nation's ninth-largest oil company -- replaces an offer Tuesday to buy 25 percent of Conoco for $2 billion. Under the new offer, as many as 35 million of Conoco's shares could be bought at $73 each, versus Tuesday's offer of $70 a share for 28.6 million shares. The offer -- being made through Seagram subsidiary JES Holdings Inc. -- is contingent on the acquisition of at least 28 million shares of Conoco stock, or 32 percent of the total outstanding.

Seagram Ltd., the world's largest producer and marketer of distilled spirits, had 1980 sales of $2.5 billion compared with Conoco's $18.3 billion. It has been flush with cash since last year when it sold its U.S. oil and gas holdings to Sun Oil Co. for $2.3 billion.

Conoco and Cities Service both halted trading in their stocks Wednesday morning with similarly worded announcements, but until late yesterday afternoon they refused to confirm or deny talks of a merger.

Discussing the new offer, Seagram spokesman Jonathan Reinhardt said, "This represents a major decision by the company to get back into the energy field," which it left with last year's sale to Sun Oil. He said Conoco's coal holdings -- the company owns Consolidation Coal Co., the nation's second-largest coal producer -- were a "major attraction." Seagram was rebuffed last April when it tried to take over St. Joe Minerals Corp., another major force in the coal market, for $2.1 billion.

Seagram's offer expires at midnight July 24 unless extended. Withdrawal rights will expire July 17 unless the required 28 million shares are not tendered, in which case they will recommence Aug. 24.

"This is a very attractive price," said Robert Morris, an oil specialist with New York securities firm Drexel Burnham Lambert. Conoco closed on the New York Stock Exchange Tuesday at $62 a share. Tuesday's closing was $7.50 higher than the price last Thursday before Conoco disclosed that an unidentified foreign company had offered to purchase 25.5 million shares at $70 a share.

Seagram said it would take legal action in delaware and Louisiana to challenge takeover laws that might affect its offer. In Delaware, Seagram said a federal court issued a temporary restraining order agains use of Delaware's law to delay the Seagram offer, with a hearing scheduled for July 1. Seagram also said it would challenge the legality of a Conoco corporate bylaw restricting foreign investors to no more than 20 percent of its stock. A hearing was set for July 13.

Talk of a Conoco-Cities merger set off a flurry of market speculation Wednesday and yesterday. The combination would have been the seventh-largest U.S. oil company, based on 1980 sales, and the 10th-largest industrial corporation in the nation. Conoco is the 14th-largest U.S. corporation with 1980 sales of $18.3 billion. Cities Service stands at 44th with sales last year of $7.8 billion.

Seagram's new offer came on the same day that two U.S. congressmen introduced a measure to restrict Canadian companies' investments in the United States. The bill would prevent any Canadian company or individual from holding more than 5 percent of the stock of a U.S. firm located in Canada as well as requiring that Canadian firms comply with the tighter U.S. securities margin requirements.

Canadian Prime Minister Pierre Elliot Trudeau has put forward a program that would restrict U.S. companies' Canadian investments, especially in oil and gas.

Conoco was the target of another Canadian takeover attempt last spring. Dome Petroleum Ltd. of Calgary bought 22 million Conoco shares in an unfriendly tender offer, then gave the shares back to Conoco in return for Conoco's Canadian oil and gas interests and $245 million cash.

Conoco's embarrassment over the Dome episode has caused some analysts to speculate that Conoco management would oppose a new Canadian attack.